Posts Tagged ‘Estate Tax’

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Business appraisal protects your family from unnecessary taxation.

Saturday, March 28th, 2009

Do you know how to make a grown man cry? Tell him his business has been destroyed by fire, flood or an act of God.

Yes, a tragedy. Bad stuff. But, most likely, the loss was insured — a bit of help. It’s even more important if Joe Owner is there on the scene to assess the damage, make plans and start rebuilding. Chances are he will make the business bigger and better than before.

End of Scene 1.

Here is Scene 2. Even the most successful, egotistical and immortal business owner knows that some day he must go to the “big business in the sky.” That will not make Joe Owner cry. He is too realistic for that. But tell him that after he is gone, his present plans, or better yet — lack of a plan — mean the Internal Revenue Service will dismantle his business.

Imagine our departed Joe in heaven; sitting on a cloud; talking to a representative of the revenue service. Joe speaks first.

“Why?” he asks.

“To pay taxes,” answers the tax representative.

“How?” he asks.

“By selling off the assets necessary to pay the tax.”

“When?” he asks.

“Within two years.”

“Why?” Joe demands.

“To pay your federal estate tax liability.”

“How much?” he queries.

“That depends on the value of your business.”

“Good,” says Joe. “I can show you just how little the business is worth without me.”

“Sorry,” responds the IRS representative. “It’s too late for that now.”

The curtain goes down.

Welcome back to earth. Is the above scenario realistic? Yes.

Crazy as it sounds.

If you own a closely held business and don’t pin down its value for tax purposes while you are alive, you are setting yourself up to be mugged by the IRS.

Every business — like it or not — must some day be valued for tax purposes. It is best for it to be done voluntarily, by you (the owner) during life. If not, the valuation will be done in an involuntary situation, after death, by the revenue service.

The only “out” is to sell the business in a real transaction during your life. For most business owners, selling doesn’t make sense for many reasons.

The two most common reasons are: First, the typical business owner wants to transfer the business to his or her kids; or second, wants to keep on working until he or she goes to business heaven.

The message should be clear: Want to save your business and your family untold aggravation, not to mention savings of 55 percent, the highest estate tax bracket in 2011? Then do three things: Find out the value of your business for tax purposes by getting an appraisal. Put a transfer plan, usually to your kids, in place during your life.

And then dovetail the first two steps with your estate plan.

Done right, you can transfer your business to your kids tax-free during your life, beat the estate tax collector legally, and control your business for as long as you live.

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Posted in Corporate Tax, Estate Tax, General Tax Strategies, Insurance, Tax Strategies | No Comments »

Plan wisely to accomplish goals for your estate, before it’s too late!

Friday, March 27th, 2009

The facts, problems and solutions of this article are so typical of the readers of this column who call me for help, that I felt compelled to write about it.

Read slowly, chances are you will see some of yourself or someone you know.

Joe, 74, owns 52 percent of an S corporation (Success Co.), and each of his three children owns 16 percent of Success Co.

He has two boys, Tom, 47, and Dick, 43, who have been in business with Joe since they graduated from college. Joe’s daughter Harriet was not and never will be involved in the business. Joe lost his first and only wife last year.

Following is a list of Joe’s assets:

Various liquid investments — $190,000

52 percent of Success Co. — $1,630,000

Real estate leased to Success Co. — $600,000

Balance in Rollover IRA — $780,000

Residence and summer home — $435,000

TOTAL — $3,635,000

Joe’s lawyer (an estate planning expert with a fine reputation), who just completed Joe’s estate plan, correctly computed the estate tax (using 2011 rates) at $1,419,771. His only recommendation: Buy $1.5 million in insurance to pay the tax.

Joe called me for a second opinion. After a long telephone conference, Joe spelled out his goals:

• Control Success Co. (and the rest of his assets) for as long as he lives

• When he is gone, to have Success Co. owned 50 percent each by Tom and Dick

• Make sure he can maintain his lifestyle for as long as he lives

The dollar value that Harriet receives from Joe’s estate should be equal to the amount received by each of her brothers.

Find a way to have each of his kids receive one-third of what he is worth now, all taxes paid in full. (Joe laughed a bit at this goal; he didn’t think it was possible).

Stop for a moment. Substitute your own list of assets and goals (remember, if you are married, some day either you or your spouse will be the first to pass on). What follows is the plan we implemented for Joe and the strategies we selected to accomplish Joe’s five specific goals (in the same order as the goals).

We recapitalized Success Co. (a tax-free transaction) so Joe now owned 52 percent of the controlling voting stock (52 of 100 shares) and 52 percent of the nonvoting stock (5,200 of 10,000 shares).

We transferred the liquid investments and the real estate to a family limited partnership (FLIP). As the general partner (owned 1 percent of the FLIP), Joe kept control of these assets.

