Why Counseling? Why the Three Steps?*

Many people think of estate planning as a way to save estate taxes and perhaps a way to avoid probate.  There are many more important reasons for estate planning.

For example, have you considered the following questions?:

• How do you want to be cared for when you can't take care of yourself?  
• If your wife remarries after you die, do you want to make sure that her new husband can't spend your money? 
•  If your husband hits a van full of lawyers after you die, do you want to make it harder for them to collect your money when they sue him?  
• If your wife divorces her new husband after her remarriage, do you want to make sure that he doesn't get half of your money?  
• Do you want to make sure that your guardians know how to share your values while they finish raising your children?

I suggest that most of people would answer "yes" to all these questions.  So how can you make sure your plan is accomplishing these things?

Problem #1 with Traditional Estate Planning:  Most estate plans are upside down!  They focus on tax planning instead of personal concern, protections, and goals.

Problem #2 with Traditional Estate Planning:  Most estate plans just don't work!  A plan works when every expectation of the client is met.  These expectations aren't met because clients and professional advisors see estate planning as a transaction ending in documents, instead of the process ending in results.  Things change.  Estate plans should, too.

We believe that client families will achieve the best estate planning results with a Three Step Strategy that uses clear, comprehensive, customized instructions for their own care and that of their loved ones.  The instructions might include a will, a trust, a power of attorney, a living will, and other documents.

Step #1: Work with a Counseling-Oriented Attorney as opposed to a word-processing attorney.  Most estate planning in the U.S. is little more than word-processing.  You don't need a professional for that! The professional's value come from the counsel and advice based on knowledge, wisdom, and experience.

Step #2:  Establish and Maintain a Formal Updating Program.  There is a constant change in personal situations, both family and financial.  Tax laws and other laws change every year in ways that will impact many estate plans.  Finally, because attorneys don't know everything, the attorney's experience and expertise change.  Without updating, plans won't work the way the family intended them to.  Without a Formal Updating Program, the updating rarely happens.

Step #3: Assure that My Wisdom is Transferred Along with My Wealth.  In many families, the parents have an abundance of wisdom that has often been earned the hard way.  Through Wealth Reception, an approach that prepares children and grandchildren (or nephews and nieces, or godchildren, or friends) to receive wealth, parents' wisdom can help make their money a benefit instead of the burden that is often becomes.

Most financial windfalls, including inheritances, disappear within 18 months.  Our clients can avoid that unfortunate conclusion to an otherwise worthy inheritance with proper Wealth Reception planning.

*Adapted from the Planning Partners Press.

Quality and Net Worth Are Not Synonymous*

Jack Kent Cooke started his business as a high school drop-out selling encyclopedias door-to-door, and grew until he owned a collection of media companies, sports teams, and real estate valued at $1.3 billion.  Most know him as former owner of the Washington Redskins football franchise.  Although a successful and sophisticated businessman, his estate planning failed miserably.

What Does This Have to Do With You? Though most of us don't have estates worth $1.3 billion, this is a great case study on how planning that is not well-designed and customized according to a client's wishes can result in devastating financial and emotional costs after their death.  This is not an issue of net worth.  It is a planning quality issue.

Jack Kent Cooke's Plan: Mr. Cooke has a will that was amended eight times.  It left seven executors, most of them former employees.  When presented with the will, most of them had never seen it before.

The Widow's Claim: Ms. Ramallo Cooke was Mr. Cooke's wife, whom he divorced once and then remarried.  Despite having signed a prenuptial agreement on her remarriage, a fight ensued, ending in a $10 million settlement to Ms. Cooke to end the expensive litigation ($6.8 million in legal bills.)

Sell Which Assets? An executor, Stuart Haney worked with Mr. Cooke to create the Jack Kent Cooke Foundation to help underprivileged students.  Due to a large estate tax bill, the only way the foundation could be funded was to sell assets of the estate.  Cooke's son (also an executor), has worked in management of the Redskins for most of his life, shared his father's passion for football, and dreamed of someday owning the Redskins.  Cooke, Jr. was adamant that the Redskins franchise not pass from family control.  However, because the sale of the team promised the best return, the executors, against the protests of Cooke, Jr., chose to auction the Redskins.  Cooke, Jr. was outbid an the team passed out of family control.

