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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.

Sixteen Strategies for Avoiding Estate Taxes #20
Changing the Remainder of a Charitable Remainder Trust (CRT) to a Family Foundation at an Appropriate Time has Significant Benefits
Read this Article...

16 Strategies for Avoiding Estate Taxes #9
Using Multiple Crummey Trusts
Removing taxable assets from an estate using the gift tax exemption can greatly benefit the heirs
Read this Article...

A Well Managed Bond Ladder Can Reduce Interest Rate Risk:
It is a strategy that can add value no matter which way rates move.
Read this Article...

When the Perfect Storm of Financial Challenges Hits Financially Prudent Families: Careful, living-within-their-means families are being overwhelmed by financial demands in every aspect of their lives. What can they do?
Read this Article...

Sixteen Strategies for Avoiding Estate Taxes: #8
It’s all About Avoiding Transfer Taxes
Read this Article...

16 Strategies for Saving Estate Taxes #7 Family Foundations
Hoped for elimination of death tax unlikely, foundations save tax bite

Read this Article...

16 Strategies for Saving Estate Taxes #6 Charitable Lead Trusts
When you determine that your own children will have “enough” of your estate, use a 30-year charitable lead trust to transfer assets to grandchildren and avoid all death taxes.
Read this Article...

16 Strategies for Saving Estate Taxes #5 Intentionally Defective Trusts
A Valuable Resort Business Can Be Given to the Children Without Gift Taxes
Read this Article...

16 Strategies for Saving Estate Taxes #4
Grantor Retained Annuity Trusts Allow You to Move
Assets Out of Your Estate, but Maintain Control
Read this Article...

16 Strategies for Avoiding Estate Taxes #20 Changing the Remainder of a Charitable Remainder Trust (CRT) to a Family Foundation at an Appropriate Time has Significant Benefits.
Family Foundations Can be Instructive for Children Likely to Inherit Wealth

Charitable Remainder Trusts (CRT_ are a good income stream for the families who set them up.  Close to the time when the assets (remainder) in a CRT would go to the original charity, it is important to look at three significant benefits that can occur when a family instructs the CRT to turn into a Family Foundation rather than having the assets flow directly to the charity.  

This strategy can result in a far larger gift over time from the family to its original charity as well as to others, while still allowing the family to control and invest money, normally lost to taxes  

Most CRTs have provisions that allow the owners to change the charity in their lifetimes, should the charity go out of business, or experience bad management.  The family can exercise that provision and create a family foundation.  Here is an example of how it could work.  

Elsie and Fred Richards have a Charitable Remainder Trust with a $2 million remainder.  That remainder, transferred to the Family Foundation, can ultimately make far more of a charitable impact than if it had been left to the original charity.   If the assets earn 9% and pay out 5% annually (as required by the foundation) to the family’s favorite non-profits, including the original CRT charity, great things can happen.    

The children who are likely to survive for 30 more years at the time of their parents death, and their grandchildren who are likely to survive for 60 years after their grandparents death, can experience a growth of the foundation’s assets to $21 million over a sixty-year span.  During that 60 years, the family foundation will have paid out over $30 million to non-profits.   

Even more important to the donors, the Family Foundation can require participation of the children and grandchildren in the work of making grants to appropriate non-profits, teaching current and future generations about giving back and about family finances.  Such stewardship can instill a sense of responsibility in family who might otherwise be cavalier about inherited wealth. A Family Foundation, by its specific gifts, can pass on the family’s core values and principles.  For one or several children, the Foundation can offer a modest salary for managing the Foundation.  

16 Strategies for Avoiding Estate Taxes – # 9 Using Multiple Crummey Trusts:
Removing taxable assets from an estate using the gift tax exemption can greatly benefit the heirs

Alice and Bernard Hopkins had made their estate plan five years ago. They moved to a new community and wanted a financial advisor who lived within reach for in-office visits when they had questions. They showed the new advisor their completed estate plan and he asked one question. “Are you satisfied with the tax impact of this plan?”

The Hopkins had been so focused on which heir would get which valuable assets that they had not concentrated on tax avoidance or tax abatement strategies available to them. The new advisor suggested the multiple Crummey trust/dynasty trust strategy for sheltering 1/5th of a $10 million dollar apartment building that they owned.

Here is what was done:

One million of the value of the apartment building was put in a Crummey Trust (also a dynasty trust) to the benefit of Alice. An additional $1 million of the value of the apartment building was put into a second Crummey trust (also a dynasty trust) to the benefit of Bernard. At this point $2 million of the building’s value had been removed from their estate using the gift tax exemption.