He will make annual gifts ($12,000 each) of limited partnership interests to the kids.

These limited interest (99 percent of the FLIP) have no voting rights and are entitled to significant discounts (about 35%) for tax purposes. As a result, Joe can give about $19,000 to each kid of limited FLIP interests every year, yet for tax purposes the interests are only worth $12,000.

Joe sold the 5,200 shares of nonvoting stock to a so-called defective trust (defective for income tax purposes) for $1.5 million plus interest. The trust paid for the stock with a note.

Success Co. will distribute S Corporation dividends each year to the trust, which will then pay off the note to Joe.

The beneficiaries of the trust are Tom and Dick who will each own half of the 5,200 shares when the note is fully paid and the trust terminates.

Joe’s 52 voting shares will go to Tom and Dick when Joe dies.

The shares owned by sister Harriet will be redeemed by Success Co., according to a new buy/sell agreement, when Joe passes on. Then Tom and Dick will each own 50 percent of Success Co.

Joe’s flow of cash to maintain his lifestyle would come from many sources. (a) a small salary from Success Co., plus all of his usual perks; (b) The note payments from the trust (the entire $1.5 million plus the interest is tax-free to Joe because of the defective trust); and (c) distributions from the rollover IRA. Actually during the years (about 8 to 10) while the note is being paid off, Joe will have more cash than he needs to live. This excess cash will be put into the FLIP (and, of course, will be available for distribution in future years). Actually, all the assets of the FLIP will be available to Joe if needed.

As a final back up, Joe will enter into a death benefit agreement with Success Co., that will pay Joe $75,000 per year starting when Joe retires (probably never) and continuing until the day he dies.

We created a Subtrust (using the Rollover IRA and Success Co.) to purchase a $1.5 million life insurance policy. The entire $62,187 annual premium will be paid out of plan funds (it won’t cost Joe a penny), and because of the subtrust none of the $1.5 million ultimate policy proceeds will be included in Joe’s estate.

Appropriate language in Joe’s death documents (will and revocable trust) makes sure Joe’s “goal” will be accomplished; the $1.5 million in tax-free insurance makes this goal easy.The residence (worth $355,000) was transferred to a qualified personal residence trust (QPRT).

The QPRT was set up in such a way that Joe could live in the residence for as long as he lived, yet it would be out of his estate.

If Joe gets hit by a bus the day after the plan described above is put in place, this “goal 5″ (the entire $3,635,000 to the kids) will be accomplished (along with the four other goals). The longer Joe lives, the less the IRS gets and the more the kids get (in excess of the $3,635,000).

One warning: The above story does not explain all the technical details of Joe’s plan.

Only work with a tax advisor that knows, understands and has worked with the strategies used for Joe. A will and trust alone (no matter how long or how fancy) will not get the job done. (All your wealth to future generations, while totally eliminating the impact of the estate tax.)

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Posted in Estate Tax, Planning, Tax Strategies | No Comments »

The tax knight and his merry men rescue a distressed taxpayer…

Friday, March 27th, 2009

OK, so it’s a corny title. Yet it sure describes the economic and tax pain of Joe, a 79-year-old widower. Don’t feel sorry for Joe, he’s generally a healthy and happy guy. He hits golf balls, spends lots of time with the grandkids and still goes to work every morning at the successful business he started, which he transferred to his two sons, who now own and run it.

But you should hear Joe howl about the cost of paying the annual insurance premiums on his irrevocable life insurance trust. Joe’s trust owns a $4 million insurance policy on his life with annual payments of $87,000. Yes, he needs the insurance to cover a portion of his potential estate-tax liability. No, he couldn’t buy second-to-die — normally at substantially less premium cost — because his wife was uninsurable when the irrevocable trust bought his policy.

It should be noted that an irrevocable trust protects the death benefits of a life insurance policy from the clutches of the estate tax.

Now, stop for a moment and look at your insurance cost situation. Chances are you’ll find you have one or more of the same complaints as Joe. He’s got three:

• Every year when Joe wrote his check to the trust for $87,000, he got four exclusions of $11,000 each, or $44,000 annually, one for each of his two sons and two grandkids. That left a taxable gift of $43,000 ($87,000 minus $44,000), which eats away at his $1 million lifetime unified credit. No cash gift-tax now. Simply put, the first $1 million of taxable gifts do not require cash to pay the gift tax, but are paid by using your lifetime unified credit. When Joe gets hit by the final bus, those annual taxable gifts will turn into an estate-tax liability (most likely 55 percent of the total of all those annual taxable gifts for Joe). Starting in 2006 the $11,000 is raised to $12,000.

Joe fumes!

