The Gift of a Generation - NFP€¦ · Insurance Services, Inc. which is a subsidiary of National...

The Gift of a GenerationPlanning in the New Tax Environment

There are several important issues that should be considered before entering into any of the following wealth transfer and charitable planning arrangements. A comprehensive examination of all relevant issues is beyond the scope of this presentation. Wealth transfer and charitable planning strategies have tax implications in a number of areas, including estate, gift, and income taxes. Wealth transfer and charitable planning participants must rely on their own legal and tax advisors to navigate through the various legal and tax issues associated with the following wealth transfer and charitable planning strategies. National Financial Partners and its affiliates do not give legal or tax advice.Pursuant to IRS Circular 230, we are providing you with the following notification:The information contained in this report is not intended to (and cannot) be used by anyone to avoid IRS penalties. This report supports the promotion and marketing of life insurance. You should seek advice based on your particular circumstances from an independent tax advisor.Securities may be offered through Registered Representatives of NFP Securities, Inc., a Broker/Dealer and

Disclosures

2011 NFP SCHOOL OF EXCELLENCEINTERNAL USE ONLY. Not for public distribution.

Securities may be offered through Registered Representatives of NFP Securities, Inc., a Broker/Dealer and Member FINRA/SIPC. Investment Advisory Services may be offered through Investment Advisory Representatives of NFP Securities, Inc. a Federally Registered Investment Adviser. Highland Capital Brokerage is a division of NFP Insurance Services, Inc. which is a subsidiary of National Financial Partners Corp, the parent company of NFP Securities, Inc. Not all persons using this material are registered to offer securities products or investment advisory services.Neither NFP Securities, Inc., nor Highland Capital Brokerage offer tax or legal advice. Clients should consult with their individual tax and legal professionals prior to entering into such transactions.A well planned exit strategy should be in place from the beginning.The hypothetical example results are for illustrative purposes only and should not be deemed a representation of past or future results. This examples do not represent any specific product, nor do they reflect sales charges or other expenses that may be required for some investments. No representation is made as to the accurateness of the analysis. Discusses fixed products only. Guarantees subject to the claims paying ability of the issuing insurance company.

Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010(the “Tax Act”)

New Federal Tax Laws

Key Transfer Tax Provisions of Tax Act

GiftTax

EstateTax

GenerationSkipping

Reinstated and retroactiveto 1/1/10

No Yes Yes

RateMaximum Rate

35%Maximum Rate

35%

Flat Rate2010: 0%


35% 35%After 2010: 35%

Exemption2010: $1 million

After 2010: $5 million$5 million $5 million

Election N/A

2010 only: can elect (1) carryover basis regime, or (2) provisions of the New Tax

Act.

Not impacted by carryover basis election

� Transfer Tax Provisions� Exemption Reunification and Inflation Adjustments

� Exemption Portability (Only last deceased spouse, Not for GST)

� Deduction for State Death Taxes

� Notable Income Tax Provisions



Notable Income Tax Provisions� Extension of Tax Brackets

� Extension of Dividends & Capital Gains Rates

� Charitable planning (Charitable IRA Rollover, Easements)

� Reduction in Payroll Taxes for 2011



Setting the Stage

� What is a Grantor Trust?� Grantor is treated as owner of all trust assets for income tax purposes

but not estate tax purposes.

� Why use a Grantor Trust?� Grantor pays grantor trust income tax liability

� Tax-free Gifts

� Grantor trust assets grow income tax-free

Setting the Stage: Importance of Grantor Trusts


� Grantor trust assets grow income tax-free

� Grantor and grantor trust are one tax payer

� Income Tax-free Transactions

� How are they used in wealth transfer?� Gifts

� Installment Sales

� Private Financing/Intra-family loans

� GRATs

� Increasing Income Tax Rates for Trusts in 2013?� Growing federal deficit may lead to rate hikes.

� 3.8% Medicare surtax will apply to trusts, on lesser of:

� Trust’s undistributed net investment income, or

� Trust’s excess of AGI over threshold for trusts’ highest income tax bracket (estimated at $12,000 for 2013).

Setting the Stage: Importance of Grantor Trusts


tax bracket (estimated at $12,000 for 2013).

*Top capital gains rate of 20% and top dividend rate of 39.6%, with 3.8% Medicare surtax added to each.

