Your Money Matters More

Trust Decisions

I am often asked the question, what do I need to consider when daftng a trust. Below I have listed the top 3 items I think are important when creating a trust.

First you need to consider the beneficiaries. What are their ages and their spending habits? Are they a minor or an adult? They will have very different needs and you will have different decisions to make for different situations.  For a minor, you need to provide your spouse or the minor directly with income as well as a way to pay for college.  If some of them have been to college and others have not you need to determine when to make distributions from the trust and how long you keep the money in, and trust.

Next you have to determine how many distributions you make from the trust. I suggest to clients that they make more than one but not more than three. The reasoning behind this is that two gives them a second chance and handling the money.  However if they have not learned their lesson by the time they receive the third distribution they probably are a lost cause.

The final main decision are the trustees. While corporate trustees such as banks provide for a knowledgeable trustee, you don't know who you're going to get when your trust actually comes into existence.   A private trustee, although less expensive, may not know what to do.

These are the main decisions you need to make.   Although there are many more decisions that have to be made.  You should consult with an attorney before drafting any trust documents.

Demystifying Life Insurance

Life Insurance is not as mystical as it may seem. When you strip away all of the riders you are left with one of four types of policies. These policies are annual renewable term, whole life, universal, and variable universal. These differ in cost and risk and it is important to know what you are looking for.

 

Annual Renewable Term Insurance is pure insurance. It is a pay as you go type of policy with costs increasing every year. This type of policy is good for a young family, because it allows one to buy a larger policy than a whole life when you have a greater need for coverage and you are still healthy. This would cover such things as your mortgage and children’s education in years where sufficient income is not available to pay for a whole life policy.

 

Whole Life Insurance is permanent insurance. In other words if you pay your premium you will always have coverage. This type of policy is good for middle aged individuals who have a health issue or want to have burial costs covered. Partners in business can buy whole life policies on each other. After the death of one of the partners, the remaining partner would be able to use this insurance to buy the remainder of the company from the deceased’s estate. The premium on this type of insurance remains the same. A percentage of this premium is put towards its cash value and the rest is put towards the insurance itself. Over time the amount towards its cash value declines and the cost for insurance increased. This is due to the well known fact that getting older puts you at greater risk to shuffle off this mortal coil, kick the bucket, or join the choir invisible. But even as you age the premium doesn’t change.

 

Universal Life Insurance is a combination of cash value and term insurance. This allows you to contribute at a minimum the cost of insurance and additionally as much cash value as you want to with some coverage limits. You can’t contribute more than a certain percentage of the policies worth in cash value. This allows you to have a greater amount of term, and later in life contribute to cash value as you are able to. Unlike a Whole Life policy the premium is not guaranteed to stay the same. Just as with a Term policy you are subject to any price hikes the 

insurance company puts in place. This would be a great policy for those who want to hedge their bet, get an affordable insurance premium, and still be able to build cash value as their income increases.

 

Variable Universal Life Insurance is similar Universal except that you are responsible for the investment of your cash value. You are given a selection of pseudo mutual funds to invest in. These funds may be stock, bond, or international funds allowing your cash value to participate in the returns or losses of their respective markets. If you or your financial planner (for example Charles T. Shearman CFP of Prospero Financial) is market savvy, this may be the appropriate insurance policy for you.

 

These are the basis for all life insurance policies. Make sure to carefully examine any policy you are thinking about purchasing. Riders can substantially modify the look of the policy, but the underlying policy is one of these four. Understanding what your policy can do for you or your estate is very important, both when choosing, and when cashing it in.

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Different Types of Trusts

Different Types of Trusts

When establishing your estate plan, trusts can serve as a way to put your intent into the estate plan even after your death. The trust is funded from the estate. In an estate, property passes by ownership first where jointly owned assets are passed to the joint owner, contracts with a named beneficiary are second (i.e. IRAs, Insurance Policies), and lastly only what is left over flows through your will. Many people establish elaborate trusts only to have them unfunded at their death because they have everything titled jointly with their spouse.

Testamentary Trusts 

The most common trust is a Testamentary Trust. This trust is drafted as a part of your will and is funded at the time of your death. This is the next step up from having only a simple will. While this is a perfectly acceptable form of trust, this lacks several of the advantages which Living Trusts provide.

 Living Trusts or Inter-Vivos Trusts

These are the next step in the sophistication of your estate plan. This form of trust can be funded during your lifetime or upon your death. A living trust can be the beneficiary to contractual assets. In addition, the will would divide your assets into two baskets; personal property and invest property.  This means that all of the personal property are disposed of through the will and the remainder are investment assets which are transferred into the trust.

