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LEGACY PLANNING
While most people have given some consideration to their legacy, most have never put it in writing, and even fewer have established a plan of action.
Most people think of legacies as inheritances they leave in their will; after they are gone. Estate Planning achieves the effective and efficient transfer of wealth to the next generation. Legacy Planning is more about your values; and it starts well before life has ended.
Living legacies are a hidden gem that few consider or know about. Living legacies can range from philanthropic planning to passing along family values to engaging family and community. They allow you to see the impact your generosity has on your favorite charities, your family, your business and your community.
We have a myriad of tools to help you plan your legacy. Legacy Planning, is so much more than Estate Planning
THE LEGACY TRUST
There are times when grandparents or other family members wish to create a fund to provide an economic benefit for a young family member. There are several choices, but each has a few problems.
- Outright gift to the minor child
The child, as a minor, cannot manage investments. All such amounts are available to the child at age 18 - a time when the undue influences of peers may encourage profligate use of the funds.
- Gift to the child, with parents as custodians
If the parents in any way use the funds, they could be construed as part of the parent’s estate and thus subject to taxation and even attachment.
- Gift to a 2503(c) Minor's Trust
This requires a carefully drafted legal instrument and will permit the retention of funds for a longer period. If the child’s parent were not the trustee, there would be no question of attribution to the parent. However, there are installation and administration fees as well as investment responsibilities.
- Use of a "Legacy Trust" with insurance
There are significant income and estate tax savings with long term transfer of wealth assured. If properly structured and funded, the proceeds are excluded from the estate of the grandparent (donor) and the parent.
CREATING THE LEGACY TRUST
A legal instrument is drawn for the benefit of the child (or children) naming a trustee who is neither the grandparent nor a parent. This avoids the inclusion of the trust in either's estate. The assets of the trust are protected from the creditors of the grandparent, parent and even those of the child. The trustee could be a trusted friend or a family member who is not the parent. A provision would include as successor trustee a financial institution. This would be a 2503(c) trust that would extend to age 21 the beneficiary’s right to demand withdrawal.
FUNDING THE LEGACY TRUST
A grandparent may transfer to such a trust up to $12,000 per year, per child. If there are two grandparents, the "gift splitting" provision permits the transfer of up to $24,000 per year. This could be done for several grandchildren. Since the future financial or medical events might cause a change in the grandparent’s circumstances, there is no requirement that future transfers be made, even though that might be the intent at the outset.
INVESTMENTS OF THE LEGACY TRUST
The Trustee transfers the amount of each year's gift toward the purchase of an interest sensitive, investment grade life insurance policy on the life of the child’s parent. Thus if the parent were to die, the value of the trust would be substantially increased, replacing the previous economic support of the parent.
INSURANCE FEATURES
The insurance policy would use a minimum death benefit to avoid the MEC (Modified Endowment Contract) potential. This would enable the child to withdraw funds for education without income tax implications. Whenever gifts to the trust cease, the policy would not lapse, but move into a "paid up" mode using one of several options.
COMPARING THE LEGACY TRUST
To determine whether this is a viable option, it is necessary to answer the following question, “How does the Legacy Trust compare with other investments?” Let us look at six options that might be compared with regard to their capacity to transfer wealth. These are examples only and not intended to portray any particular investment, but rather average historical results that are not an estimate of future earnings.
- Option 1 - Certificate of Deposit. This is a low risk, secured investment where the earnings are fully taxable each year. A long term rate might be 5%. Net after tax return 3.25% in a 35% tax bracket.
- Option 2 - Treasury Note or Bonds. This is a longer term, higher yield investment that might have a surrender penalty for early withdrawal. Yield might be higher, but without risk of principal, such as 8%, net 5.2%.
- Option 3 - Traditional Taxable Investment. This might be a corporate high yield bond fund - with earnings at 10%. Because of the higher yield, there might be some risk involved. As bond interest rates increase, the principal value declines. Net return 6.5%.
- Option 4 - Municipal Bonds or Bond Fund. This is a tax-free investment with assumed earnings of 6% and no tax on any appreciation. In essence, a zero coupon bond that it is not called and therefore, there are no capital gains.
- Option 5 - Growth Mutual Funds. This assumes that the Mutual Fund pays a dividend of 3% per year and has growth (appreciation) of 8% per year - a total yield of 11%. The dividends would be currently taxed and the growth would be taxable upon liquidation. Net return 7.15%.
- Option 6 - Interest Sensitive Life Insurance. This assumes the life insurance was issued on a 35-year-old male (father) with the earnings credited at 8.75%. While rates will vary with the economy, in general, reduced earnings of other investments would parallel a reduction of insurance policy earnings.
OTHER ASSUMPTIONS
The annual gift is $12,000 per year for a maximum of 18 years. The net reduction of the estate of the grandparent(s) would be less, since federal estate tax would range from 18% to 55%. Thus, if the federal and state tax brackets totaled 50%, the net amount transferred to the child in this example was only $90,000. Income taxes are computed at 37%, reflecting both federal and state duties. Withdrawals from the Legacy Trust would be tax free via law (IRC Section 72) and Death Benefits would be received tax-free as well (IRC Section 101a).
SUMMARY OF LEGACY TRUST BENEFITS
- Assets within Legacy Trust grow tax-free
- Tax-free distributions can be taken on a discretionary basis
- No investment decisions are necessary
- No trust management or reportable income
- Substantial estate transfer cost savings
- No gift or estate tax consequences
- No application of the “Kiddie Tax” to grandparent or parent
- Substantial increase in value should parent die
- Proceeds are liquid and easily available
- Plan is flexible - deposits can be altered or discontinued
- The child is discouraged from removing trust proceeds
- Total withdrawal triggers income taxes
- Discretionary withdrawals are always available
- Tax benefits are extended
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