If the building’s value grows at 7.2% a year, and the couple lives for 20 years, a total of $8 million could transfer to Alice and Bernard’s children, with no estate tax on it at all because it had been taken out of their estate and the growth of the value of the building was not taxable. In 2009, there is a possibility that the gift tax exemption may be increased to $2 million per person, making it possible for Alice and Bernard to repeat the establishment of additional Crummey trusts to move more assets from their taxable estate to their trusts and increase the amount of tax free transfer they are able to implement for their heirs.

A Well Managed Bond Ladder Can Reduce Interest Rate Risk:
It is a strategy that can add value no matter which way rates move.

Successful investors have used the bond ladder strategy to reduce the interest rate risk of bonds.  A bond ladder is a portfolio of bonds, each with different maturities.  A GNMA Government bond has guaranteed principal payments every month spread out over the “average life” of the bond.  If interest rates go up, you will receive principal each month to reinvest in bonds paying a higher rate, increasing the overall yield to maturity.  If interest rates fall, all of the bond that doesn’t mature each month continues to earn the higher rate which would also protect the overall yield of the bond ladder.  In other words, it is a strategy that can add value no matter which way rates move.   

Worried about bonds with all the dire news lately.  Here’s an overview.

A U.S. Government bond is a direct obligation and since the government can literally print money to pay back investors at maturity, it is generally considered a risk-free asset.  However, as interest rates rise, the price of a bond falls so a sale of the bond before maturity could result in a loss.  To avoid any loss of principal, you simply hold it until it matures and continue to collect the fixed interest payment that is also guaranteed by the U.S. government. 

 When you invest in a government bond, it is very important to know the yield to maturity so there is no doubt about what you will receive in interest and ultimately in principal at maturity.  The Government National Mortgage Association (GNMA) also known as “Ginnie Mae” is a U.S. Government-owned corporation.  They are the only mortgage-backed securities guaranteed by the U.S. Government.  GNMA securities have the same credit rating as the Government of the United States.  The interest payments and the return of principal at maturity are guaranteed by the full faith and credit of the U.S. Government. 

 Ginnie Mae has no relationship at all to Fannie Maes or Freddie Macs, which are stockholder corporations traded on the New York Stock Exchange, and that have absolutely no guarantee of principal or interest from the government. 

A well-managed bond ladder can stabilize your portfolio and your income.   Ask your advisor to discuss this option with you.

When the Perfect Storm of Financial Challenges Hits Financially Prudent Families Careful, living-within-their-means families are being overwhelmed by financial demands in every aspect of their lives. What can they do?

Take the Gallihers.  John and Emily both work, are both 50-years-old, have met the match   in their 401(k)s at work for many years.  As well they have regularly put money into a taxable account for retirement, and done a too modest job (they now say) of saving for college for their four teenagers. Their current financial realities are not theirs alone, but shared by numerous other families.

•  John used to spend $100 a month in gas.  It now costs $500.  The trade-in values for gas-inefficient cars has gone down dramatically.  Buying a new car is simply not in the budget. for the Gallihers considering how little they could get for a trade-in.

•  College loans, John finds, are difficult to come by.

•  The value of his suburban house is down so a home equity line is out of the question

•  His variable mortgage is due to recalculate in a year

•  His mother's funds are running out that have been paying for her assisted living

•  His company just announced that employees will be paying more for  the employee share of health coverage at work.

•  Sixty employees were just laid off at work and John is worried.

• John and Emily are feeling very risk averse about their investment portfolio for their retirement savings

These are not unusual worries and many Americans may have one or two of this list to deal with at any one time, but John and his wife, Emily, are dealing with all of them at once.  What can they do?

• Consider public transportation, or work hard to create a car pool with other employees

•  Keep digging for those college loans that are so difficult to find and ask the children to take out the largest loan for which they qualify.  Better to get needed tuition money and help kids pay back loans later then deplete retirement accounts and take early withdrawal penalties.

•  Keep watching home values.  If a home equity is not possible now, perhaps it will be by the time the last of the four children needs help with their college tuition.

•  Watch mortgage rates and keep all necessary papers in one file (tax returns, most recent tax bills for property) so that you can contact a mortgage broker the instant the mortgage you want becomes attractive.  Create a relationship with a mortgage broker who will watch the rates for you.

•  The assisted living issue is a major one.  Bringing John's mother home for care is a massive change for the family and for her.  Get help from local Council's on Aging about home-based services his mother may qualify  for when her money runs out.  

•  John and Emily may want to consider a company health plan option with a larger deductible  to lower the bite to John's paycheck of the employee increase for the coverage.

•  John will need to have his resume updated and in great shape before he needs it.  He should also be talking to colleagues in his field about opportunities before he suffers a layoff.