 Irrevocable Insurance Trusts

These are drafted in addition to or in place of the two other trusts. This trust is named the owner and beneficiary of your insurance policies. Since they are irrevocable they are not included in your estate at your death.  A neat trick is to make it the owner of a term policy. That way if you later decide that you don’t want the trust, if you are insurable, then you simply don’t fund the policy and it defaults thus rendering your trust irrelevant.

 Items of Note

With any of these trusts the terms are open to your intent. Regarding distribution, you can distribute income and principle as you see fit.  You will probably want to make the terms of all your trusts similar if not identical. Children with special needs require specific care to be drafted within the trust so as not to disrupt their disability services.

 

This is an oversimplification of the trust law and you should consult your attorney before establishing your estate plan.

Buy Smart

    I have always had medical professionals as clients. One thing this has taught me is that being smart enough to pass med school doesn’t necessarily translate into financial intelligence. Doctors, as well as any professionals who have a steadily increasing salary at the start of their careers, can often make purchases that hurt their cash flow down the road once their income plateaus. This makes it all the more important to develop an emergency or “slush” fund early in your career no matter what your occupation. Then later in life, once your rainy day money has grown, the finer things are less of a strain on your bank account. The two main purchases that can set an individual up for financial distress are expensive cars and big houses. Making the right buys can lead to a life of comfort, if done correctly.

 

Fancy Cars 

 

When individuals jump up into the six figure income bracket one of the first things they want to do is buy an expensive new car. What they fail to realize is that when they drive their so called “investment” off the lot, it loses thousands in value immediately. Their new car will then continue to lose value until the wheels fall off. But Chuck, “How am I supposed to show off my financial superiority while I’m on the go?” It’s  simple. Buy used. Say you think you would look nice in a Mercedes-Benz SLK350. You’ve worked hard to bring in the money and its time to reward yourself. A new SLK350 costs over $55,000. A used last year model costs $36,000. Paying an extra nineteen grand for that “new car” smell seems quite ridiculous. Any other investment that declined in value by 35% its first year would make you furious. Even for individuals with more modest tastes, a Honda Civic loses four thousand in its first year off the lot which is still a 20% decrease. Do yourself a favor and let someone else be the sucker who has to unload their bad investment in a year’s time.

 

Living Large 

 

The other mistake many make is purchasing a house that is too big early in their careers. If your job is putting fat stacks in your slacks the worst thing you can do is tie yourself down to a house that will pull cash out of your pocket for the next fifteen to thirty years. We at Prospero Financial always push to develop a solid emergency account before purchasing an expensive home. Buying a less expensive home allows you to build that emergency fund faster.  You will then be able to make a larger down payment on your next home. This will give you more equity to build on. You will need 20% equity in the property in order to avoid private mortgage insurance and decrease your mortgage payment.

 As unpredictable as the housing market is, you want to make sure that your house and property are sellable when the time comes. Choosing your neighborhood wisely can make a huge difference in the future. Picking the right house in that neighborhood can be just as important. The most expensive house in a neighborhood will be the hardest to sell. When prices in housing go up your palace might increase in value, but a home is worth nothing if there’s no one to buy it. The cheapest house in the neighborhood can be just as tough. Look for a home that is in the upper middle price range for the neighborhood you are moving into and you will have made a safe choice if you ever need to liquidate the property. Lastly, when  it comes time to sell a house, you need to leave yourself at least six months time to keep from leaving money on the table. Selling a home can be profitable, as long as you make smart decisions along the way.

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Should You Buy a New Home or Older Home?

Paterno

I was reading in a blog the other day about some estate planning Paterno had done that looked like he was trying to avoid prosecution on any law suits. Nothing could be farther from the truth in that these were done for estate planning reasons. See the crux of it is a Qualified Personal Residence Trust (QPRT). We have done those for clients over the years to preserve their assets and reduce them from estate taxes. They are good vehicle for that as opposed to keeping them from being attached in the case of a lawsuit. They are for keeping a property in the family by gifting it away while still holding a hold on the assets for some fixed term. This is a legitimate technique as he has the right of all Americans to not pay more then their fair share of taxes. This would be no different than people having their parents gift assets to them in order to qualify for Medicare. They do this without a second thought while still taking advantage of the system and the other taxpayers indirectly. Why is this different? It is still a legitimate technique to get out of paying more than once fair share in preserve the asset base. This is all that Paterno was trying to do when he went about using us in estate planning technique that is basic in nature for wealthy individuals. Since it was not done in contemplation of the lawsuit as indicated in the Times article but well in advance of that and really provides limited protection from the lawsuit sensationalism of this information not only was erroneous but was inflammatory.