Paying the Executors: The will didn't specify how much the executors should be paid.  In Virginia, up to 5% of the estate is allowed.  Again, lawyers were hired, and litigation began.  Cooke, Jr. claimed that executors' fees exceeding $5 million were unreasonable.  The remaining executors felt that they earned and deserved the 5% fee ($37.6 million).  The case was decided in favor of the 5% fee.  Subsequently the count commissioner of accounts cut his fee to $415,000 to avoid further litigation.

In the End: Cooke, Jr. never received the Redskins, which he dreamed about and worked towards his entire life.  The executors were divided and bitter, and still have to work together as board members for the Foundation.  The estate settlement lasted 7 years and cost $64 million in professional fees.

Learning from Mistakes: Most clients believe that their situation is straightforward and simple and that they don't have a lot of money.  They may not have the wealth of Jack Kent Cooke, but proper planning is every bit as important for them as it was for him.  If they fail to plan well, or if their plan fails them, the result can be financial and emotional devastation for their families and loved ones after death.

*Adapted from the Planning Partners Press.

An Irrevocable Life Insurance Trust With All the Ingredients for Success*

As we've recently been discussing, Irrevocable Life Insurance Trusts (ILITs) are very powerful estate planning tools.  Unfortunately, they often fail  because people do not follow the particular rules necessary for them to succeed.  In addition, there are gift and estate tax consequences to be considered.  In this issue, we want to review with you a Private Letter Ruling (200404013) from the Internal Revenue Service about an ILIT that passed all tests with flying colors.

The Trust
The Basics: A husband created an Irrevocable Life Insurance Trust.  The husband funded the trust with shares of an S corporation, along with other assets.  The Trustees of the trust were his wife, along with a Corporate Co-Trustee.  The beneficiaries of the trust were the couple's children.  The distribution provided that upon the death of the husband, the trust would divide into separate trust shares for each child.

The Insurance: The trust then purchased a survivorship life insurance policy on the lives of the husband and wife.  The policy was purchased with the assets already inside the trust.  Ten annual premium payments were to be made, all with assets in the trust.  There would be no additional contributions to the trust by the husband or wife.

The Distribution: The sub-trusts created for each child, upon the death of the husband, would pay quarterly to each child the net income of their respective trust share.  The remainder assets will be kept in trust and distributed at the discretion of the trustee for care, health, education, maintenance, or support.

The Key Ingredients
The legal, financial, and tax advisors who participated in the creation of this trust really took the time to think through the variety of rules that impact this type of planning.  Some of the key strategies they implemented that allowed this trust to succeed are as follows:

1. The wife, as Co-Trustee of the ILIT, executed a written document denouncing her right as trustee to:
     a. Change the beneficiary of the policy
     b. Revoke any change of beneficiary
     c. Assign the policy
     d. Revoke any assignment of policy
This result was the avoidance of incurring incidents of ownership, which would have caused the amount of the life insurance to be included in the husband's estate.

2. The husband renounced any right to make contributions to the trust and to appoint a successor advisor.
This resulted in avoiding a gift tax problem.

3. The husband funded the trust, but had his wife consent to treat the gift as a split gift.
This resulted in doubling the amount allowed to be gifted without incurring gift tax liability.

4. Sufficient Generation-Skipping Tax exemption was allocated to the trust to result in zero inclusion ration for GST tax purposes.

The Payoff
This strategic approach allowed this ILIT to avoid any gift tax liabilities.  The proceeds of the policy were not included in either the husband's estate or the wife's estate.  The trust also has a zero inclusion ratio for GST tax purposes.  Most important, this trust accomplished the goals of the clients:

1. To leave money to their children in a way that is protected from creditors and potential divorces;
2. To leave money to their children in a leveraged manner; and
3. To utilize strategies to reduce their estate tax liability.

This is a great example of how the strategic planning of advisors can help clients accomplish their goals!

*Adapted from the Planning Partners Press.

Irrevocable Life Insurance Trusts: Using ILIT Proceeds to Pay the Death Tax*

One of the more confusing aspects of an Irrevocable Life Insurance Trust (ILIT) is how the life insurance proceeds paid out to the ILIT can be used to pay the death taxes of the insured person.  The temptation is for the ILIT trustee (especially if the trustee is an inexperienced family member) to find out what the tax bill is, and then write a check to the IRS.  However, just as there are certain steps that must be followed in establishing an ILIT, there are also special considerations in receiving and paying out the life insurance proceeds after the insured has passed.

