1 Step 1: Data Gathering Personal Factors John and Mary Client are both age 55 The Clients have three children: Junior, age 30; Anne, age 27, Carol, age24. All three children are married and have their own families. Anne is active in the business, Client Manufacturing, Inc. (CMI). Junior and Carol live in other parts of the country. Mary is not active in the business, and is unlikely to become so in the future. John and Mary have an annual income of $250,000 which includes $50,000 of net rental income from the property that houses CMI. Both spouses have Wills that leave everything to each other, then equally to the children when neither survives.
2 Planning Goal : Family Harmony
3 Asset Inventory Residence Summer Home Business Real Estate Client Manufacturing, Inc. Assets Owned Assets Owned Assets Owned By John By Mary Jointly $400,000 $200,000 $1,000,000 $2,500,000 Life Insurance $500,000 $250,000 Listed Securities $100,000 $50,000 $50, (k) Account $250,000
4 Planning Objectives I. John wants Mary to receive as close to their current level of income as possible. II. Anne has become very important to the business operation, and John would like her to own it someday. III. All three children are to share equally in the estate when both parents are gone. IV. Reduction of estate taxes whenever possible.
5 Step 2: Hypothetical Probate and Observations CURRENT ESTATE DISTRIBUTION If John Predeceases If Mary Predeceases JOHN'S ESTATE $4,675,000 - Administration Costs $20,000 - Federal Estate Tax $0 MARY'S ESTATE $625,000 - Administration Costs $20,000 - Federal Estate Tax $0 $4,655,000 MARY'S ESTATE $625,000 - Administration Costs $20,000 - Federal Estate Tax $1,757,200 $605,000 JOHN'S ESTATE $4,675,000 - Administration Costs $20,000 - Federal Estate Tax $1,757,200 JUNIOR, ANNE, CAROL JUNIOR, ANNE, CAROL TOTAL ESTATE EXPENSES: $1,797,500 TOTAL ESTATE EXPENSES: $1,797,500
6 Current Schedule of Estate & Gift Tax Exemptions Estate Tax Highest Gift Tax Reduction In Tranfer Estate & Gift Tranfer Maximum Year Exemption Tax Rate Exemption SDTC $1,500,000 47% $1,000, % $2,000,000 46% $1,000, % 2007 $2,000,000 45% $1,000, % 2008 $2,000,000 45% $1,000, % 2009 $3,500,000 45% $1,000, % 2010 Taxes Repealed 0% $1,000,000 NA 2011 $1,000,000 55% $1,000,000 0% 1. State Death Tax Credit 2. Deduction for state death taxes paid replaces credit.
7 Objective I : $250,000 Annual Income for Mary Listed Securities Net of Administration Costs $10,800 6%) John s Life Insurance Proceeds 6%) 30, (k) Account 6%) 15,000 Rent From Business Property 50,000 Total $105,800 Sources of Additional Income Mary s CMI stock ownership Salary?...Reasonable compensation under Sec Dividends?...Current law subject to sunset provision. Presumption of continuing profitability. Anne s cooperation...and effectiveness.
8 Objective II : Ownership Of Client Manufacturing, Inc. Passing To Anne. ' Second estate transfer costs in excess of $1,797,500. ' Available liquidity: Life Insurance Proceeds: $750,000 Listed Securities 200, (k) Account 210,000 $1,160,000 ' Forced sale of assets. Most salable assets are first to go. ' Mary s Will divides assets equally among children.
9 Objective III : All Three Children Share Equally In Their Parents Estate. ' Will Anne become minority shareholder in CMI? ' Her interests divergent from brother and sister. ' What benefit will Junior and Carol derive from stock ownership? ' Effect on family relationships if business fails.
