Funding
Your Estate Plan
Funding
refers to the act of placing the assets that you and your family
own into a Trust. Funding is accomplished by re-titling the assets
in the Trust's name. The act of funding one's Trust is so important,
since the Trust can only benefit those assets that it maintains
title to.
Thousands of
Americans each year take the time, effort, and expense of diligently
setting up a trust of some type, but then fail to fund the trust
with their assets. The actual establishment of the Trust is only
half the battle. Your most valuable assets, which you want to be
controlled by the Trust, must be titled with the Trust's name for
the Trust to afford any benefit to your family.
There is no
universal rule of thumb when it comes to funding your estate plan.
Trusts should only hold title to certain types of financial vehicles.
The following is not intended to be a complete list of financial
vehicles but, rather a listing of the most common ones our clients
own today. The financial vehicles are listed alphabetically, in
order for you to get some idea which estate strategy fits which
vehicle.
Annuities
Annuities avoid
probate upon the death of the annuitant, and are viewed by many
as estate planning tools for this very reason. However, in estate
planning, there are only two wealth transfer strategies where annuities
are appropriate: in the A Trust of an A-B Trust, or within a Charitable
Remainder Trust.
Within the A
Trust, an annuity works well because the principal and earnings
grow completely income tax-deferred. When the owner of an annuity
is ready to withdraw from the annuity contract, the owner has two
options: a lump sum distribution, where earnings (and principal,
in qualified annuities) are subject to income tax, or over the owner's
lifetime, in the form of monthly income. Also known as annuitization,
this monthly income withdraws principal and interest on a tax-preferred
basis.
Annuities are
designed to be withdrawn or annuitized at some point. If you die
with an annuity contract in your estate (where either the second
spouse dies, or there is no spouse at all), the annuity does not
qualify for a stepped-up cost basis and will be subject to income
taxes. It is therefore a good idea to draw down the annuity after
the first spouse has died. This makes the annuity an excellent choice
for the A Trust when following the Shrinking Trust Principle.
Annuities are
also suitable for Charitable Remainder Trusts. However, they should
never be used in an irrevocable trust. The owner of the annuity
(in this case, the irrevocable trust) would be considered a non-natural
person. Since a non-person owns the contract, the gains lose their
tax deferred status, thus defeating the purpose of owning an annuity
in the first place.
Variable annuities
are sold through registered representatives by prospectus. You should
read the prospectus carefully prior to investing or sending money.
To request a prospectus, click
here.
Equities,
Stocks and Mutual Funds
Common stock
funds, whether they are managed by mutual fund managers or private
money managers, are an excellent funding method for estate planning
strategies. Over the past 50 years, equities have far outperformed
bonds or money market funds, making them suitable investments for
long-term objectives. Most private foundations invest in managed
equity accounts because of their long-term growth.
Equity investments
are suitable for both trusts in an AB Trust. Family
Limited Partnerships can also utilize equity investments, particularly
those with rising dividends. The dividend can go to the partnership
creator as a form of additional income under the deferred payment
plan, while the principal and the appreciation of the stock or managed
equity account is retained by the limited partner. Therefore, both
the assets and their growth pass outside the estate to the general
partner.
Equities, in
the form of common stocks, mutual funds, or managed accounts, are
also good investments for Charitable Remainder Trusts. However they
do not have the principal or appreciation guarantees that other
investments do, like annuities.
When equities
are owned by a trust, it is important to be aware that the trust
is in a slightly higher income tax bracket than an individual. If
stock dividends are paid to the trust beneficiaries, then taxes
are not a problem. But if the dividends are retained and reinvested
to make the trust grow, the trust could get hit with steep income
taxes. It may be better for the trust to invest in growth stocks
which pay little or no dividends, but produce investment returns
through appreciation. That way, current income taxes are avoided.
Alternatively,
you may want to place equities inside a Legacy Trust. The
Legacy Trust may be drafted as a grantor trust, which allows
you to pay the taxes on income earned by the trust. You can consider
these taxes an additional gift to the trust beneficiaries, since
it is not subject to estate or gift taxes.
Mutual funds
are sold through registered representatives by prospectus. You should
read the prospectus carefully prior to investing or sending money.
To request a prospectus, click
here.
Gov't
and Corporate Bonds
Long-term bonds
and funds have been very popular investments for individuals and
qualified retirement plan accounts. However, bonds or bond funds
are usually not recommended as permanent funding vehicles for estate
planning strategies. This is due to bonds' history of fluctuating
principal and interest, and their relative lack of appreciation
potential.
Life
Insurance
Cash-rich life
insurance, the type Fortune 500 companies use, is an ideal funding
vehicle for all versions of the Generation-Skipping Dynasty
Trust. Life insurance is the only vehicle that is self-completing,
meaning that your funding objectives (whether you seek $1 million,
$2 million, $5 million, $10 million or more) are achieved immediately
upon the passing of the owner.
