Feature Stories - November 2008

Transferring Wealth

Securing tax-efficient distribution of your wealth

by Alexis K. Burke

Estate planning is a key component in a wealth management program and yet, too few individuals take the appropriate steps to create a wealth transfer plan. In most cases, people do not approach estate planning with eagerness or ease, but unexpected tragedies occur often and this is reason enough to address estate planning as a financial priority. Hesitancy with regards to wealth transfer planning can lead to unnecessarily high tax burdens, extended periods of probate, endless litigation and loss of lifestyle.

Regardless of an individual’s level of wealth, there will likely be assets that outlast their life. Deciding what to do with those assets is the initial step in the process of estate planning. Solid estate planning informs one’s advisors and family of their plans, crafts a wealth transfer program that centers on personal goals and protects one’s wealth from superfluous taxes.

According to Reed Radosevich, President of Northern Trust in Las Vegas, “Wealth transfer is a lifelong process of allocating your wealth to provide for and protect the people you care about, which can include community giving. Every adult who desires to have their wealth distributed according to their wishes in a tax-efficient manner should have a wealth transfer plan in place.”

Crafting Your Estate Plan

David Turner of the accounting firm Turner, Loy & Co., LLC in Reno begins estate planning by simply asking his clients, “Why don’t you tell me what you want to have happen to your money today?” With this question, Turner opens the dialogue that is crucial to the discussions of planning one’s estate. He added, “The answers to that question depend upon such things as age, health, family situation, retirement needs and expectations, charitable inclinations, status of business or employment and the desire to pass on wealth to heirs.”

It is easy to do estate planning by the numbers, but there is a personal side that needs to be considered, said Turner. “There has to be a certain level of trust that includes open communication between the individual and their advisor and ideally, estate planning would begin early in a person’s life with a professional hand at the helm along the way.”

Identifying what a person wishes to achieve with their wealth is the cornerstone of successful estate planning, though once this distinction has been made, one will likely realize that their financial goals will evolve over the course of their lifetime and periodic revisions are a must. At Northern Trust, it is suggested that a wealth transfer plan be updated in the event of the following:

• Death of a spouse or child

• Serious illness

• Birth of a child or grandchild

• Employment change

• Marriage or divorce

• Sale of business• Move to a new state

• Change in asset value or composition

• Health changes

• Change in goals and objectives

• Tax law revisions

Understanding what is owned and how it is owned seems straightforward and yet assets often get overlooked when constructing an asset inventory list. Ownership structure [individual, tenants-in-common, community property, etc] ultimately determines how a beneficiary will benefit. Typically, estate planners will request a written asset inventory list that should include:

• Investment portfolios

• Annuities

• Homes (primary, vacation, timeshares)

• Employee stock options

• Interests in trusts and investment partnerships

• Insurance policies

• Retirement plans

• Business interests

• Real estate and mineral interests

• Outstanding notes and loans

• Collections

Wealth Transfer Fundamentals

Most people do not have a will, much less power of attorney documentation or a revocable trust in place. In fact, according to recent statistics, nearly one-fourth of wealthy individuals stated that their will was updated five or more years prior.

It is generally understood that a will is a document which enables the transfer of assets individually owned upon a person’s death, names an executor to oversee the estate, lists special bequests and disposes of remaining assets not titled in the name of a trust.

Radosevich warns that the need for revocable trusts remains due to certain asset classifications that do not transfer under a will, such as property titled in a revocable trust, property titled in joint tenancy with right of survivorship, retirement accounts, life insurance, annuities, pay-on-death bank accounts, transfer-on-death brokerage accounts and assets under beneficiary deeds.

It is important to understand the functions of a revocable trust, also referred to as a living trust, this type of document can be altered or changed by the grantor during his or her lifetime. Upon death the trust becomes irrevocable and its assets are distributed according to the trust’s provisions.

Power of attorney documents protect an individual and their family while they are alive in the event that they are no longer capable of speaking on their own behalf and grants legal representation to a designated individual. A power of attorney ceases upon death, at which point a person’s will and revocable trust will be relied upon to correctly dispose of their assets.