• Interest rates are much lower now than when Joe bought the policy. Result, the premiums are much more than the projections made by his insurance agent.

Joe’s expletives are not fit to repeat here.

• Joe’s smart. He figured out that in his tax bracket — state and federal combined — he must earn $145,000 and pay $58,000 in income tax in order to have the $87,000 needed to pay his insurance premium which is actually a gift to the trust. Joe fervently argues that life insurance premiums should be deductible. Good idea. But we need an act of Congress to change the Internal Revenue Code.

Now you know why Joe is a distressed taxpayer.

Readers of this column know I have a network of professionals to help me work my tax magic. So I, the tax knight, and my network of merry men, went to work.

We had Joe’s irrevocable trust restructured with his insurance using a strategy called “premium financing.” Essentially, premium financing is an economic concept where policy premiums are paid by a lending bank. Like before, Joe’s premium financing policy is owned by the trust. When Joe dies the bank loans and accrued interest on the loans will be paid out of the policy proceeds.

Joe’s premium financing is set up for $5 million — net proceeds after paying off the bank — to the trust, and the beneficiaries are his kids and grandkids. Joe’s only potential out-of-pocket costs are $60,000 to initiate the bank loan the year the premium financing is set up. If Joe lives to be 100, the total additional cost will be about $352,000, with varying small amounts to be paid each year to maintain the loan. Of course, if Joe dies sooner, these costs stop.

Now, what are the final results for Joe by using premium financing?

• To start, no more $87,000 annual premium payments — actually, no more premium payments. All three of his complaints disappeared.

• No out-of-pocket costs — not the $60,000 or any portion of the $352,000. Why? Because the cash surrender value of the original $4 million policy owned by his trust was more than enough to cover all of the premium financing costs. The old policy was canceled to free up the cash surrender value and put the premium financing strategy in place without any further out-of-pocket costs to Joe.

Even Joe is happy.

Premium financing is a relatively new concept — easy to understand, complex to implement. It really takes a network of experienced professionals working together. The results create an economic windfall — all tax-free.

But sorry, everyone cannot take advantage of premium financing. You must qualify by bringing two things to the table:

First, you must be insurable or if married, one spouse must be insurable, so your irrevocable trust can buy second-to-die coverage.

Next, you must be worth a minimum of $5 million. The more you are worth and the more investment-type assets such as stocks, bonds or even real estate you have, the more likely you will qualify for this strategy.

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Posted in Corporate Tax, Estate Tax, Family Tax Issues, Insurance | No Comments »

Turn common insurance mistakes into tax-free wealth…

Friday, March 27th, 2009

It’s frustrating. Year after year, our office is asked to give a second opinion on the completed estate plans of owners of family businesses.

It is very rare to analyze the estate plan, particularly the life insurance policies, of a real-life client and find that all is as it should be.

Typically, we find the wrong kind of insurance. Wrong ownership. Wrong beneficiaries. Wrong tax consequences. It goes on and on.

This is a big deal. We are talking big money. Typically, the IRS gets 50 cents to 55 cents out of every life insurance dollar. Imagine owning a $1 million policy, and the IRS gets $550,000, but your family gets only $450,000. It happens all the time. A needless tax travesty.

Let’s review the three biggest mistakes business owners make concerning life insurance.

• Mistake No. 1

A corporation should never own insurance on the life of a shareholder, particularly a majority shareholder. Why? The trouble starts as soon as the shareholder dies. The policy proceeds are subject to the claims of corporate creditors.

Worse yet, if a C corporation, the proceeds can be subject to the alternative minimum tax — which can steal up to 20 percent of the proceeds — and the net proceeds after the tax can only get into the hands of your family by paying a second tax via a taxable dividend. Ouch!

If an S corporation, the proceeds (although not subject to the alternative minimum tax) are still locked in the corporation and can only be paid out tax-free if all old C corporation surplus is first paid out as a dividend — a terrible and tax-expensive idea.

• Mistake No. 2

The life insurance policy is owned by you or your spouse. Someday the policy proceeds will be included in your estate. You just guaranteed the IRS a big, unnecessary payday.

• Mistake No. 3

The policy, with cash surrender value, is old and the cash surrender value is half or more of the death benefit. You no longer have a life insurance policy but a lousy investment.

What should you do? Here are the typical recommendations we give to our clients so that you and your family — instead of the IRS — win the insurance tax game.

In the case of mistake No. 1, transfer the policy from the corporation to your name, paying the corporation only the amount of the cash surrender value, a tax-free transaction. Next, transfer the policy to a wealth creation trust (an irrevocable life insurance trust that eliminates all income and estate taxes).

For mistake No. 2 transfer the policy to a wealth creation trust.

And for mistake No. 3, if you are insurable, dump the old policy and replace it with a new policy to be owned by a wealth creation trust.

