CLAT. At the end of the term of the trust, the remaining assets pass to the donor s heirs, spouse, or sometimes back to the donor, if living.

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1 Charitable Lead Annuity Trust CLAT In General A donor may transfer assets to an irrevocable charitable lead annuity trust (CLAT). The trust then pays a fixed dollar amount to a qualified charity for either a set number of years or the lifetimes of individuals. When the trust term has ended, the remaining assets are distributed to the donor, his or her spouse, heirs or others. The trust must pay out the same dollar amount each year, without regard to its earnings. If the trust earns more than it pays out to the charitable beneficiary, those extra earnings (or asset appreciation) will pass to the non-charitable beneficiaries (children, grandchildren, others) without additional estate or gift taxes. Valuation of assets is required only at the time the assets are transferred to the CLAT. A new trust will be required if additional contributions are made in later years. Ideally, assets in the CLAT should have both income potential (to make the required payments to the charitable beneficiary) and growth potential (to pass long-term appreciation to the ultimate beneficiaries with a minimum of estate or gift taxes). After the lead (or income) period has expired, if the beneficiary of the trust is other than the donor or his or her spouse, there may be a taxable gift. The gift tax would be based on the present value of the beneficiaries right to receive the trust remainder at some future time. This calculation is dependent upon the term of the trust, the amount payable each year to the charity and the AFR (applicable federal rate) at the time of the transfer. Planning Considerations A donor establishing a CLAT needs to consider several key questions. Income tax deduction: If certain requirements are met, an income tax deduction is allowed for the value of the income passing to charity. 1 With a grantor trust the donor is considered the owner of the trust (taxable on the income under the grantor trust rules of IRC Secs ) and is allowed the tax deduction, subject to certain percentage of AGI limitations. If the trust is a non-grantor trust, the trust itself is permitted an unlimited tax deduction for distributions to qualified charities. If these requirements are not met, no charitable income tax deduction is allowed to either the donor or the trust. Remainder interest: At the end of the trust term, should the assets remaining in the trust revert to the donor or pass to other individuals such as the donor s heirs? Generation-Skipping Transfer Tax (GSTT): A taxable event for GSTT purposes will occur if the individuals who ultimately receive the assets when the trust terminates are the donor s grandchildren or a later generation. 1 See IRS Reg A

2 Charitable Lead Annuity Trust CLAT The donor transfers an asset to the trustee of the charitable lead annuity trust (CLAT), which pays the same fixed dollar amount for each year thereafter to a selected charity. A current income tax deduction is generally allowed for the present value of the income interest paid to the charity. At the end of the term of the trust, the remaining assets pass to the donor s heirs, spouse, or sometimes back to the donor, if living. Donor Transfers asset to CLAT. Receives income tax deduction. 1 Asset CLAT Trustee pays fixed dollar amount each year to the selected charity for the term of the trust. Charity of Choice Receives fixed dollar amount each year. Annual Payout Income Tax Deduction 1 After the trust is terminated the remaining trust assets pass to the person or persons selected by the donor. Final Beneficiaries These beneficiaries could be the donor, if the trust was set to last only a term of years, or it could be the donor s spouse, children, grandchildren 2, etc., which may also produce an estate tax reduction. 3 1 The income tax deduction, allowable only to grantor trusts, is based on a government determined applicable federal rate and may have to be spread over more than one year, if it exceeds certain percentage of income limitations. 2 Choosing grandchildren (or later descendants) to receive the assets when the trust terminates may trigger the Generation-Skipping Transfer Tax (GSTT). 3 Under the Tax Act of 2001, the federal estate tax is gradually phased out until its final repeal in the year If Congress does not act at that time to repeal it for the years following, it will automatically revert back to the rates in effect during the year 2001, with an exemption for the first $1,000,000 of assets. 889

3 Term Life Insurance What Is Term Life Insurance? Term life insurance, as the name suggests, provides life insurance only for a limited period of time, or term. Other types of policies, such as whole life, universal life, or variable life, are considered to be permanent insurance, and are designed to provide protection for the entire life of the insured. Term insurance might be compared to an automobile insurance policy. While the auto policy is in force, the insured enjoys protection against loss from an auto accident. If no accident happens, no benefits are paid under the policy. At the end of the period covered by the policy, there is no refund of premiums paid. Term life insurance works in much the same way. Term insurance thus provides only pure insurance protection and does not have the cash value feature typically found in most permanent life insurance policies. Unlike most permanent policies, in which premiums usually remain level over the life of the policy, the periodic cost of term life insurance increases as the insured becomes older. The cashvalue feature found in permanent policies provides a cash build-up within the policy which allows for the level periodic premium. In later years, the premiums for a typical term life policy will far exceed those of the typical permanent policy. Policy Variations There are a number of different types of term insurance: Annual renewable term: Term insurance characterized by a level death benefit, a premium that increases at each annual policy renewal, and no cash-value accumulation. Example of Annual Renewable Term $ Time Annual Premium Death Benefit 303