In a nutshell, the trustee of the Irrevocable Life Insurance Trust cannot pay the death taxes created by the insured person's estate  directly.  If the ILIT trustee does so, the payment is considered a taxable gift.  Instead, the death taxes should be paid by the living trust or probate estate of the deceased insured person.  Assuming the ILIT was set up and the insurance was purchased specifically to take care of this expense, how do we get the death proceeds from the ILIT to the living trust?

One method we employ is to include special language in the ILIT that allows the trustee to make loans to the maker's living trust or probate estate.  Let's say the life insurance proceeds are for $1,000,000 and the estate tax bill is $894,000.  The trustee of the ILIT can loan money to the trustee of the living trust.

If the loan method is used, the transaction must be at arm's length to avoid any gifting problem.  In addition, the indebtedness should be evidenced by a formal promissory note, and interest must be paid on the loan.  The loan must eventually be repaid or extinguished in some manner.  (We'll say more about that momentarily.)  So at the end of the transaction, the ILIT has a note receivable and the living trust has a note payable.

An alternative to making a loan is to have the Irrevocable Life Insurance Trust buy property from the maker's revocable living trust or probate estate.  Under current law, all of the property included in the maker's estate receives a step-up in basis at death.  Therefore, if the ILIT purchases property that has a step-up in basis for the purchase price equal to that stepped-up value, there will be no taxable gain.  If the price paid exceeds the value, then the difference will be subject to capital gains tax.

The net effect is that the living trust or estate has cash with which to pay the death taxes, and the ILIT now owns property.  Since the beneficiaries of the revocable living trust and the ILIT are almost always identical, there has been no real change in their economic positions.

Additionally, we typically included a merger clause in both the revocable living trust an the ILIT. This language allows the two trusts to collapse into one another and be administered as one trust -- as long as the terms of the two trusts are substantially identical.  In such a merger, the notes payable and receivable from the loan strategy would also cancel each other out.

*Adapted from the Planning Partners Press.

Irrevocable Life Insurance Trusts: Choosing Trustees*

Trustees for Irrevocable Life Insurance Trusts (ILITs) must be selected with special care because the consequences for not following the instructions in the trust can be serious.  The trustmaker is not permitted to act as a trustee of an ILIT.  Doing so would give the trustmaker too much control, and the value of the life insurance proceeds would be includable in his or her estate.  If the trust owns a second-to-die policy, neither trustmaker can be the trustee.

During the lifetime of the client, the family CPA may be the best choice.  Accountants are a good choice primarily because of their attention to detail.  An ILIT requires close attention for accounting, notification to beneficiaries, payment of premiums, and follow-up.  Since administration of an ILIT during the trustmaker's life is mostly ministerial, the accountant can be relied upon to meticulously follow the correct procedures.  After the death of the trustmaker, other trustees (including the client's children) can either replace the accountant or can be added.  At that point, we recommend appointing ILIT trustees consistent with those found in the trustmaker's Revocable Living Trust.

A bank trust department is another good candidate for the position of the initial ILIT trustee.  Like accountants, bank trust departments can be relied upon to carefully perform the business of administering the ILIT.  That is their primary business after all, and they typically use reliable and experienced professional trust officers.

Generally, if the ILIT holds only life insurance policies and a nominal amount of cash, the fee charged by most banks trust departments is reasonable for the tasks performed.  Recently however, bank fees have been escalating due to perceived liability, and many banks will only serve as trustee when there is a significant banking relationship.  On the other hand, accountants usually charge an hourly rate, and annual administration of an ILIT is often not terribly time-consuming.

Other advisors can make good trustees, too.  However, it is important that an advisor be detail-oriented and equipped to administer the ILIT properly.  Desire is not enough.  Attention to detail, good bookkeeping practices, good follow-up, and existing systems and procedures are absolute requirements for an advisor who takes on the job of ILIT trustee.  Attorneys and other advisors usually are not covered by malpractice insurance for work performed as a trustee and will usually turn it down.

If a trustmaker feels uncomfortable naming a bank or an accountant as sole trustee, or insists on naming a friend, a relative, or an inexperienced advisor, it is almost always better to add an accountant or a bank trust department as a co-trustee.  Two heads are better than one, and that is especially true in trusteeship.

The client may reserve the right to remove the trustee and (with certain limitations) to replace him if the arrangement later proves to be unsatisfactory.

*Adapted from the Planning Partners Press.