•  John and Emily are professionals, successful, middle-aged people, who have led careful financial lives.  They are very risk averse at the moment and do not want risk in their investment portfolio.  It is important for them to talk to their financial advisor so that their investment plan takes into account inflation, taxes, and fees that impact their return.  John and Emily must accept some risk, but know that their trusted advisor's goal is preservation of their capital first, growth second.

16 Strategies for Avoiding Estate Taxes: #8 It’s all About Avoiding Transfer Taxes:
A Valuable Resort Business Can Be Given to the Children Without Gift Taxes

Emily and Abner Brown have spent many years running their popular and financially successful seaside resort valued at $5 million. They want their grown children to take it over. But the Brown’s have already used up all their gift tax exemptions. The resort is appreciating in value and the Browns want to get it out of their taxable estate with the fewest tax consequences possible.

If they give the business to their children outright, the kids will owe the IRS over 40% of the value of the property or $2 million. Instead, their advisor suggested they set up an intentionally defective trust. This strategy allows them to save gift taxes and allows the value of their business to grow tax-free in the future.

The Brown’s chose to sell their business to their children at fair market value inside the trust drawing up a legal mortgage note. The children will use the revenue from the growing business that they now own inside the trust to make the monthly mortgage payments of principal and interest to their parents. By purposely making the trust defective, all the taxes incurred by the business are taxable to the parents, not the children, and will be paid using the parents’ other taxable assets helping them draw down their taxable assets over time, further reducing transfer taxes.

The greatest benefit to the parents is, of course, that the $5 million dollar business is no longer in their estate. The mortgage note gets smaller every year and the parents pay all the taxes, which in effect, are additional gifts to the children without gift taxes.

Another benefit accrues to the children if the business earns 10% a year going forward and all that revenue goes to trust. The children can pay 5% or $250,000 in mortgage payments and still have an additional 5% or $250,000 revenue to share without any gift tax. If they leave the $250,000 a year in revenue from the business in the trust, growing at 6 or 7 percent annually, the business could be worth $10 million in ten years.

The Browns have the potential of saving more than $3.75 million in estate taxes by getting the resort to the next generation with no gift or estate tax using an entirely aboveboard strategy.

16 Strategies for Saving Estate Taxes #7 Family Foundations:
Hoped for elimination of death tax unlikely, foundations save tax bite  

Current costs of the Bush Administration’s foreign policy have been estimated at about $ 3 trillion, money that the U.S. Government does not have and has not yet grappled with paying.  All three candidates for President have said they will not eliminate the estate tax, often called the war tax, because its loss would put a further strain on the U.S. budget.  

This reality makes saving estate taxes more important than ever.  Numerous strategies are available, one of which is the establishment of a Family Foundation with dollars that otherwise would go directly to Uncle Sam.    

The first question a family must answer is “how much is enough in regard to what to leave to children and grandchildren.  Once made, that decision allows a family to look at “the rest” of the estate.  Under ordinary circumstances, an unprotected estate with no tax avoidance strategies in place would see the remainder taxed at  about 67% (income tax and estate tax deductions.)  

From a tax standpoint, every dollar placed in a non-profit foundation saves 35 cents on every dollar in income tax.  The tax deduction can be spread out over a six year period.   It further saves the 50% estate tax at death.  

Foundations can also function as glue for a family.  When the mission of the foundation is a cause important to the family, all of the children and grandchildren can be brought together to make both investment decisions on management of the assets in the foundation, as well as the decisions on where the required 5% distributions will be made.  Even after the donor’s death, the remaining family will be drawn together to fulfill a mission of importance to the original creators of the foundation.

16 Strategies for Saving Estate Taxes #6 Charitable Lead Trusts:
When you determine that your own children will have “enough” of your estate, use a 30-year charitable lead trust to transfer assets to grandchildren and avoid all death taxes.

There are many strategies for eliminating estate or death taxes. For families who are certain they have the ability to set aside “enough” for their adult children, the charitable lead trust is an excellent vehicle to transfer a large portion of family’s assets to the grandchildren with no estate (death) taxes.

While the concept of “enough” is different for all families, Jennifer and Sid Howland seem clear that giving $2 million to each grown son was “enough.”  Their total estate is $10 million.  Now the Howland’s must plan on managing the $6 million remainder with the lowest tax consequence possible.

If the $6 million were assigned to a 30-year charitable lead trust, it could greatly benefit the grandchildren who, at the end of the 30-year term, would access the assets with no taxes, a savings of 50% or $3 million.

The rules of charitable lead trusts require that trustees pay out 5% of the Trust’s assets a year.  However, at end of term, whatever the size of those assets, the grandchildren will receive the principal, the growth above the 5% distribution, and all with no estate tax in the transfer. 