First, if you are married, make sure that replacing the policy on your life is the right type of policy. About 80 percent of the time a second-to-die policy insures you and your spouse will get significantly more bang for your insurance-premium dollar.

Second, determine how to reduce the premium cost: (1) if your company has a 401(k) or other qualified plan look into a subtrust. The plan, not you, pays the premiums. Even your IRAs — traditional or rollover — can join in the premium-saving fun; (2) Whether you need single life (only you are insured) or second-to-die, check out premium financing. You don’t pay any premiums, nor do you pay interest, just the low fees to the bank to initiate and maintain the loan.

This article does not even begin to explore all of the economic possibilities and tax tricks that you should learn to win the insurance tax game. Also, there are exceptions and traps.

Here’s an easy way to get started: List the policies on your life and your spouse’s life, whether owned by you, your corporation, a trust or otherwise. Then ask this question about each policy: What is the ultimate tax cost — income and estate — while I’m alive? When I die? When my spouse dies? The answer should be zero. If not, do what is necessary to make the answer zero. This usually means implementing one or more of the recommendations listed above for each of the above mistakes.

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Posted in Estate Tax, Tax Strategies | No Comments »

Complete estate plan requires more than will and revocable trust…

Friday, March 27th, 2009

This report on the 2005 wealth transfer plan test improves on the results of my 2004 report, which said in part:

“If you use the right tax tools and techniques together with the right professionals (lawyer, insurance consultant and CPA), you can and will develop a plan to beat the IRS. Every time.

And legally.

“Unfortunately, the goal of the typical estate planner is to reduce estate taxes. Our goal is always the same: to eliminate taxes.

“There are three types of readers who call us for help: readers who (1) have an estate plan but need a second opinion; (2) have no plan; or (3) have been working on a plan for years and just can’t seem to get it done. Which type are you?

“We will do a business succession/estate plan (and any necessary valuation) for each reader. We will report back to you (through this column) how many readers responded, how many we could and could not help, and a summary of the tax tools and techniques used to help the readers.”

Here are the 2004 results. In all, 16 readers (more than we expected) responded; 15 were in either the first or second category and, of course, were easy to help using the tax techniques and strategies described in this column over the years.

A 61-year-old from Ohio — let’s call him Joe — fell into the second-opinion category.

Joe’s letter said in part: “I … enclosed all the information … you asked for. My current plan (it was two short wills and two long revocable trusts — one of each for Joe and for his wife, Mary) looks good … but somehow I don’t feel comfortable.”

Joe and Mary turned out to be a very interesting case, yet sadly, their plan contained some common estate-planning errors. Sure, their documents — wills and trusts — were nearly perfect. Problem is, they just didn’t work. Let’s see why.

Joe and Mary are worth slightly more than $7 million, plus Joe has a number of life insurance policies totaling $2.2 million on his life that name Mary as the beneficiary. The $7 million includes $1.8 million in Joe’s rollover IRA with Mary as beneficiary. The balance of the assets ($5.2 million) — Joe’s business, their residence, some real estate and other investments — are all held in joint tenancy by Joe and Mary.

The wills and trusts — 46 pages in total — were designed by a large law firm to pass Joe and Mary’s assets in a highly organized plan, first to the surviving spouse and then to their children and grandchildren. Because Joe is four years older than Mary, and women outlive men by about four years, it was assumed that Joe would pass on first.

OK, suppose Joe goes to heaven first. Everything, and we mean everything, would go directly to Mary. Joe’s trust would get nothing and be a worthless stack of paper.

This is why: As the named beneficiary, Mary would get the $2.2 million of insurance. For the same reason — being the named beneficiary — Mary gets the $1.8 million in the IRA.

What about the other assets, worth $5.2 million? All to Mary immediately — because property held in joint tenancy goes to the survivor.

It should be pointed out that if Mary dies the day after Joe, the tax bite would exceed $3.5 million (using 2011 estate tax rates) of the $9.2 million now owned by Mary. Their kids would net only about $5.7 million.

What’s the lesson to be learned from this second-opinion story? Standing alone, a will and a revocable trust — no matter how terrific — can never be a complete estate plan.

We used a number of strategies to change Joe and Mary’s estate plan:

• A qualified personal residence trust for the residences.

• An intentionally defective trust to transfer Joe’s business to the kids tax-free.

• An irrevocable life insurance trust for the insurance.

• A subtrust for the profit- sharing plan to pay for the additional life insurance needed.

• A family limited partnership to hold the balance (real estate and investments) of their assets.

• An organized future- gift-giving program to their children and grandchildren.

With minor changes, the original wills and trusts were left alone.