Individual life
insurance and second-to-die life insurance are commonly used in
funding the Generation-Skipping Dynasty Trust. Term
life insurance, while useful for ensuring a support and income
for beneficiaries, is not always ideal when used with advanced estate
planning techniques. For instance, when using life insurance to
fund the Generation-Skipping Dynasty Trust, it is paramount that
cash-rich life insurance be used (not "term" insurance)
to avoid any loss of liquidity. At the end of ten years, the policy's
cash value, either on a guaranteed basis or using very conservative
interest rate assumptions, should equal the amount of premiums paid
in.
It's important
to note that the life insurance is owned by the Trust. The Trust
creator transfers cash to the Trust, which in turns pays the life
insurance premiums.
Life insurance,
purchased from highly-rated insurers, is frequently used by Fortune
500 companies to finance their deferred compensation plans. Here
are just a few of the reasons why Fortune 500 companies rely on
life insurance plans:
- The
gain on the death benefit, which can be a substantial amount over
the premiums paid in, passes 100% income tax free if paid as a
lump sum.
- The
accumulation of the cash value, or investment account, grows income
tax free.
- All
withdrawals, up to the amount of the total premiums paid, are
income tax free under current tax law.
- Policy
loans can be taken on an income tax-free basis; however, they
may be subject to a small interest charge, under current tax law.
Variable Universal
Life Insurance is sold through registered representatives by prospectus.
You should read the prospectus carefully prior to investing or sending
money. Insurance policies may contain exclusions or limitations,
please consult the carrier or insurance agent for more infromation.
To request a prospectus, click
here.
Limited
Partnerships
Limited partnerships
should not be used as investment vehicles. Many Limited Partnerships
are created for tax reasons, not investment reasons. Most wealth
transfer strategies work best when funded with cash-rich, income-building
vehicles. However, there is always an exception, such as a family
venture utilizing a limited partnership format. An Account Specialist
can answer your specific Limited Partnership questions, and how
they could fit into your estate plan.
Keep in mind
that limited partnerships are sold through registered representatives
by prospectus. You should read the prospectus carefully prior to
investing or sending money. To request a prospectus, click
here.
Modified
Endowments
Modified Endowment
Contracts (MECs) are a cross
between an annuity and a life insurance policy. The forerunner of
the MEC was the single premium whole life contracts, used to offer
tax-free loans. MECs, whose interest rates can be fixed or flexible,
have a death benefit that passes income tax-free. This death benefit
usually starts out about double the amount contributed to the plan.
And MECs are similar to other transactional investments, since you
simply make a onetime premium or single payment into the account.
The MEC really
combines the best of two worlds. Like an annuity, the dollars in
a MEC grow tax-deferred. And, like an insurance policy, the MECs
death benefit passes income tax-free. Because of these benefits,
a MEC is an ideal asset for the B Trust of an AB Trust, when following
the Shrinking Trust Principle.
A MEC is also
excellent when funding the Personal Access version of The Legacy
Trust with a one-time, large lump sum payment. A variable MEC provides
the opportunity for tax-deferred growth and professional money management,
while offering a death benefit that passes income and estate tax-free.
Municipal
Bonds
Municipal bonds,
because of their potential federal income tax-free payment, have
proven to be very popular investments. The Generation-Skipping Dynasty
Trust can actually own municipal bonds. One strategy often used
in dynasty trusts is to use the tax-free bond interest to substantially
increase the Trustçs value by purchasing life insurance on the lives
of the trust creator(s).
Family
Limited Partnerships can also use municipal bonds as an investment
vehicle. The advantages are tax-free income generated from the bonds,
as well as substantial discounts on the value of the bonds. These
benefits are derived due to the lack of control and marketability
inherent in limited partnership interests.
Real
Estate
Real estate,
including apartment buildings, commercial shopping centers, office
buildings and raw land are excellent investments for Family Limited
Partnerships. Real estate that has a positive cash flow can generate
income for you during your lifetime, when held in a Charitable Remainder
Trust. A Charitable Remainder Trust also allows you to sell highly
appreciated real estate without paying capital gains tax. Once inside
the Trust, real estate is usually sold and the proceeds invested
in income-producing investments.
Because of the
tax ramifications and capital gains concerns, it usually is not
wise to re-title real estate inside a dynasty trust or The Legacy
Trust.
Certain states
may have their own restrictions on some funding vehicles and wealth
transfer strategies described.
Read our Funding
Special Report before effecting any changes with your current
estate plan.
Each
family's situation is different. Advanced wealth transfer
strategies all have various funding options. However, we can
lead you down the path of education and help you learn more.
Then, you can make an informed decision as to how best to
fund your estate plan, to benefit your own family.
For a FREE Special Report on Funding Options, click here!
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