Income Tax Top Rates 2011 & 2012 Potential in 2013*

Ordinary Income 35% 39.6%

Long-Term Capital Gain 15% 23.8%

Dividends 15% 43.4%

Planning Opportunities & Considerations

Take advantage reunification at increased exemptions levels in 2011-2012:

� Direct gifts to grantor trusts� Supercharge installment sales to grantor

Planning Opportunities & Considerations


� Supercharge installment sales to grantor trusts

� Forgiveness of intra-family debt

Direct Gifts to Grantor Trusts

Mr. & Mrs. Smiley

• 65 and 60; $30MM estate

• 5% return; 40% income tax

Problem

• 5% return; 40% income tax

• Minimize estate tax liability

FOR PRODUCER USE ONLY

Direct Gifts to Grantor Trust: Impact of Gift (Free ze)

Values at Joint Life Expectancy – Year 31

Today - FreezeGrowth @ 5% to

Joint LE (Year 31) Totals - Year 31


Gift 2,000,000 5,000,268 7,000,268

Income Taxes @ 40% N/A 2,000,107 2,000,107

Total 2,000,000 3,000,161 5,000,161

Direct Gifts to Grantor Trust: Impact of Grantor Tr ust

Trust Values at Joint Life Expectancy – Year 31

$2MM $10MM

Non-grantor Trust 5,000,161 25,000,803


Grantor Trust 9,076,079 45,380,395

Increase with Grantor Trust 4,075,918 20,379,590

Direct Gifts to Grantor Trust: Role of Life Insuran ce

Trust Values at Joint Life Expectancy – Year 31

$2MM $10MM

Grantor Trust 9,076,079 45,380,395


Grantor TrustWith Life Insurance

10,217,037 51,085,185

Increase with Life Insurance 1,140,958 5,704,790

Direct Gifts to Grantor Trust: Success Elements

Gift

37%

Life Insurance

14%

Grantor Trust w/life insurance


Grantor Trust

49%

Direct Gifts to Grantor Trust: Dynasty Trust

80,000,000

100,000,000

120,000,000

Grantor Trust w/life insurance Grantor Trust Non-grantor Trust


0

20,000,000

40,000,000

60,000,000

Year 1 Year 31 Year 54 Year 80


Trust Values

$2MM@ Joint LE - Year 31

$2MM to Dynasty Trust@ 3rd generation – Year 80

Increasewith Dynasty Trust

Non-grantor Trust 5,000,161 20,661,923 15,661,762


Grantor Trust 9,076,079 94,402,745 36,304,316

Grantor Trust with life insurance

10,217,037 106,270,162 96,053,125


100,000,000

120,000,000

140,000,000

160,000,000

Grantor Trust w/discounts Grantor Trust

Non-grantor Trust w/discounts Non-grantor Trust


0

20,000,000

40,000,000

60,000,000

80,000,000

100,000,000

Year 1 Year 31 Year 54 Year 80

Direct Gifts to Grantor Trust: Valuation Discounts

Trust Values

$2MM@ Joint LE - Year

31

$2MM (30%Discount)

@ Joint LE - Year31

$2MM to DynastyTrust

@ 3rd generation – Year 80

$2MM (30%Discount)

to Dynasty Trust@ 3rd generation

– Year 80

Increase with30% Discount

@ 3rd generation –Year 80


Non-grantor Trust

5,000,161 7,143,087 20,661,923 29,517,033 8,855,110

Grantor Trust 9,076,079 12,965,827 94,402,745 134,861,064 40,458,319

� Acquire Insurance for a Multiplier Effect

� Death benefits typically income, estate, & GST tax-free.

Direct Gifts to Grantor Trust: Related Tool


� Enhances life insurance’s investment performance vs. other portfolio assets

� Simplify Premium Funding

Supercharge Installment Sales

Installment Sales: What is it?

� Sell appreciating assets to a Grantor Trust in exchange for an interest-bearing promissory note at the applicable federal rate (AFR).

� The sale “freezes” the value of the appreciating assets by converting the appreciating assets into a fixed-yield, non-appreciating asset (promissory note).


appreciating asset (promissory note).� All post transfer appreciation and income is removed from

estate transfer tax-free.� Client should make an initial gift (e.g., 10% of value

of asset sold) to “seed” the trust. � Higher exemptions facilitate larger “seed” gifts, larger sale

transactions, and larger, tax-free wealth transfers.