After the above strategies and completed plans are put in place, if Joe and Mary get hit by the same bus, the kids would net, after taxes, about $9.5 million. The longer Joe and Mary live, as the future- gifting program is implemented, the more tax-free dollars are transferred to the kids.

If you want to participate in the 2006 wealth transfer plan test, please send the following information to: Irv Blackman, Wealth Transfer Plan Test, Blackman Kallick Bartelstein LLP, 3960 Deer Crossing Court, unit 102, Naples, FL 34114.

• For your business: Your last year-end financial statement (all pages).

• Personal: A current personal financial statement for you and your spouse.

• A family tree: Your name and birthday. Same for your spouse, children, their spouses and your grandchildren.

• All phone numbers: Business, home and cell.

What’s our job? To create the right plan for you, your family and your business — and to coordinate and work with your professionals. If you have a question, call me at 417-9732.

OK, that’s our plan to help you do your plan — and do it right. Let’s hear from you.

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Posted in Estate Tax, Irv Talk | No Comments »

Double rewards!

Friday, March 27th, 2009

Patrick Henry once said: “I have but one lamp by which my feet are lighted, and that is the lamp of experience.”

After years of working in wealth transfer, business succession, estate planning and related areas, I changed my view of my clients’ philosophies.

Why? Experience!

You’ll like what you are about to read: How to actually make money while giving it away.

An important task for tax advisers, particularly those doing estate planning, is to make sure they have a clear understanding of each client’s goals. So, one of the questions my staff or I ask each client is: “Do you have charitable intent?” Most clients answer no, and that is that.

In years past when a client answered affirmatively, we had a large arsenal of tax-advantaged charitable strategies that would enrich not only charity, but our clients, too. Every client made an after-tax profit.

One day about 10 years ago, we decided to dig a bit deeper when a client answered negatively to our charity question.

Here are the two most important questions we asked, the answers we got, and to our surprise, what we learned.

• A simple one-word question: “Why?”

About two-thirds of clients responded with something like: “I don’t want to reduce the amount of my children’s and grandchildren’s inheritance.”

After we learned this, it made good sense to follow with the next question — actually two questions — designed to get a “yes”:

• First, “Would you consider making a substantial gift to charity, if it would not reduce your heirs’ inheritance?”

And if that didn’t do the trick, we asked: “Would you make a large charitable gift if you could actually make an after-tax profit?”

Now, almost all clients said “yes” or “show me how” or something similar.

The simple fact is that the tax law has two tax-free environments: charity and life insurance. Marry them and you are on the road to tax heaven.

Let’s stay away from the technical stuff, like charitable remainder trusts and charitable lead trusts and their many ways to help you and charity, and look at two basic examples.

Example 1

Suppose Joe and Mary, married and both 65, buy a 15-year-pay, $4 million second-to-die life insurance policy.

The annual premium is $20,618 per $1 million payable for 15 years, or a total of $1.237 million. Joe and Mary set it up so their favorite charity is irrevocably the beneficiary of the policy.

Let’s take a look at the tax consequences of this charitable gesture by Joe and Mary.

They are in a 40-percent income-tax bracket, counting state and federal combined, and a 55-percent estate-tax bracket, using 2011 rates.

First, let’s look at the estate-tax picture. In a 55-percent estate-tax bracket, the real story is that the IRS gets paid 55 percent of that $1.237 million.

Since it’s gone, the IRS can’t tax it. So, the real out-of-pocket cost to Joe and Mary (after estate tax consideration) is only $557,000 (45 percent of $1.237 million).

Second, let’s look at the income tax consequences of the transaction. In a 40-percent income-tax bracket, Joe and Mary save $8,247 ($20,618 times 40 percent) each year as a charitable deduction.

Next, Joe and Mary buy $1.6 million of 15-year pay, second-to-die life insurance in an irrevocable life insurance trust, to keep the proceeds out of their estate. What’s the annual premium cost for only 15 years? You guessed it — their annual $8,247 income tax savings.

Finally, let’s put it all together. Their favorite charity will wind up with $4 million. Their family will make more than a cool $1 million ($1.6 insurance proceeds less the $557,000 after-tax cost of the premiums paid for the gift to charity).

Example 2

The above is only the tip of the iceberg. There are dozens of similar strategies to enrich your family while you enrich charity.

This example and the one with the best leverage is “premium financing,” where $500,000 can be turned into $6.5 million for Joe and Mary and then shared with their favorite charity. Joe and Mary can divide the $6.5 million — $5 million to their family and $1.5 million to charity — or in any other ratio they desire.

Now, $500,000 is turned into $5.5 million. That’s tax and economic leverage!