The 5% distribution from a charitable lead trust can fund a family foundation, run by Judy and George, the Howland’s children, allowing their children and multiple grandchildren to pursue charitable intentions and passions with the distributions, as long as 5% of the trust is given away each year. 

Charitable lead trusts may be funded after you die, and for any term of years you choose.  The longer the term of the charitable lead trust, the larger the tax savings will be.  A 30-year term is considered a generation skipping term and there will be no tax on the portfolio returned to the family from the trust.  If the term is less than 30 years there will be taxes on the assets in the trust, but taxes will be reduced.  For a ten-year trust, for instance, taxes may be reduced by 30 to 40 percent. 

How much is enough to give their adult children was an important question for Jennifer and Sid, but the driving force in their decision was to save more than half of their grandchildren’s inheritance by creating a 30-year charitable lead trust and eliminating a 50% estate (death) tax completely. 

16 Strategies for Saving Estate Taxes #5 Intentionally Defective Trusts:
A Valuable Resort Business Can Be Given to the Children Without Gift Taxes

Emily and Abner Brown have spent many years running their popular seaside resort and have a large taxable estate. Their grown children have worked with them in the business and they want them to have it. The resort is appreciating in value and the Browns want to get it out of their taxable estate with the fewest tax consequences possible.

The Browns have been responsible about taking advantage of appropriate one-time exemption gifting and continue annual gifting to their children and grandchildren as they look at their estate planning. Now they have maxed out their gift tax exemption opportunities, but still have a $5 million dollar property to give to their children. They know that the transfer of a family business from parents to children is a difficult issue because of taxes.

If they give the business to their children outright, the kids will owe the IRS over 40% of the value of the property or $2 million. Emily and Abner are working hard to avoid that scenario. With the help of their advisor, they set up an intentionally defective trust. This strategy allows them to save gift taxes and allows the value of their business to grow tax free in the future.

The Brown’s chose to sell their business to their children at fair market value inside the trust drawing up a legal mortgage note. The children will use the revenue from the growing business that they now own inside the trust to make the monthly mortgage payments of principal and interest to their parents. By purposely making the trust defective, all the taxes incurred by the business are taxable to the parents, not the children, and will be paid using the parents’ other taxable assets helping them draw down their taxable assets over time further reducing transfer taxes.

The greatest benefit to the parents is, of course, that the $5 million dollar business is no longer in their estate. The mortgage note gets smaller every year and the parents pay all the taxes, which in effect, are additional gifts to the children without gift taxes.

Another benefit accrues to the children if the business earns 10% going forward and all that revenue goes to trust. The children can pay 5% or $250,000 in mortgage payments and still have an additional 5% or $250,000 revenue to share without any gift tax. If they leave the $250,000 a year in revenue from the business in the trust, growing at 6 or 7 percent annually, the business could be worth $10 million in ten years.

The Browns have the potential of saving more than $3.75 million in estate taxes by getting the resort to the next generation with no gift or estate tax using an entirely aboveboard strategy.

16 Strategies for Saving Estate Taxes #4 Grantor Retained Annuity Trusts Allow You to Move:
Assets Out of Your Estate, but Maintain Control

The grantor retained annuity trust (GRAT) is an estate planning strategy that allows wealthy families to move assets out of an estate for tax saving and gifting purposes.

Gerry and Ginnie transfer $1 million to their son Hank. It is not a gift, but a GRAT. Gerry and Ginnie, as grantors, receive from Hank an annuity payment for a specified period of time. For this example we choose three years.

The IRS interest rate table 7520 sets the interest rate to be paid by the recipient or child who receives the GRAT. Assuming current 7520 rate is 6%, Hank, at the end of 3 years will pay $60,000 a year back to his parents as an annuity payment and transfer the $1 million back to Gerry and Ginnie at the end of the three year period of the GRAT’s existence.

Why would a family go to this extent to move assets out of an estate? The key is when the $1 million is given in stock in Gerry’s company, a stock that Gerry hopes and predicts will increase in value sharply because of the economic outlook for this stock if Gerry’s company stock increases by 50% it leaves Hank with assets in the GRAT worth $380,000 after returning the $1,180,000 to his parents. They have been able to transfer to him $380,000 without gift taxes. Gerry and Ginnie have saved $140,000 in gift taxes to make this transfer while they are still living.

Some families use this strategy and a family limited partnership so the grantor can continue to control and vote the stock or reinvest the cash after the sale of the stock. Under these same circumstances, if the GRAT was funded with $10 million it would avoid gift taxes and death taxes on over $3,800,000! A recession may be a great time to fund a GRAT.

 
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