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Case Studies and Position Papers from Pearson Financial Services

Every client family has different issues. These case studies and position papers are examples of issues that Pearson Financial Services has handled for its clients. They are brief write ups about how a family’s financial challenges have been solved. Each stoy focuses on the strategy chosen by Pearson Financial Services to best protect a family’s assets and its legacy.

We would be pleased to discuss, in depth, any of the concepts written about in these case studies. All the names have been changed and the numbers are hypothetical, but each story reflects a real client with real issues and successful solutions to their family’s financial challenges.

Consider Impact and Options Before Sale of
Highly Appreciated Real Estate, Not After.
Read this article...

A Generation-skipping or Dynasty Trust Functions as a Family Bank --
and the Family Retains Complete Control.
Read this article...

Inaction is Costly When You Ignore the
Generation-Skipping Tax Exemption.
Read this article...

Choose Your Professional Advisors Carefully For Real Estate Investing So You Can Acquire the Education You Need to Make Tax-Efficient Decisions.
Read this article...

Keeping Assets Under the Control of the Family is Important in Estate Planning: But are the kids ever ready to take on that responsibility.
Read this article...

Comfortable Retirements for Boomers May Depend on Their Willingness to Mortgage Appreciated Real Estate.
Read this article...

Choose Your Professional Advisors Carefully For Real Estate Investing
So You Can Acquire the Education You Need to Make Tax-Efficient Decisions.

A first home purchase is usually a family's first foray into real estate and the advisors are the real estate broker, and mortgage professional. The next stage usually occurs when families have accrued enough assets to buy a second home, or land for a future dream home, or rental income property. Some families may look to an advisor at this time. Most do not. But when the family gets to the next stage of selling their primary residence in order to downsize, or selling an appreciated second home, land or rental property, they should be looking for professionals with experience in all of the financial planning options that surround real estate transactions.
For instance, they can sell their appreciated second home, land or rental property and pay taxes on the gain. Then, they can reinvest the after-tax proceeds. However, before they pay this tax, they should be aware of all the options available that may mean keeping the house or exchanging the house.
Those options include:
o Interest-only jumbo loans
o 1031 exchanges to tenants in common, to triple net leased commercial property, or exchanges to real estate in an area where you wish to live in retirement.
o Tax-deferred exchanges to REITS, stock, bonds, mutual funds, treasuries, or certificate of deposit, giving the family a wide variety of options including private annuities, charitable remainder trusts, and charitable gift annuities.
All options have advantages and disadvantages. To determine what is best for you, find a financial advisor with experience in real estate options. Such a firm will normally include a lawyer, an accountant and a financial planner, who regularly work together to help families make educated decisions. Call a firm that has extensive experience in all these real estate options. A family's tax savings could amount to hundreds or thousands of dollars.

Keeping Assets Under the Control of the Family is Important in Estate Planning: 
But are the kids ever ready to take on that responsibility?

Ninety percent of the time, parents ready to do serious estate planning have children, grown adults, who have formed their own financial opinions and professional relationships. In fact, studies show that moral and ethical values are established by the time a child is 9 or 10. Time takes care of the rest. So just how much education - or coercion - can parents try to impose with estate planning? 
The bottom line in estate planning is the preservation of family wealth. Some families have children in very bad marriages and anticipate messy divorces. Some children are addicted to drugs, alcohol or even spending. Education is not going to impact these family situations. Estate planning lends itself to extremely specific customization so that it can reflect the needs and status of individual beneficiaries. Most kids grow into responsible adults with little or no knowledge about preservation of assets. 
Parents who create a dynasty or generation-skipping tax trust (GSTT) and introduce their children to the advisors who helped them create this trust, are offering their kids a way to preserve assets from generation to generation. The children also have the option of closing the trust and making their own, independent decisions. However, leaving a structure for preservation of your assets and asking the children to discuss your reasoning will go a long way toward helping them retain assets, the overarching goal of most parents.

Comfortable Retirements for Boomers May Depend on
Their Willingness to Mortgage Appreciated Real Estate.