Most of the time, your favorite charity is your own family foundation, which bears your name. By now you get the idea. If you, your spouse or both are lucky enough to be insurable, you can leverage small amounts of capital — an investment of $500,000 or less paid out in small amounts over many years — to mushroom into tax-free amounts of $5 million or more. Divide your tax-free profits between your family and charity any way you desire.

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Posted in General Tax Strategies, Investment Strategies | No Comments »

Truly conservative?

Friday, March 27th, 2009

I never thought there were so many conservative investors.

What makes me think so?

Well, the last time I wrote about this specific subject, I received a blizzard of responses.

I hope to cover the subject again in this column and answer the questions that were posed by my readers. So, if you have a bent for conservative investing, you’ll love what follows.

Every conservative investor tells me: “I don’t want to risk losing my investment.” Fine. A worthy goal. But here’s the problem.

Most conservative choices are in low-yield, fixed-rate stuff like CDs or U.S. Treasury bonds. But municipal bonds are the hands-down favorite for conservatives.

Watch out, when inflation rears its ugly head, conservative investments are anything but conservative. Consider just one additional value-eating bandit who walks hand-in-hand with inflation: interest rates.

Consider the three ways that bandit steals your money and hard-earned wealth when you are heavily invested in municipal bonds:

• The value of the bonds go down as interest rates go up.

• You are locked into a low-interest rate until the bond matures or you sell it (probably at a painful loss).

• Nasty inflation reduces not only the value of the interest you receive, but the already reduced value of the bond has less buying power due to inflation.

What’s the long-term impact?

Here’s a quote from the Currency Options Hotline Operating Manual that drives home the devastating economic impact of inflation over time: “If you were somehow able to take one of today’s greenbacks [dollars] back in time to 1940, you would find it worth only about 6.5 cents.”

Sorry, but it looks like inflation, plus the falling value of the dollar against most foreign currencies, will be our rather unwelcome bedfellow for at least the foreseeable future.

What is a conservative investor to do?

Actually, we all know the answer: Find an investment vehicle that overcomes the three evils of the rising interest-rate bandit.

First, let’s outline the attributes of such an investment, second identify the investment, and finally, give an example of how the investment works.

Here are the attributes of the investment:

• A higher rate of return than on traditional conservative investments like CDs, treasury bills, notes and municipal bonds.

• The interest rate tends to go up as inflation goes up.

• Your investment will never go down in value, and in fact, will always guarantee you a profit.

• The interest earned and your investment profit are income tax-free.

• Your total investment at time of death including original investment, interest earned and profit escapes the clutches of the estate tax (when properly structured).

What’s the identity of this picture-perfect investment? It is simply a type of life insurance, which I call conservative investment life insurance.

Next, let’s look at an example. Joe and his wife, Mary, are both 70 years old. They buy a $1 million policy (it could be any amount, usually more) of second-to-die life insurance with an annual premium of $23, 516. The policy currently earns 5.7 percent.

The payoff on their investment comes after the second death. For the purpose of this example assume after 10 years, at age 80, both Joe and Mary get hit by the same bus.

Their heirs would receive:

1. Death benefit: $1 million.

2. Premiums paid: $235,160 ($23,516 times 10 years).

3. Interest earned on premiums paid (at 5.7 percent, but could be higher if interest rates rise, or lower, if interest rates fall): $75,411.

The total amount (tax-free) to their heirs is $1,310,571.

Next, suppose the second death of either investor happens at age 90. Their heirs would get a total of $1,816,458 (tax-free).

The easy way to summarize the investment is as follows: You get the premiums paid back, dollar-for-dollar, plus earnings on the premiums paid. You get a guaranteed bonus in the death benefit (here $1 million), and best of all, it’s all tax-free with no income tax and no estate tax.

If you are single, or married and your spouse is uninsurable, conservative investment life insurance can be purchased on a single life. However people younger than 50 years of age should not buy this insurance whether single or married. You have better insurance alternatives.

Here’s the big question most readers asked: “How does the insurance company make money?”

Don’t worry, those guys are not about to serve you a free lunch. Companies simply charges you enough premium in the first place to actuarially cover the final anticipated death benefit based on your age, sex, health and other factors.

For more information on how a conservative life insurance might work for you, your parents or your grandparents, contact me and I will get you the information you need and will answer your questions.

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Posted in Insurance, Investment Strategies | No Comments »

Wealth transfer plan should target needs of each generation.

Friday, March 27th, 2009

While browsing though my small mountain of files looking for column ideas, I ran across a still timely and interesting article in an old issue of Newsweek titled Darling, It’ll All Be Yours — Soon. The article explains how “the inheritance boom is quietly reshaping how we think about death.” How true.

When I began my professional practice as a CPA and lawyer in the ’50s, a millionaire was hard to find. Today, millionaires are bountiful. And when it comes to estate planning, they scurry around trying to find a professional who can lower their estate tax before they get hit by the final bus.