10 Step 3: Plan Design and Implementation John and Anne establish Buy-Sell Agreement covering transfer of Client Manufacturing, Inc. Agreement funded with life insurance. $2,500,000 at 6% provides Mary with additional annual income of $150,000. (Objective I) Anne owns and controls CMI. (Objective II)
11 Implementation of estate tax reduction strategies (Objective IV) ESTATE DISTRIBUTION WITH CREDIT SHELTER TRUSTS If John Predeceases If Mary Predeceases JOHN'S ESTATE $4,675,000 - Administration Costs $20,000 - Federal Estate Tax $0 MARY'S ESTATE $625,000 - Administration Costs $20,000 - Federal Estate Tax $0 $3,155,000 $575,000 MARY'S ESTATE Income Standard of Living CREDIT SHELTER TRUST JOHN'S ESTATE Income Standard of Living CREDIT SHELTER TRUST $625,000 $1,500,000 $4,675,000 $30,000 - Administration Costs $20,000 - Estate Tax $1,052,200 - Administration Costs $20,000 - Estate Tax $1,743,100 Estate Taxable JUNIOR, ANNE, CAROL Tax Free Estate Taxable JUNIOR, ANNE, CAROL Tax Free TOTAL ESTATE EXPENSES: $1,092,200 PROJECTED SAVINGS: $705,300 TOTAL ESTATE EXPENSES: $1,783,100 PROJECTED SAVINGS: $14,400
12 Implementation of estate tax reduction strategies (Objective IV) ESTATE DISTRIBUTION WITH CREDIT SHELTER TRUSTS AND ASSET TRANSFER If John Predeceases If Mary Predeceases JOHN'S ESTATE $3,000,000 - Administration Costs $20,000 - Federal Estate Tax $0 MARY'S ESTATE $2,300,000 - Administration Costs $20,000 - Federal Estate Tax $0 $1,480,000 $780,000 MARY'S ESTATE Income Standard of Living CREDIT SHELTER TRUST JOHN'S ESTATE Income Standard of Living CREDIT SHELTER TRUST $2,300,000 $1,500,000 $3,000,000 $1,500,000 - Administration Costs $20,000 - Estate Tax $1,052,200 - Administration Costs $20,000 - Estate Tax $1,052,200 Estate Taxable JUNIOR, ANNE, CAROL Tax Free Estate Taxable JUNIOR, ANNE, CAROL Tax Free TOTAL ESTATE EXPENSES: $1,092,200 PROJECTED SAVINGS: $705,300 TOTAL ESTATE EXPENSES: $1,092,200 PROJECTED SAVINGS: $705,300
13 Implementation of estate tax reduction strategies (Objective IV) ESTATE DISTRIBUTION WITH CREDIT SHELTER TRUSTS, ASSET TRANSFER & IRREVOCABLE LIFE INSURANCE TRUSTS If John Predeceases If Mary Predeceases JOHN'S ESTATE $2,500,000 - Administration Costs $20,000 - Estate Tax $0 MARY'S ESTATE $2,050,000 - Administration Costs $20,000 - Estate Tax $0 -Georgia $0 $980,000 $530,000 MARY'S ESTATE $2,050,000 Income Standard of Living CST & ILIT $500,000 plus $1,500,000 JOHN'S ESTATE $2,500,000 Income 5% or $5,000 CST & ILIT $250,000 plus $1,500,000 - Administration Costs $20,000 - Estate Tax $699,700 - Administration Costs $20,000 - Estate Tax $699,700 Estate Taxable JUNIOR, ANNE, CAROL Tax Free Estate Taxable JUNIOR, ANNE, CAROL Tax Free TOTAL ESTATE EXPENSES: $739,800 PROJECTED SAVINGS: $1,057,700 TOTAL ESTATE EXPENSES: $739,800 PROJECTED SAVINGS: $1,057,700
14 Equal distribution of assets to all children (Objective III) U Estate assets of $5,300,000 less expenses of $739,800 leaves net assets of $4,560,200 for children. U Anne s portion comprised of business real estate. < Eliminates being in business with siblings. < Junior and Carol receive more cash, fewer illiquid assets.