Many Boomers are beginning to understand that their appreciated real estate is their future financial saving grace. A straight sale, with the intention to downsize and invest the difference, is often the least beneficial way to use valuable real estate. Reverse mortgages, interest-only loans, and even home equity lines may make the difference between a difficult, money-pinched retirement and a comfortable one. Reverse mortgages can produce enough money to pay increased property taxes, maintenance costs on a retirement home, as well as increased health care and long-term care expenses for one or both parents. Keeping real estate means keeping an appreciating investment and the appreciation is probably better than most conservative investment portfolios.
Few adult children begrudge their parents the right to use their wealth in any way they must to have comfortable senior lives. It is the Boomer parents themselves who are having problems with the concept of the extended lengths of retirement they must fund. The potential of reverse mortgages for anyone other than a destitute widow in her 80s, is a new concept. Once a Boomer couple realizes they have potential reverse mortgage assets they can apply to their income stream, they can reduce their worry and manage their older lives more comfortably.
Bottom line, the children can still inherit their parents’ valuable real estate, because despite the money owed to the bank at the time of the death of the parents, the home continues to appreciate annually, and at a greater rate than is withdrawn for the reverse mortgage.
For example:
Mr. and Mrs. Green, age 61, with a $500,000 home, may take a $200,000 new reverse mortgage with no closing costs, a product now commonly available. If the cost of the mortgage on that $200,000 averages 6.23% during their lifetime, 24 years later, at the time of the parents’ death at age 85, the mortgage balance is $786,000. Meanwhile the house has grown by 6% a year, the national average for the last 50 years. The house is now worth $2 million. The children inherit the property and the mortgage. In fact, they are inheriting a substantial estate of more than $1.2 million. If the parents used the money to maintain and improve the real estate, it would have appreciated more.
If the Green’s three children want to keep the house, a dynasty trust allows them to take title, sell it, keep it, or mortgage it in order to keep it. The children could take title as tenants in common, and each one sign for a third of the outstanding mortgage as trustees of the Dynasty trust. The trust defers capital gains in the transfer.
The children will have to qualify for and be able to pay a mortgage for their one-third share, but they can also choose to sell and discharge the mortgage with the proceeds. Banks do not make reverse mortgages without a serious look at the appreciation potential of the home. It is likely that the property will continue to appreciate if one child or the three children keep it. The value can be borrowed against for college costs or any other income needs the adult children have. All children will get a step up in basis.
Appreciating real estate can be looked at as an excellent solution to the future cash crunch many Boomers can expect to have.

Consider Impact and Options Before Sale of
Highly Appreciated Real Estate, Not After.

Many families are not exposed to alternative strategies for selling highly appreciated real estate because each of their trusted advisors' limits their advice to specific specialties. This can result in
great financial loss to a family's net worth. Options available when a property must be sold can include tax savings, controlling and directing the assets, and enhancing a family's charitable efforts.
Take this case study. A successful engineer, Mr. Galvin, with a $7 million portfolio was ready to sell a multi-family rental property for $825,000 using a 1031 exchange into a Tenants-In-Common (TIC) real estate limited partnership found in the Wall Street Journal. He had a stock broker and an attorney, and had been a very successful and smart investor, but knew nothing about his alternatives when it came to real estate. Galvin wanted to rid himself of both the rental manager responsibilities and liability from tenants. Here are five options from his financial advisor that the engineer considered: a charitable remainder trust, a charitable gift annuity, a private annuity, a 1031 exchange to a single family rental property with management, and a 1031 exchange to a TIC.
The TIC would get Mr. Galvin out of the rental management business, but came with large, upfront expenses, modest income, a lack of liquidity, and a possibility of investment loss through risk of tenant bankruptcy. Armed with information from his financial advisor, discussed at length, Galvin passed on the TIC, a charitable gift annuity, the private annuity, the 1031 exchange to a single family rental with management, and settled on the charitable remainder trust as best fitting his income and estate planning requirements. 
Before the sale, Galvin titled the rental property to the charitable remainder trust (CRT). When the sale was completed, he had the entire universe of investment products including REITS if he wants to stick with real estate as part of his asset allocation, at his disposal for investments within the CRT. Lump sum taxes of $160,000 are avoided because the sale of assets will be inside the trust. The CRT throws off 8% income a year, about half is taxable at the capital gains rate upon time of receipt of income, and half is taxed as ordinary income (based on the owner's cost basis.). This is more income than he would have received from the TIC with greater safety assuming he continues doing well in his long term investing practices. He has total control, because he is entirely in charge of this investment.
The tax code allows significant tax deductions ($147,000 spread over six years) because the assets are in a charitable remainder trust. In Galvin's and his wife's lifetime, nothing goes to charity. All the income and control is retained for their lifetime. When the Galvin's die, the value of the CRT goes to the Galvin Family Foundation, headed by the Galvins' daughter, which is required to distribute 5% a year or more (in fact, it could be the entire amount) to non-profit organizations in perpetuity.
Left in his estate and not titled to a CRT, the rental property would have been assessed a 50% death tax. This planning and the creation of several additional trusts have reduced the daughter's tax liability on the estate from $1.9 million to $1.5 million. 
In summary, every family has at least six options when selling highly appreciated real estate, including pay the full tax immediately, 1031 to another property or properties, 1031 to a tenants-in-common partnership, charitable gift annuity, charitable remainder trust, and a private annuity. Only an informed family can make the best decision for the option that is best for them. 
If you have highly appreciated real estate and are interested in selling, find an advisor who can take you through each of the many alternatives to a direct sale, protecting you from unnecessary capital gains that serve only to lower your family's net worth.