Robert J. Samuelson’s well-written article, like so many other articles, entertainingly explores the problem, but it offers no solutions.

Let’s set the scene for how you — whether you are parents trying to give it away tax-free or one of the kids on the receiving end — can solve the problem.

Let’s start with Mom and Dad, who have the wealth.

• Fact No. 1: You ain’t dead yet. Typical estate plans (separate wills and trusts for him and her) don’t speak until you are dead — too late to beat the tax collector.

The solutions lie in lifetime planning: A lifetime plan keeps you in control of your wealth for as long as you live, yet transfers it — including your business — to your kids and grandkids while you are alive.

• Fact No. 2: Years of experience have taught us that wealth is always passed on to the younger generations of the family. And then the younger generations step into the parents’ shoes and typically increase the family wealth. This gives the second generation an even bigger estate tax problem than the parents had.

Here’s how we solve this do-not-enrich-the-IRS estate tax problem.

Logic tells you that the children — particularly the business children — are likely to become wealthy. Usually, these children accumulate more wealth than their mom and dad — to be repeated again when the family wealth goes to the grandchildren two generations later.

Because of this generation-to-generation wealth transfer pattern, we view each generation of the family separately in terms of its special needs and objectives. But the plan should not be just for Mom and Dad; it should be a comprehensive plan for the entire family.

Following is an overview of how it’s done: keeping your wealth — every dollar of it — in your family, instead of losing it to the IRS.

You and your spouse (first generation)

Install a lifetime plan that removes wealth from your taxable estate during your life.

Use strategies like:

• A qualified personal resident trust for your residence.

• An intentionally defective trust for your business.

• A subtrust for your profit-sharing plan, rollover IRAs and similar plans.

• A family limited partnership for your other assets — typically investments like stocks, bonds and real estate.

• An irrevocable life insurance trust for insurance, probably second-to-die.

All of these strategies — and there are many others — begin their work now, while you are alive, and allow you to stay in control of your assets, including your business, for as long as you live.

Of course, we’ll dovetail your will and trust (death documents) with your lifetime plan. But when done right, your death documents just clean up what’s left. The first part of the family plan, including a business succession plan, and your wealth transfer plan are completed — tax-free — while you and your spouse are alive.

Your children (second generation)

After we complete a comprehensive plan for Mom and Dad, it is easy to project what the financial future of the kids might look like. So as soon as we finish the plan for the first generation, we start a plan for each of the kids, based on their individual assets and objectives.

Your grandchildren (third generation)

The plans for this generation are closely tied to the plans of the two older generations. Probably the most important point to keep in mind is that because of the young ages in this generation, getting the children into a tax-free environment as soon as possible is a wealth-building must.

These plans center on short-and long-term tax-advantaged strategies that fulfill lifetime needs: education, buying a house, starting a business and, if they don’t go into the family business, building a retirement fund.

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A tale of two clients

Friday, March 27th, 2009

It is rare that I consult with any two clients who are the same. Or even almost the same.

This column is an exception to the rule.

Two couples called me for a second opinion in the same week. They wanted my advice on their four-year-old estate plans.

Let’s start with the basic facts.

Estate A

Joe, 67, and May, 65, have three children, none of whom is in the business. For their five grandchildren they used an education plan.

They used a family limited partnership for their $400,000 in cash assets and their $9.6 million invested in stocks and bonds.

The couple used a 50/50, a method for holding title to their homes yielding a large discount for estate tax purposes, for their two residences worth $1.8 million.

They used a subtrust for their $2.4 million in IRA and 401(k) investments.

They sold their business and their total assets are $14.2 million.

Estate B

Pat, 62, and Sue, 61, have three children, all of whom are in the business. For their seven grandchildren they used an education plan.

They used a family limited partnership for their $300,000 in cash assets and their $1.9 million invested in stocks and bonds.

The couple used a 50/50 for their two residences worth $2.1 million.

They used a subtrust for their $2.2 million in IRA and 401(k) investments.

They used an intentionally defective trust for their business worth $7 million. They used another family limited partnership for their business real estate worth $2.6 million.

Their total assets are $16.1 million.

A few more facts: Joe had a successful business that he wanted to transfer to his son, Sam (the only business child), who ran the business daily.

Sam was killed in an auto accident. Heartbroken, Joe sold the business, including the business real estate. The after-tax proceeds are included in Joe and May’s investments.

An interesting point is that if Joe had not sold his business, the total assets for Joe and May and for Pat and Sue would be almost identical.

Also, the asset mix now — except for the business and business real estate — is identical.

If both couples got hit by the same bus (with their current estate plans in place), the estate tax liability using 2011 rates would be about $6.8 million for Joe and May and $7.7 million for Pat and Sue. That leaves a net of $5.4 million to Joe and May’s family, and $6.4 million to Pat and Sue’s family.