15 WEALTH, RETIREMENT, ASSET PROTECTION WRAP TRUST JOHN CLIENT Annual Premiums IRREVOCABLE LIFE INSURANCE TRUST Personal Loans Asset Collateral CHILDREN TOTAL ASSETS ZERO TAXES
16 Inverse Commercial Loan Plan 1) Corporation is owner & beneficiary of life insurance policy. 2) Upon Owner s death, creditors may require full payment. 3) Owner's family pays estate tax on increased value of the corporation. 4) Owner family must deal with taxation of funds withdrawn from the corporation. Loans Paid In Full Premiums Corporation $1,000,000 Insurance Proceeds Life Insurance Covering Business Owner Creditor/ Lender 5) As owners of common stock, family members are at bottom of list for liquidation rights. Owner s Family
17 Inverse Commercial Loan Plan Split-$ Life Insurance Premiums Business Owner Annual Bonus Value Annual Loan Payment Family Trust $1,000,000 Life Insurance Policy 1) Corporation pays annual premium via either Split- Dollar or Executive Bonus. 3) Upon Owner's death, Family Trust receives insurance proceeds. 5) Owner's family pays estate tax on corporation value net of loan amount. Also, Family Trust is not subject to estate taxation. 6) Family s liquidation rights improve as general creditors. 2) Owner makes annual gift to Family Trust equal to life insurance premium. 4) Family Trust purchases loan indenture and now becomes creditor of corporation. 6) Owner's heirs receive annual income on a favorable basis from Family Trust. Loan Indenture Loan Purchase Creditor/ Lender Annual Income Owner s Family
20 SAMPLE CASE Fair Market Value : $1,000,000 of Real Estate Conservative F.L.P. : 30% or $300,000 Discount 10-Year G.R.A.T. : 50% or $350,000 Discount Gift Taxable Value : $350,000
22 Three significant outcomes of a well structured Buy-Sell Agreement for the Closely Held Corporation: Guarantees a market for the stock; Ability to determine price in advance; Opportunity to assure funding.
23 Two Types of Buy-Sell Agreement Cross Purchase < Remaining Shareholders purchase Withdrawing/Deceased Shareholder s stock. Stock Redemption < Corporation purchases Withdrawing/Deceased Shareholder s stock.
24 Buy-Sell Agreements...Key Provisions Lifetime Withdrawal < Withdrawing Shareholder must first offer his stock to the Remaining Shareholder. < Remaining Shareholder has right of first refusal to purchase stock. < If remaining Shareholder refuses to purchase stock, then Withdrawing Shareholder is allowed to negotiate sale with any third party. < Terms of agreement for sale/purchase reached with third party must be offered to Remaining Shareholder.
25 Buy-Sell Agreements...Key Provisions Sale Upon Death < Estate of Deceased Shareholder must sell, and Surviving Shareholder must purchase, or find a suitable buyer, for all shares.
26 Buy-Sell Agreements...Key Provisions Sale Upon Disability < Definition of disability... Inability to perform material duties of his/her position, (duties should be specified in separate schedule), or Same as qualification for Social Security disability benefits, or Same as qualification for benefits form individual disability income insurance policy.
27 Buy-Sell Agreements...Key Provisions Sale Upon Disability < When will sale commence?... Co-incident with qualification of insurance benefits, or Following stated period of continuous disability, i.e. 12 months, or Following any twelve months of disability accumulated over a period of eighteen consecutive months.
28 Buy-Sell Agreements...Key Provisions Purchase Price Valuation < For Lifetime Buy-Out, price to be negotiated at time of transaction.
29 Buy-Sell Agreements...Key Provisions Purchase Price Valuation < For Lifetime Buy-Out, price to be negotiated at time of transaction. < For Buy-Out upon Death or Disability, alternative valuation methods available: Book Value Capitalization Of Earnings Year s Purchase Method Weighted Average of Above Stated Value Per Share.
30 Buy-Sell Agreements...Key Provisions Purchase Price Valuation Book Value )Excess of assets over liabilities of the business. )Neglects any goodwill. )Likely that physical assets have been depreciated substantially...may bear little relation to market value.