A Generation-skipping or Dynasty Trust Functions as a Family Bank --
and the Family Retains Complete Control.

A family bank, that is, a generation-skipping trust or dynasty trust overseen by a team of investment and estate planning experts is an excellent and much less well known alternative to a commercial bank's private banking division.
The family bank or dynasty trust gives your family great flexibility and the protections of a trust without the over-controlling and inflexible regulations that limit a trust at a commercial bank. The dynasty trust, like most trusts, can reduce or eliminate taxes, avoid capital gains taxes, bypass probate (ensuring your privacy) and can enhance charitable deductions. But only the dynasty trust can provide long-term tax avoidance, family access, asset protection, and total control from generation to generation.
A family bank allows you, while you are alive, to access all of your assets. You can spend them, or give them away. When you die, part or all of your estate is left in the dynasty trust, and thereafter, your beneficiaries can own assets in your dynasty trust which functions as a family bank. Your family could borrow from it without jeopardizing any of its assets. Family beneficiaries can also put their own assets in the family bank, up to $1 million per person, and reap all the benefits of the dynasty trust to protect their own wealth.
Expenses, such as travel, food, schooling, or clothing can come from the family bank. The goal, of course, is to leave as much in the trust as possible so it is protected, but if family members' income or investments are not sufficient to pay personal expenses, they can elect to distribute principal and draw income as needed.
A dynasty trust is not a magic wand; creating it, monitoring its value, and maintaining it require experts who are trustworthy in both senses of the word. In addition to the family bank, selected financial advisory practices provide clients with a family financial office staffed with skilled estate planning attorneys, financial planners, and tax accountants. The purpose of the family financial office is to provide ongoing, comprehensive care to the client and client's family for all issues affecting their financial lives, providing continuity from one generation to the next. Once the beneficiaries gain control of the dynasty trust, they have professionals who can interpret the details and help the next generation to fully understand their role, responsibilities and how the resources (assets) can be available to them.

Inaction is Costly When You Ignore the
Generation-Skipping Tax Exemption

In the U.S., we have two tax systems. One for "Those Who Plan" and one for "Those Who Don't Plan". With planning, you and your spouse can pass on a little more than one million dollars per spouse to your family, without taxes, using the generation-skipping tax exemption. The catch is that you need to prepare to use this exemption by understanding everything there is to know about Dynasty Trusts, also known as Generation Skipping Trusts. You can protect your assets and their appreciation from both lawsuits and transfer taxation. You can help your family retain access to and control over your money for ninety-nine years after your death -- or longer.
Significantly, if you do not use this exemption, you lose it when your assets pass to the next generation. Also, your family stands to lose 50 % of the value of your assets every time ownership transfers to the next generation. So, it's not only when your children inherit your estate that you lose 50%, but when their children inherit, and so on, until your "legacy" has been whittled away within a few generations.
The U.S. government levies estate taxes at death when assets change ownership through inheritance. Congress has traditionally used estate taxes to pay for wars. While estate taxes have been abolished numerous times, they keep coming back, as do the wars. You can protect your wealth from this greedy estate tax by understanding and creating a Dynasty Trust. Create security for your family's assets during your lifetime, extend that protection into perpetuity. Provide your family with privacy -- trusts are not probated and do not become public record. Trusts help sustain family values because explaining your trust to your children requires an open discussion of your plans for your money. Proper trust development and administration helps family members who are not trained in the investment, legal, or accounting fields.
Trusts are all too often ignored by families who believe their assets are too insignificant to warrant such a legal hassle. Keep in mind, that even if you do not have $1 million in assets, your appreciated home, a life insurance policy, pension account, and savings could add up to a significant sum. Don't ignore the possibilities of a Generation-Skipping Trust and related tax exemption. Be one of "Those Who Plan." For most investors, it is the right thing to do.

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