Mr. and Mrs. Client

Grantors

1Initial Gift to Trust (At least 10% of Value of Sale to Trust)

Annual Interest Payments at AFR4

Irrevocable Life

Insurance Trust (ILIT)

Grantor Trust

Owner/Beneficiary of Life Insurance

Policy

3 ILIT Pays Annual Premium

Sold and Gifted Assets Earn Rate of

Return

2 Installment Sale to Trust

Balloon Note Payment at End of Loan

Term6

5

Payment of

Installment Sales: How do they work?


Life Insurance Carrier

Death Benefit on a Joint and Last Survivor Policy

CHILDREN / HEIRS

Receive Death Benefit plus Other ILIT Assets at Second Death

8

Death Benefit7

IRS

Collects Taxes on Income and Realized Capital Gains Earned

By Grantor Trust

Payment of

Income Taxes

on Behalf of

Trust

� Transfer Growth Only� Unlike a direct gift, a sale returns the value of an asset, with interest,

to the client.

� Means direct gifts project better performance than sales.

� Provides client with a predictable income stream.

Installment Sales: Potential Benefits


� Requires less gift/GST exemption than a direct gift. � May appeal to clients who:

� Are younger or have limited liquid reserves.

� Have/will exhaust most of their gift & GST tax exemptions and still have estate tax exposure.

� Requirements for Success� Investment Performance: Asset growth above AFR.

� Client Longevity: Client survival of note term.

� Ideal Planning Environment� Historically low AFRs (May 2011 long-term AFR: 4.19%).

Installment Sales: Planning Considerations


� Depressed values (e.g., stock, real estate).

� Continued availability of valuation discounts.

� Market Risk - Investment returns on guaranteed products do not depend on market performance.

� Mortality Risk - Death benefit protects against transaction mortality risk.

Installment Sales: Role of Life Insurance


� Larger seed gifts and sale transactions help fund both note payments & insurance premiums.

Mr. and Mrs. K

• John, 68, and Susan, 65, are successful, retired and currently worth $150 million, which includes non-voting stock in a family business worth $110 million.

• Susan creates a grantor dynasty trust. seeds trust with $10 million gift

Problem

trust with $10 million gift • Applies $10 million gift & GST tax

exemptions.• Sells $100 million of assets to trust.• 10-year, interest-only note; long-term AFR of

3.88%.• Annual interest payments: $1,940,000.• 5% cash flow/5% growth (Susan pays trust’s

income taxes).


Supercharging Installment Sales

Insurance Funded Arbitrage

2010 2011-2012Amount of gift without incurring gift tax $2 million $10 million

Installment sale $20 million $100 million

Total grantor trust assets growing income tax-free $ 22 million $110 million


Cash flow from grantor trust asset s (5%) $1.1 million $5.5 million

Annual cash flow applied to interest payments (AFR 3.88%) $776,000 $3,880,000

Annual free cash flow used for life insurance premi ums (10 Pay –guaranteed to A100)

$324,000 $1,620,000

Death benefit purchased $27,741,531 $138,707,655

Post transfer asset appreciation through end of not e term (Year 10) $13,835,682 $69,178,409

Income taxes paid by grantor – tax free gift and red uces clients taxable estate

$4,950,000 $24,750,000

Supercharging Installment Sales

Insurance Funded Arbitrage

2010 2011-2012

Assets Growing Tax Free $22MM $110MM


Free Cash Flow for Life Insurance Premiums $324,000 1 ,620,000

Death Benefit Purchased $27,741,531 138,707,655

Freeze Post-transfer asset appreciation

(thru Yr 10) $13,835,682 69,178,409

BurnIncome taxes paid by Grantor

(thru Yr 10)$4,950,000 24,750,000

Direct Sale to Grantor Trust: Success Elements

Grantor

Trust

Sale to Grantor Trust

$138.7MM death benefit


Gift

76%

24%

Technique is Scalable (per $1MM gifted)

$11MM Remove Remove

$2.5MM of Acquire

Liquidity to cover estate


$11MM growing

income tax-free

Remove $6.9MM of

post-transfer appreciation

$2.5MM of income taxes

paid on grantor trust

assets

Acquire $13.8MM

death benefit

cover estate tax liability of

$30MM estate

Supercharge Installment Sales: Related Tool


Forgiveness of Intra-family Loan

Forgiveness of Intra-family Loan

� Intra-family transactions (e.g., installment sales to grantor trusts, loans, private financing of life insurance premiums or private split dollar arrangements) often result in a debt obligation being included in the grantor’s/client’s estate and subject to estate tax.