31 Buy-Sell Agreements...Key Provisions Purchase Price Valuation Capitalization of Earnings )Multiplies average net earnings (usually for 5 years), by a factor specified in the agreement. )Multiplier normally between 1 and 15, depending upon risk of past earnings not continuing in the future. )The greater the risk, the lower the multiplier.
32 Buy-Sell Agreements...Key Provisions Purchase Price Valuation Years Purchase Method )Assumes a given rate of return on average book value over stated period, and this return is deducted from average earnings over the same period. )Difference is multiplied by assumed number of years to arrive at goodwill. )Goodwill is the added to book value to arrive at final valuation.
33 Buy-Sell Agreements...Key Provisions Purchase Price Valuation Stated Value Per Share )Shareholders agree upon current value per share. )Value is reviewed annually and can be adjusted up or down as long as all parties agree. )Provision included which increases value automatically if review was not completed within stated number of years prior to commencement of sale.
34 Buy-Sell Agreements...Key Provisions Funding Lifetime Buyout )Provisions can be negotiated at time of transaction. Sale Upon Death or Disability )Funding can be guaranteed with insurance proceeds. )If insurance amount is less than required, provisions are included to cover installment payments for the balance.
35 One Final Element...
37 Various Types of Life Insurance Coverage Term - Renewable and Convertible Current vs. Guaranteed Rates Intended for limited (Term) use/need. Male Age 45, Preferred Non-Smoker, $1,000, Year Level 15 Year Level 20 Year Level Level Premium $592 $1,041 $1,394 Beginning Annual Renewal Rate $13,440 $23,971 $40,419 Ohio National Life Insurance Company, Cincinnati, Ohio
38 Various Types of Life Insurance Coverage Universal Life Traditional - Insurance company assumes investment risk. Flexibility - Face amount, premium level and frequency. Male Age 45, Preferred Non-Smoker Death Benefit -Option A Ohio National Life Insurance Company, Cincinnati, Ohio
39 Various Types of Life Insurance Coverage Universal Life...continued Male Age 45, Preferred Non-Smoker Death Benefit -Option B Ohio National Life Insurance Company, Cincinnati, Ohio
40 Various Types of Life Insurance Coverage Universal Life...continued 20 Year Premium Payment 20 Year Premium Payment with Face Amount Reduction
41 Various Types of Life Insurance Coverage Variable Universal Life Underlying assets based in equities Insured assumes investment risk.
42 Various Types of Life Insurance Coverage Traditional Whole Life Insurance Typically has higher guaranteed values. Ability to Blend Whole Life and Term coverage. Male Age 45, Preferred Non-Smoker $1,000,000 Whole Life Face Amount Security Mutual Life Insurance Company, Binghamton, New York
43 Various Types of Life Insurance Coverage Traditional Whole Life Insurance...continued Blended $285,715 Whole Life with $714,285 Term Rider. Blended Coverage with 20 Premium Payments
44 Various Types of Life Insurance Coverage 2nd-To-Die Survivorship Life Insurance Joint Life Insurance Contract Benefit At First Death Benefit At Second Death John & Mary Client Plus Current Cash Value Face Value Plus Dividend Additions Significant Features! Tax free build-up of interest and dividends.! Tax free borrowing of equity interest.! Tax free payment of death benefits.! Extremely low insurance charges with Joint Life Contract.! Bankrupt-proof account not subject to claims of creditors.
45 Various Types of Life Insurance Coverage 2nd-To-Die Survivorship Life Insurance...continued Comparison of Insurance Costs Per $1,000 For Single Life Vs. Joint Life Coverage* * Single life based upon gov't "Table 2001" rates, joint life based upon gov't "Table 38" rates.
46 Income Taxation of Life Insurance Premiums Owned by individual: < Individual's personal rate. IRC Sec. 262(a) Owned by Business Entity: < C Corp. - Taxed at corporation's rate. < Pass-through entity - Taxed at owner's rate. Owned by Qualified Retirement Plan: < Tax-deductible.
