In 1789, Benjamin Franklin penned a letter containing that most infamous phrase, “In this world, nothing can be said to be certain, except death and taxes.” Let’s face it—although we’ve pretty much given up on becoming immortal, our desire to avoid taxes has persevered and, in all reality, has intensified.
Within the P&G community, the desire to avoid taxes is predominantly manifested in a retirement plan distribution technique referred to as the Duke method. The interest in this method tends to hit a fevered pitch during company-sponsored separation programs or when Congress considers a tax increase.
The Duke method is touted for its supreme tax-savings abilities. Many people believe this method eliminates all income tax imposed on a portion of their P&G retirement accounts. With such expectation, it is no wonder this method garners so much attention.
But is this an accurate understanding of this method? Can you really eliminate all income tax? To be very clear, the answer is almost always “No!” We’ll explore the reasons why in a series of articles on the Duke method and whether it could be a good fit for you.
What the Heck Is the Duke Method?
Simply put, the “Frank Duke method,” named for the P&G alum who originally created it, advises employees to take a lump sum distribution from their P&G Profit Sharing Trust (PST) and Savings Plan (SP). Its intention is to move all assets out of your P&G retirement plans in a tax-efficient way. The big selling point: If you administer the Duke method correctly, you can avoid up-front ordinary income tax when you move P&G shares from your retirement account to an outside brokerage account.
Admittedly, this is an over-simplified explanation. Throughout our Duke method series, you’ll learn that this approach isn’t actually a singular method, but a strategy for approaching PG retirement assets that might benefit certain people in specific situations
Before jumping into the nitty-gritty, let’s walk through some background.
The Duke method is based on the IRS’s apparent approval of certain divestment strategies. However, it is critical to understand that this approval stems from what the IRS calls a “private letter ruling” (PLR)—a written statement from the IRS that is issued directly to a specific taxpayer. Strictly, a PLR relates only to that taxpayer and that particular set of facts. As odd as it may sound, a PLR may not be relied on as precedent for other taxpayers. Nevertheless, many practitioners often view a PLR as an indication of the IRS’s position on a certain issue. It is particularly important to remember the nature of a PLR when it comes to the Duke method because the method has never been addressed in case law or by another binding authority. The entire basis for the method stems from a PLR.
This means that the IRS could disallow the Duke method in an audit. If that happens, a person will likely face additional taxes, underpayment interest, and possible penalties. Although one can take steps to mitigate the risks of incurring certain penalties, there is no way to avoid the assessment of additional tax and underpayment penalties.
Where Do We Go from Here?
Don’t misunderstand: There is good reason for the interest in this method. Under the right circumstances and with a bit of good luck, the Duke method could lower the income tax burden on your PST assets. However, a current year tax consequence is a woefully inadequate basis for decision making.
Over the next several months, we’ll share additional articles (referenced below) that explore the Duke method in greater detail. To truly understand the Duke method, one must first understand the distribution framework. More specifically, you must understand qualified lump sum distribution rules. Sounds fun, right? That’s where we’ll turn our attention in the next installment.
Until then, if you’re considering the Duke method, you should think beyond the drive-by appeal of potential up-front tax savings. Instead, you should more thoroughly analyze your situation, including everything from your basic day-to-day cash flow to potential consequences for your heirs.
Coming up in our Duke method series:
- Part II: Distribution Framework
- Part III: Financial & Investment Management Factors
- Part IV: Income & Estate Tax Factors
- Part V: Conclusion