When designating authority to someone such as a power of attorney, choosing the executor of a will or a trustee, it is important to consider a few factors. Will this person be able to carry out your wishes in the face of disputes? Do they possess the capacity to handle the legal requirements? Oftentimes, people choose to have a corporate successor co-trustee or co-executor whereby they are able to include a family member in the execution of the estate but also tap into the knowledge of a trust professional simultaneously.

Decreasing Your Tax Liability

A large facet of estate planning is aimed at minimizing the amount of taxes owed through the proper use of tax exemptions, exclusions and deductions. Currently, there are three transfer taxes, gift, estate and generation-skipping that inflict taxes on transfers of wealth. For 2008, estate tax exemption stands at $2 million and in 2009 it will be $3.5 million.

Gift tax is not imposed on transfers to ones spouse, a charity or for the direct payment of tuition and medical care. There is an annual gift tax exclusion ($12,000 for 2008) that allows individuals to give gifts up to this amount and not impose a tax. A person is allowed to give away $1 million during a lifetime in addition to their exclusion gifts. In some instances, it is more tax-efficient to transfer wealth through this medium than transferring at death because it shifts assets out of your taxable estate before they appreciate further and also reduces the amount of the taxable estate at the time of your death.

Generation-skipping tax (“GST”) is applicable to transfers made to grandchildren or a non-family member who is more than 37 ½ years younger than the person transferring. There are annual exemptions for the GST as well, $2 million in 2008.

“Developing a program of lifetime gifting that takes advantage of the array of exemptions, exclusions and deductions available is key to avoiding transfer taxes,” said Radosevich. “This will include consistent use of the annual gift tax exclusion, use of the unlimited exclusion for direct payment of tuition and medical expenses, including payment of health insurance premiums and for the very wealthy, utilizing taxable lifetime transfers that use part or all of your available gift tax exemption. Also, if you are charitably inclined, consider a program of lifetime philanthropy.”

The Use of Trusts

Trusts offer a large amount of flexibility in achieving estate planning objectives. Knowing which type of trust is best suited for a particular wealth transfer plan can depend on the following considerations:

• Marital status

• Have young children or grandchildren

• Desire to protect an heir’s inheritance from lawsuits, creditors or divorce

• Have spendthrift or irresponsible children to protect

• Want to make a charitable gift

Revocable trusts or living trusts are the most popular type which allows an individual to add or remove assets, change investments, change beneficiaries or fully revoke the trust during a lifetime. The trust documentation names beneficiaries and the conditions of distribution to those beneficiaries.

“The most commonly cited benefits of a revocable trust include protection of privacy, helping manage your affairs if you become incapacitated, ease of asset administration and usefulness for multi-state assets,” said Radosevich. “While an important wealth transfer tool, revocable trusts do not eliminate all estate taxes, negate the need for a will, affect non-probate assets or protect your assets from creditors or disgruntled relatives.”

Irrevocable trusts on the other hand cannot be altered or amended once established. This type of trust does not allow creditors or ex-spouses access to the assets named in the trust, an important feature for certain circumstances. Common irrevocable trusts include:

• Charitable trusts

• Irrevocable life insurance trusts

• Grantor retained annuity trusts (GRAT)

• Asset protection trusts

• Retirement assets

Retirement assets such as an individual retirement account cannot be passed on by a will or revocable trust. These assets pass at death to beneficiaries named by the deceased in a separate document called a ‘beneficiary designation’ which states who will receive the retirement plan proceeds. It is important to think about taxes when making these designations because the fair market value of a retirement plan is included in the value of the estate and therein subject to estate tax. Additionally, distributions made to the beneficiaries are typically taxed to them at ordinary income rates. “Properly structured beneficiary designations can save or defer taxes by stretching out the payout period since distributions are not taxed until distributed,” said Radosevich.

It is a frequent misconception that only the extremely wealthy are in need of wealth transfer programs, but without the proper documents in place, an unnecessary portion of your assets will be lost in probate due to the higher costs of resolving the estate. “There is no equity in courts. Decisions are made based on evidence produced, even if one side is incompetent and that is scary,” said Turner, a strong advocate of avoiding court battles.

“A wealth transfer plan should express a person’s financial objectives, personal values and beliefs, philanthropic goals and specify how they want their wealth transferred during their life and upon their death,” commented Radosevich. “Ultimately trying to preserve what may have taken someone a lifetime to build.”