Something Old, Something New: Creating a Comfortable Future Using Existing Policies and Plans

By: Randy Fox
Firm Name: InKnowVision
Contact: Randy@inknowvision.com   
Location: Naperville, IL
Industry: Tax Consulting

Quick Read
Karl and Rachel Parsons are 54 and 47 respectively, have two grown, unmarried daughters, and have a total net worth of $6.7M. Karl is a successful physician who has worked very hard to build his practice and he would like to retire in four or five years. In preparation for this occasion he has already invested $2M in various retirement plans, and individually Karl and Rachel own life insurance policies as well as an Irrevocable Life Insurance Trust (ILIT).

In addition to passing on as much of their estate as possible to their children, the couple also wants to ensure a $500K charitable gift upon death, and create a plan that allows for a comfortable retirement.

Challenge
With a large portion of the Parsons' assets going toward income taxes each year, there is little room to plan for the desired gifts to children and charity. This problem gets worse as the years go by and, using our illustrations, shows that the children would receive around the same amount as would be paid to taxes, with no gift going to charity. Retirement would be less than desirable for the couple as their tax burdens would increase annually.

Design
As we discovered after utilizing the Family Wealth Diagnostic, the Parsons' current planning indicates they will pay more than $2M of estate and income taxes if they passed away this year leaving $9M to the children (including their existing insurance). By 2032 (the couple's expected life expectancy) that number grows to $13M in tax and $14.5M to the children with no gift to charity. In order to achieve their objectives, they will need a well-developed strategy that helps them:

·         Give the maximum amount to children

·         Provide a gift to charity

·         Reduce the amount of estate and income taxes

·         Ensure  a comfortable retirement

Using the Family Wealth Goal Achiever we were able to integrate several strategies which helped the client to establish a means of achieving all of their goals and more:

1. Re-titled assets into Rachel's name to maximize the use of her exemption
2. Established a Family Limited Partnership (FLP) and transferred $3M in exchange for GP and LP interests
3. Established Grantor Deemed Owner Trusts (GDOTs) for each individual and made a cash gift to each
4. Appraised and sold LP interests to trusts in exchange for notes with 20-year amortization
5. Purchased $10M survivorship insurance on the lives of Karl and Rachel using GDOT, where GDOT pays first year premium and then not again until 2017
6. Entered into 1035 exchange on three existing life insurance policies
7. Transferred personally held insurance policies to existing ILIT
8. Established separate Qualified Personal Residence Trusts (QPRTs) for their lake home, using 15-year terms due to their ages
9. Set up early withdrawals (before 70 ½) from Karl's retirement plans to relieve excess tax burden from large concentration of wealth in retirement assets

The re-titling of the assets under Rachel's name fully utilizes the applicable exclusion for each spouse, and eliminates any planning concerns. The 1035 exchange and transfers of existing life insurance policies help to remove the insurance death benefits from the Parsons' taxable estates.  Even though the insurance will be included in their estate if they die within three years following the transfer, it is expected that they both will survive for that period of time and complete the transfer without any problems. Following the 15-year term of the QPRT, the couple will pay rent for the property which creates another gift and income tax-free wealth transfer to the heirs. Additionally, in order to maximize the transfer of wealth to their children, early withdrawals from the retirement plans created the best results, eliminating the need for heirs to use those retirement assets to meet later liquidity needs.

Results 
Using the Family Wealth Diagnostic along with the Family Wealth Goal Achiever we were able to identify the current risks as well as the potential opportunities. We concluded our recommendations would significantly reduce estate and income taxes, make more of the estate available to the children, allow for a charitable gift, and allow the clients to feel more secure about life after retirement.

By following our recommendations we were able to transfer an additional $10M to the heirs if the clients died in the current year, and $14M more by 2032 -- their life expectancy. We were also able to accomplish the $500K charitable gift while assuring the couple's retirement goals.

Lessons Learned

·         Use FLP, GDOT, ILIT, and QPRT for a combination of tax advantages

·         Use the GDOT cash flow as a means of acquiring a large life insurance policy

·         Use existing plans to reduce tax and establish tax-free transfers