4 Long-Term Care Long-term care (LTC) is the term used to describe a variety of services in the area of health, personal care, and social needs of persons who are chronically disabled, ill or infirm. Depending on the needs of the individual, long-term care may include services such as nursing home care, assisted living, home health care, or adult day care. Who Needs Long-Term Care? The need for long-term care is generally defined by an individual s inability to perform the normal activities of daily living (ADL) such as bathing, dressing, eating, toileting, continence, and moving around. Conditions such as AIDS, spinal cord or head injuries, stroke, mental illness, Alzheimer s disease or other forms of dementia, or physical weakness and frailty due to advancing age can all result in the need for long-term care. While the need for long-term care can occur at any age, it is typically older individuals who require such care. Individuals With Disabilities, by Age 1 Age Range No Disability With a Disability 5-15 Years 94% 6% Years 93% 7% Years 87% 13% Years 70% 30% 75 Years and over 48% 52% What Is The Cost of Long-Term Care? Apart from the unpaid services of family and friends, long-term care is expensive. The table below contains national average cost data (regional costs can vary widely) for typical long-term care services; it provides an approximate guide to the cost of long-term care: Service Assisted living facility 2 $2,524 per month $2,905 per month $2,968 per month ($30,288 per year) ($34,860 per year) ($35,616 per year) Nursing home 3 (Private room) $192 per day ($70,080 per year) $203 per day ($74,095 per year) $206 per day ($75,190 per year) Nursing home 3 (Semi-private room) $169 per day ($61,685 per year) $176 per day ($64,240 per year) $183 per day ($66,795 per year) Home health aide 3 $19 per hour $19 per hour $18 per hour Homemaker/companion 3 No data available $17 per hour $17 per hour 1 Source: U.S. Census Bureau, 2005 American Community Survey. Table B18002, sex by age by disability status for the civilian noninstitutionalized population 5 years and over, male and female. 2 Source: The MetLife Market Survey of Assisted Living Costs, October, Source: The MetLife Market Survey of Nursing Home and Home Care Costs, September,

5 Simplified Employee Pension (SEP) Disadvantages to Employer A. Contributions must be made for part-time and seasonal employees. B. Employees can withdraw the funds as fast as they are put into the account. C. Employees are always 100% vested there are no forfeitures to reduce employer contributions. D. Employees control investments. E. Allocation methods that reduce employer costs may not be used; employee costs can be high compared to other types of plans. However, some plan documents used by investment vendors permit integration with social security, which will reduce employer contributions to some extent. Disadvantages to Employees A. There is no guarantee as to future benefits. B. Investment risks rest on the participant. C. There is no assurance as to the frequency and amount of employer contributions. D. Special lump-sum tax treatment of distributions is not available. E. There are no forfeitures to be reallocated. F. Life insurance funding is not available. 497

6 Simplified Employee Pension (SEP) SEP vs. Profit Sharing Plan Item SEP Profit Sharing Maximum employer 25% of covered compensation 25% of covered compensation deduction for all plan participants Maximum amount excludable from current taxation for Lesser of 25% of compensation (limited to $230,000 in 2008) or $46,000 Lesser of 100% of compensation (limited to $230,000 in 2008) or $46,000 employer Included in employee No No gross income? Eligibility All categories of employees except Some flexibility union Waiting period Age 21/any amount of service during 3 of last 5 calendar years Age 21/1 year service (or 2 years if 100% vested) Part-time employees Eligibility for contribution Must annual contributions be made? Deadline for making contributions Reporting and disclosure (employer) Must be included if they earn more than $500 in the year for which a contribution is made. If eligibility for plan is met, the employee is entitled to contribution whether or not employed on date of contribution No Discretionary Tax filing date, including extensions Minimal Excluded if less than 1,000 hours in plan year Determined by the plan document No Discretionary Tax filing date, including extensions Full ERISA requirements Top-heavy regulations Apply Apply Investments Decided by employee; no hard assets or collectibles (except certain government coins) Decided by trustee Plan may allow participants to direct investments Allocation of contributions Pro rata by compensation, but may be integrated with Social Security Various Most favorable to highly paid and/or older participants Federal bankruptcy law provides significant protection from creditors. Terms of the plan trustee/administrator Protects from claims of bankruptcy creditors Federal bankruptcy law provides significant protection from creditors. Who controls Employee withdrawals? Vesting requirements Always 100% vested May be graded up to six years 498

