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An adviser must integrate tax planning techniques with other tools that a client may use for asset protection, business succession, portfolio management, retirement planning or other objectives. The process of choosing and integrating tools requires an evaluation of the client’s planning goals in full view of the vision that most inspires the client. Uniting a team of advisers to implement the most effective planning tools is much like bringing together the architect, electricians, plumbers, stone masons, and other builders to construct a dream home. So that all the team members can review the proposed building materials and then work in harmony, an architect should first create a blueprint.
Creating a custom blueprint requires seasoned expertise with choosing, customizing, integrating, and implementing the right components. A 21st century wealth adviser may consider literally hundreds of different planning instruments when creating a wealth blueprint. Whereas advisers typically used just a handful of planning instruments a quarter century ago, the modern adviser must now sort through a complex assortment of trusts, money management instruments, and insurance techniques in order to suggest which legal instruments can form the best building blocks when refining a plan to realize the client’s dream.
Experienced advisers realize that no one planner has sufficient knowledge about all of the legal tools typically required for a zero-tax plan. The few advisers with broad expertise involving trusts and legal tools typically admit that they do not know how to find the optimal combination of investments and insurance to fund or complement the legal tools. In fact, finding the best array of legal, financial, and insurance concepts often involves analyzing quintillions of possible outcomes without losing sight of the client’s cash flow needs, wealth transfer goals, and envisioned future.
At least one planning team member must have a proven process for uniting planning team members around the client’s vision while illustrating how planning techniques impact financial statements and realize non-financial goals as well. Fortunately, advanced software packages now give advisers the power to analyze the impact of adding legal and financial instruments to a client’s plan. As long as one adviser on a planning team has an effective process for choosing the right planning tools before running the software, advanced technology can evaluate and illustrate desired outcomes with clear reports. The remainder of this article will explain how advisers can start with just three basic zero-tax tools and then choose additional tools in order to create leveraged, total wealth control, and optimized plans.
Advisers Should Consider Enhancing Basic Plans to
Create Leveraged or Total Wealth Control Plans
A common basic zero-tax plan typically involves three planning tools: a Revocable Living Trust (“RLT”), an Irrevocable Life Insurance Trust (“ILIT”), and a Generation Skipping Trust (“Dynasty Trust”). Even a basic estate plan, if based on the RLT, ILIT, and GST tools, can eliminate millions of unnecessary taxes. The RLT can currently zero-out transfer taxes on an estate with $4 million or less. The ILIT can theoretically avoid all estate taxes on tens of millions of dollars of death benefits while also eliminating income taxes on death benefits or loans made from life insurance cash values. The dynasty trust can offer advantages of the RLT and ILIT trust while also leveraging generation skipping tax (“GST”) exemptions to zero-out taxes in multiple future generations.
An adviser can enhance the benefits of the basic plan by adding a Family Limited Partnership (“FLP”), Qualified Personal Residence Trust (“QPRT”), and Intentionally Defective Irrevocable Trust (“IDIT”) to create a leveraged plan that directs more wealth to family members. Leveraged plans generate benefits by making the best use of the standard $1 million gift tax exemption given to all American taxpayers. An astute adviser can leverage these exemptions to transfer many millions to heirs with zero transfer taxes. For example, an FLP can discount $3,000,000 of assets down to $2,000,000 or less, and a couple can use their gift tax exemptions to move all the wealth to their children with no gift taxes. A QPRT can transfer a $4,000,000 home to children tax free in 20 years or less by leveraging less than $1,000,000 of the gift tax exemption.
Leveraged zero-tax plans frequently include IDITs because they can provide the most efficient use of a client’s gift tax exemption. These benefits result from the IRS respecting the IDIT for estate tax purposes but regarding the IDIT as “defective” for income tax purposes. Most IDITs are implemented primarily to transfer ownership, management, and control to heirs in the right way at the right time.
The IDIT rewards the pursuit of non-tax goals with four significant tax benefits. First, the IDIT helps a client avoid estate taxes by moving assets out of an estate to a trust where assets can appreciate without any estate tax on the growth. Second, IDITs avoid gift taxes because the proper sale of an asset to a defective trust is not a gift. Third, IDITs avoid capital gains taxes because the IRS disregards sales to defective trusts when calculating income taxes. Fourth, when the sale is completed, the client will usually take back an interest bearing note to provide lifetime income. Given the defective nature of the IDIT trust, the note “interest” need not be subject to the ordinary income taxes normally assessed on interest. Payments on IDIT notes may be paid as capital gains income or even tax-free distributions, depending on the type of income produced by assets in the IDIT trust. |
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Voorhees Family Office Services, Inc.
650 Town Center Drive, Suite 890, Costa Mesa, CA 92626
Phone: (800) 447-7090 • Fax: (866) 447-7090
©Tim Voorhees, 2002-2017 |