Case Study in Retirement Planning - Part 2

In Part 1, we established the Jack and Diane Davis family and their current net worth.  In this, Part 2, we will address gifting to their soon-to-be-born grandchild.  There are a variety of ways to accomplish this and not pay any gift tax.  And since they have more income than will be needed in their retirement they wish to make a gift to their grandchild.

 

Gifting Options

• One option they can use is their annual exclusion.  This amounts to $13,000 each, or a total of $26,000 for the couple.  Since they will be buying Christmas and birthday presents throughout the year, it's not advisable to use all of this credit.  They would probably want to use $25,500 at a maximum.  This can be done each year for each grandchild from this point forward.  This needs to be a "present value" gift.  In other words, this needs to be money they can spend, i.e. cash. 

• Another option is to use their one-time credit that ultimately totals $1 million for each spouse, and then it will be gone.  Right now it might seem excessive, but the child will have many years to receive gifts and this is better reserved for a future time, or when they can do some form of "leveraged gifting.” 

• “Leveraged gifting” means that something that is valued at than $1 today will only use $1 of the lifetime credit.  Since the value of things is calculated at the time of the gift, now would be an ideal time to do this, when the market has not fully recovered, and prices are depressed.  Leveraged gifting involves either giving a future interest in something, or something that has its value decreased by its container, i.e., a family limited partnership.  The reason a future value gift is not worth dollar-for-dollar is because it has delayed gratification to it.  A problem with these gifts is they may never be completed, and they have the ability to get sucked back into your estate.  These may take the form of a Grantor Retained Income Trust (GRIT).  In other words, the grantor retains the right to the income during his/her lifetime, or a specified number of years.  The longer the term, the greater the discount.  This is just one type of leveraged gifting. 

• Wrapping these gifts in a partnership which has a general partner and limited partnership interest is another form of discounting.  These are discounted because they have strings attached.  In other words, because of the restrictions placed on the beneficiary, the gifts can't just be spent or sold.  Real estate and business interests are often ideal assets for this type of entity.  It makes it easily dividable into units to distribute among the children.  For example, Jack could take the stocks in the furniture store and divide them among the children, giving a limited partnership to all the children, and the general partnership to only those children involved in the business.  Or he can retain the general partnership interests, thus retaining control of the partnership. 

These are only a few of the endless possibilities for gifting.  In fact, I have seen some individuals who have used these techniques to keep the family together at holidays by holding board meetings in exotic locations!  And this arrangement is advantageous for tax reasons too. 

I will expand on this subject in future articles.  For now, suffice it to say that Jack and Diane have a multitude of good options they can choose.

 

Case Study in Retirement Planning - Part 1

This is the first in a series of blogs that will follow a couple, called Jack and Diane, who are approaching retirement.

 

Family Background

Jack is a business owner, and Diane is an anesthesiologist.  They have four children, one of whom is a special needs child. This gives us ample fodder for this series of articles that we are going to do in this blog.  Following this couple from age 50 through the birth of their first grandchild and business planning succession, funding of their retirement, estate planning and estate equalization for those children who don't work in the business.  They will also need to make provisions for the special-needs child.  And they will also develop some lifetime gifting programs.

Through this blog, you can follow the couple as they journey through the many facets of retirement and estate planning.  Please stay connected to learn how all of these things are accomplished to help Jack and Diane arrive at retirement with their financial arrangements in order and a sense of well-earned peace of mind.

Diane participates in a 403(b) plan at her work for a not-for-profit hospital.  Her annual salary is $250,000.  Jack has amassed a large portion of his money in a 401(k).  His annual salary through the furniture store he owns is $175,000.

Family Statistics

John (Jack) Davis, age 50, furniture store owner

Diane Davis, age 50, anesthesiologist, member of anesthesiology group

Child:  Gregory, age 25, married, no children – is involved in furniture business

Child:  Lynn, age 23, married, expecting first child – not involved in furniture business

Child:  Allison, age 20, in college, working part-time at furniture business

Child:  Timothy, age 16, special-needs child

 

Jack and Diane's Balance Sheet

Assets
Jack’s 401(k)	$350,000
Diane’s 403(b)	$450,000
Furniture Store	$1,750,000
Primary Residence	$450,000
Investments	$200,000
Duplex (rental property)	$125,000
Personal Property	$225,000
Total	$3,550,000
Liabilities
Mortgage on Residence	$250,000
Mortgage on Duplex	$125,000
Total	$375,000
Net Worth	$3,175,000

 

 

 

Since this is the first in a series of articles, Be sure to check back and stay tuned to see how we deal with family and business issues and successfully bring Jack and Diane to retirement.