� The increased gift and GST exemption amounts - $5 million per individual ($10 million per married couple) - in 2011 and 2010, likely enable clients to forgive these loans.

Mr. and Mrs. K

• John, 68, and Susan, 65, are a retired married couple with a net worth of approximately $50 million.

• Existing note of $7.5MM from sale of business to grantor trust; interest only, AFR 2.05% due May 2018

Problem

business to grantor trust; interest only, AFR 2.05% due May 2018

• Trust generates cash flow of $350k/yr and interest payment of $154K/yr

• How can they take advantage of reunification at increased exemption levels?


Forgiveness of Intra-family Loans

Current Plan Proposed Plan

Year Age

Assets Inside Estate

Estimated Estate Taxes Net to Heirs

Assets Inside Estate

Estimated Estate Taxes

Increased Amount in

Trust Net to Heirs

1 66 50,031,250 (14,010,938) 36,020,312 42,377,500 (13,957,125) 20,822,233 49,242,608

5 70 55,490,374 (29,264,706) 26,225,668 47,221,624 (28,841,893) 20,822,233 39,201,964

10 75 63,867,063 (33,871,885) 29,995,178 54,227,860 (32,695,323) 22,124,275 43,656,812


10 75 63,867,063 (33,871,885) 29,995,178 54,227,860 (32,695,323) 22,124,275 43,656,812

15 80 74,004,589 (39,447,524) 34,557,065 62,447,563 (37,216,160) 24,568,130 49,799,533

20 85 85,756,760 (45,911,218) 39,845,542 72,074,007 (42,510,704) 27,401,227 56,964,530

25 90 99,380,747 (53,404,411) 45,976,336 83,331,250 (48,702,187) 30,685,564 65,314,626

27 92 (LE) 105,419,713 (56,725,842) 48,693,871 88,347,629 (51,461,196) 32,141,378 69,027,811

32 97 (LE + 5) 122,175,499 (65,941,525) 56,233,975 102,333,415 (59,153,378) 36,180,698 79,360,735

35 100 133,484,183 (72,161,300) 61,322,882 111,818,475 (64,370,161) 38,906,884 86,355,198


60,000,000

80,000,000

100,000,000

120,000,000

Current Plan Proposed Plan


-

20,000,000

40,000,000

60,000,000

66 70 75 80 85 90 92 (LE) 97 (LE + 5) 100

Age


Take $7.5MM note Acquire

Increase Simplify

Increase


Take advantage

opportunities available in 2011-2012

$7.5MM note removed from clients’ estate

Acquire additional $13.3MM

death benefit

Increase wealth

transfer by 41.8% or $20.3MM

Simplify existing wealth

transfer plans

Increase internal rate of return of

existing transaction

Forgiveness of Intra-family Loans: Related Tool


Wrap up

� The Act only temporarily reduces the number of families affected by the transfer tax system.

� Increased exemptions:� Offer new opportunities for tried & true techniques.

� May expand the range of products and amounts of coverage

Wrap Up: New Tax Act


� May expand the range of products and amounts of coverage that clients can afford.

� Act’s temporary nature and recent rise in federal rates could make time of the essence for certain planning.

� Advisors may want to highlight the limited timeframe so clients do not miss once-in-a-lifetime opportunities.

Wrap Up: Continuing Need for Life Insurance

� Insurance as uncorrelated asset type offers hedge against market risk

� Income Replacement� Wealth Creation

� Act’s Sunset � State Estate Taxes � High net worth clients must

still manage estate tax exposure above increased exemptions.


� Wealth Replacement� Funding vehicle (buy-sell;

key man; NQDC; DBO)� Income-Tax-Free Status of

Death Benefits

exemptions. � Insurance continues to

provide a hedge against the mortality exposure of certain planning

Questions & Answers

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