7 How a SEP-IRA Works Employer Contributes for all qualified employees. 1 Contributions are tax deductible. Plan is flexible (contributions are not required each year). Generally little or no administrative expense. SEP-IRA A separate IRA exists for each participant. Employer contributions are not currently taxable. Earnings accumulate taxdeferred. Plan is self-directed (employee controls investments). Investment risk remains on employee. Employee Maximum 2008 allocation to a SEP for an employee is $46, For a selfemployed individual, the limit is also $46, Early Withdrawal A 10% penalty generally applies if withdrawals are made before age 59½. Some exceptions to 10% penalty are available. Earnings + deductible contributions taxed as ordinary income in year received. Retirement Distributions must begin by April 1 of year following year owner reaches age 70½. Required minimum distribution rules apply. Earnings + deductible contributions taxed as ordinary income in year received. Death Value of IRA is included in owner s gross estate. Proceeds can pass to surviving spouse with payments over survivor s lifetime. Income and estate taxes can severely reduce SEP-IRA funds left to nonspousal heirs. 1 Any employee at least 21 years of age who has performed service in three of the last five years, and whose total compensation exceeds $500 for the year. 2 For an employee, contributions may not exceed the lesser of 25% of compensation (maximum of $230,000) or $46, For a self-employed individual, contributions may not exceed the lesser of 20% of compensation (maximum of $230,000) or $46,

8 Reverse Mortgages The Pros and Cons of Reverse Mortgages There are a number of reasons why a reverse mortgage may not be appropriate: Not needed: Some retired individuals will not want to consider a reverse mortgage simply because it is not needed; their financial needs during retirement are already adequately met. Security: Reflecting long-held attitudes toward savings and debt, some individuals may not be comfortable with the idea of placing any type of mortgage on the home, once it is paid for. Legacy for heirs: Rather than using the equity in the home for current needs, a homeowner may want the equity to pass to family members or other beneficiaries, such as a charity. There are also a number of situations where a reverse mortgage can help: Enjoy life: For some, the extra dollars provided by a reverse mortgage may make it easier to pay routine monthly expenses. For others, it may allow an occasional splurge. Pay off debt: Funds from a reverse mortgage can be used to pay off other types of personal debt that require monthly payments, such as credit card balances. Maintain independence: Some may wish to make improvements to the home, or pay for in-home care, to allow them to remain independent as long as possible Provide for the future: Even though the present financial situation is stable, a reverse mortgage can provide a way to meet unforeseen future circumstances. Choosing a Reverse Mortgage Unlike just a few years ago, a wide range of reverse mortgage programs is available today. Further, the specific details of each program can vary greatly. A standard series of questions can be used to compare and contrast each program: How much cash? In general, the amount of cash which can be borrowed will depend on the lender s policies, the age of the borrowers, the value of the home, the home s condition and location, and the interest rate. The amount of available cash can vary greatly from one lender to the next. How will the cash be paid? Depending on the lender, the cash from a reverse mortgage is typically available to the borrower in one of three ways. In some cases a combination of payment methods may be available: Lump sum: The loan proceeds can be paid with one check, usually at the time the loan is closed. 193

9 Reverse Mortgages Many retired individuals find themselves living on a fixed income. Many also own a home which is either paid for, or which has a very small mortgage, a situation often described as house-rich-and-cashpoor. In the past, there have been few acceptable ways to take advantage of this home equity, apart from selling the home. Recently, however, a new financial tool has been developed the reverse mortgage which provides qualified individuals access to the equity in their homes, and still permits them to retain ownership of the home. What Is a Reverse Mortgage? Most homeowners are familiar with the traditional home mortgage. An individual buys a home, and, over time, as the monthly payments are made, the balance due on the mortgage is gradually reduced. A homeowner s equity the difference between what is owed and the market value is also increased if a home s market value increases. In the traditional, forward mortgage, as debt decreases, equity increases. A reverse mortgage, as the name implies, works in the other direction. With a reverse mortgage, cash flows from a lender to a borrower. Over time, the balance due increases. In a reverse mortgage, as debt increases, equity decreases. Eligibility: Reverse mortgage programs generally require that all borrowers be at least 62 years of age. The home must be owner-occupied, and be the borrower s principal residence. Not all types of homes qualify; all programs accept single-family detached homes, and some allow 2-4 unit owner-occupied homes, condominiums and manufactured homes. Only first mortgages are permitted. Any other debt secured by the home must either be first paid off, or paid off with proceeds from the reverse mortgage. Ownership: During the term of the mortgage, the borrower remains the owner of the home, and is responsible for payment of property taxes, maintenance and repair, and keeping the home insured. Repayment: No payments are required as long as the borrower lives in the home. The outstanding loan balance, including accrued interest and any loan costs, is due when the last borrower sells the home, permanently leaves or dies. In a few instances, the loan is due at the end of a fixed term. Typically, the loan is repaid by either selling or refinancing the home. Any remaining equity is paid to the borrower, the borrower s estate or heirs. Maximum loan balance: A borrower can never owe more than the value of the home at the time the loan is repaid. Reverse mortgages are generally nonrecourse loans, which means the lender can only look to the value of the home for repayment. 192