47 Income Taxation of Life Insurance Death Benefits IRC Sec. 101(a)(1) As a general rule death proceeds are excludable from the beneficiary''s gross income. Exceptions : < Proceeds received from a Modified Endowment Contract (MEC).IRC Sec. 7702(g)(2)! Proceeds in excess of basis are subject to tax. < Proceeds as corporate dividends or compensation. < Where there is no insurable interest in the life of the insured. < Proceeds received as alimony by a divorced spouse. < Proceeds received by a creditor from insurance on the life of the debtor.
48 Income Taxation of Life Insurance Death Benefits IRC Sec. 101(a)(1) Exceptions...continued < Proceeds subject to "Transfer for Value" rules. IRC Sec. 101(a)(2)! Occurs when policy is sold or exchanged for value.! Proceeds in excess of basis are subject to tax.
49 Income Taxation of Life Insurance Death Benefits IRC Sec. 101(a)(1) < Exceptions to "Transfer for Value"! Policy is transferred to the Insured.! Policy is transferred to a partner of the insured, to a partnership in which the insured is a partner, or to a corporation in which the insured is an officer or shareholder! If the basis for determining gain or loss in the hands of the transferee is determined in whole or in part by reference to the basis of the transferor; for example, where a policy is transferred from one corporation to another in a tax free reorganization, where the policy is transferred between spouses or where a policy is acquired in part by gift.
50 Income Taxation of Life Insurance Corporate Owned Life Insurance subject to AMT IRC Sec. 56(g) Death proceeds in excess of basis are subject to AMT. Cash build-up in excess of premiums paid is also subject to AMT. "Small corporation exemption" : average annual gross receipts for previous three years must not exceed $7.5 million.
51 Estate Taxation of Life Insurance Proceeds will be includable in Insured's gross estate if he possesses any of the following incidents of ownership: IRC Sec The right to change the beneficiary, The right to surrender or cancel the policy, The right to assign the policy, The right to revoke an assignment, The right to pledge the policy for a loan, The right to obtain a policy loan.
52 Gift Taxation of Life Insurance Life insurance proceeds treated as taxable gift when paid to a third party beneficiary. Example #1: Wife owns policy on husband, and designates children as beneficiary. Upon death of husband, insurance proceeds paid to children are taxable gift. Example #2: Wife owns policy on husband, and designates irrevocable trust as beneficiary. Wife is recipient trust income during her lifetime, then trust corpus to children. Upon husband's death, gift occurs from trust to children. Value of gift equals policy proceeds less present value of wife's life estate.
53 REAL ESTATE BUSINESS INTEREST EMPLOYEE BENEFITS RETIREMENT LIFE INS Deed Designation Buy-Sell Agreement Beneficiary Designation Will Designation ESTATE SETTLEMENT PROCESS 6 Months to 5 Years Delay For tax purposes all assets pass through the probate process, while for DISTRIBUTION purposes, some assets avoid probate. TAXES AND EXPENSES OWED Federal Estate Tax State Inheritance Tax Probate Fees Personal Income Tax Estate Income Tax Debts Legal/Accounting Fees
54 Retirement Planning Update... Roth 401(k) contributions allowable beginning in 2006 under Sec. 402(a) Subject to same maximums and ADP testing as 401(k) elective deferrals. Currently available only for 2006 thru Sec. 402(a) sunsets in Subject to Roth distribution rules, plus minimum distribution requirements after age 70½. Ability to rollover to pre-exiting Roth IRA account.
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The trusted source of actionable technical and marketplace knowledge for AALU members the nation s most advanced life insurance professionals. This report has been prepared exclusively for Albert Gibbons,
Life Insurance Role of Life Insurance Insurance Program A life insurance program should be an integral part of the overall estate plan. The estate planner should review all of the forest owner s policies,
FINANCIAL PLANNING ISSUES Table of Contents The Financial Planning Puzzle 1 The Need for Financial Planning 2 Basic Steps in the Financial Planning Process 4 Choose the Financial Planning Team 5 Annual