Now look at Estate A’s strategies — the family limited partnership and subtrust — and Estate B’s strategies — the family limited partnership, subtrust and intentionally defective trust. You get a quick bird’s-eye view of two typical estate plans: one without a family business and one with a family business.

This column over the years has hammered away at the concept that you design a proper estate plan by selecting the right strategies to satisfy your goals based on the assets you own. Basically, these two families have identical goals: to maintain their lifestyles for as long as they live, to pass their wealth on to their heirs intact (eliminating the impact of the estate tax) and to educate the grandchildren.

And, of course, Pat and Sue have one more goal: to transfer the business tax-free to their three sons, all of whom are active full time in the business.

One final goal: Both Joe and Pat want to control all their assets — including the business, for Pat — for as long as they live.

Pause for a moment. How many of the above goals are the same for your family?

The strategies used in both of the estates accomplish all the goals listed for both families. The single biggest tax-saver and creator of tax-free wealth is the subtrust, which was used to buy second-to-die life insurance ($5 million for Joe and May and $6 million for Pat and Sue).

When the new estate plans are fully implemented, it is estimated that the families will receive the following dollar values of assets — all taxes, if any, paid in full: Joe and May in excess of $16 million; Pat and Sue in excess of $18 million. These amounts are more than double what would have been received under the old estate plans.

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Rising interest rates may wound conservative investments

Friday, March 27th, 2009

It’s amazing how often the voice at the other end of the phone says something like, “Irv, I’m very conservative.”

Then they prove it. They tell me they have parked all or a large amount of their extra cash in what they consider conservative investments.

Most conservative investments are in low-yield, fixed-rate stuff like CDs or U.S. Treasury bonds. But municipal bonds are the hands-down favorite conservative investments.

Here’s a well-known fact: When inflation rears its ugly head, conservative investments are anything but conservative.

Consider just one additional value-eating bandit that walks hand in hand with inflation: interest rates.

Here are the three ways the bandit steals your hard-earned wealth when, for example, you are heavily invested in municipal bonds:

1. The value of the bonds goes down as interest rates go up.

2. You are locked into a low-interest rate until the bond matures or you sell it, probably at a painful loss.

3. Nasty inflation reduces not only the value of the interest you receive, but also the buying power of the already reduced value of the bond (see No. 1 above).

Here’s a quote from the Currency Options Hotline Operating Manual that drives home the devastating economic impact of inflation over time: “If you were somehow able to take one of today’s greenbacks (dollars) back in time to 1940, you would find it worth only about 6.5 cents.”

Sorry, but it looks like inflation — plus the falling value of the dollar against most foreign currencies — will be our rather unwelcome bedfellow for at least the foreseeable future.

What is a conservative investor to do?

Actually, we all know the answer: Find an investment vehicle that overcomes the three evils of rising interest rates.

First, let’s outline the attributes of such an investment; second, identify the investment; and finally, give an example of how the investment works.

Here are the attributes of the investment:

• A higher rate of return than on traditional conservative investments like CDs, Treasury bills and notes, and, of course, municipal bonds.

• The interest rate tends to go up as inflation goes up.

• Your investment will never go down in value and, in fact, will always guarantee you a profit.

• The interest earned and your investment profit are income tax-free.

• Your total investment when you die — original investment, interest earned and profit — escapes the clutches of the estate tax when properly structured.

And now — drumroll, please — the identity of the investment: a particular type of life insurance that I call conservative investment life insurance, or CILI.

Finally, let’s look at an example. (Note: This investment concept works for any age, but is typically used by an individual or a married couple who are 50 or older.)

Joe and his wife, Mary, are both 70. They buy a $1 million second-to-die CILI policy (it could be any amount) with an annual premium of $23,516.

The policy currently earns 5.7 percent.

The payoff on Joe and Mary’s investment comes after the second death. It is determined assuming that after 10 years — age 80 — Joe and Mary get hit by the same bus.

Their heirs, children and grandchildren would receive:

• Death benefit — $1 million.

• Premiums paid ($23,516 times 10 years) — 235,160.

• Interest earned on premiums paid (at 5.7 percent, but it would be higher if interest rates rise or lower if interest rates fall) — $75,411.

• Total amount tax-free to heirs — $1,310,571.

Next, suppose the couple’s second death happens at age 90. Their heirs would get $1,816,458 tax-free.

To summarize the investment:

1. You get your investment (premiums paid) back, dollar for dollar, plus earnings (5.7 percent here).

2. You get a guaranteed bonus, the death benefit ($1 million here).

3. It’s all tax-free (no income tax, no estate tax).

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by Irv Blackman

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