Lifetime planning not only saves you a ton of tax dollars, but also significantly increases your wealth and makes the rest of your life less stressful. Of course, your lifetime plan will dovetail with your estate (death) plan.
Let’s use Joe as an example for how this works. Joe is worth $44 million. Here are his significant assets: He owns 51 percent of Success Co., which is worth $19 million; his business real estate is valued at $10 million; his two residences are worth $4 million; his rollover IRA is worth $2 million; and his stock portfolio is worth $9 million. Joe also has a $10 million life insurance policy.
His sister Sue owns 49 percent of Success Co. Only one of Joe’s five children, Sam, is in the business and will take over for Joe someday.
Joe, age 62, plans to live to age 87, and his 60-year-old wife, Mary, plans to live to 93. Remember, no estate tax is due until the second death, which is a long time frame for a comprehensive lifetime plan.
Joe hates paying taxes. He has spent a small fortune over a span of 5 years with various professional advisors in an attempt to create an estate plan that accomplishes four key goals: get the business to Sam without losing control of it; treat the four non-business kids fairly; grow his wealth so he can leave an equal dollar amount to the non-business kids; leave at least $10 million to his alma mater; and find a tax-effective way to buy Sue’s 49 percent of Success Co.
The following are strategies we used to accomplish Joe’s goals based on the assets he owns. Notice that every one was implemented as part of Joe’s lifetime plan, while leaving his estate (death) plan alone.
1. Success Co.: We created 100 shares of voting stock (51 for Joe and 49 for Sue) and 20,000 shares of non-voting stock (10,200 shares for Joe and 9,800 for Sue). We then created two intentionally defective trusts (IDTs) to buy the non-voting stock. Sam is the beneficiary of both IDTs and will own all of the non-voting stock when the cost is paid using Success Co.’s cash flow. The entire IDT transaction is tax-free to Joe, Sue and Sam. This means no income tax, no capital gains tax and no estate tax.
Joe bought Sue’s voting stock for $100,000 and will continue to control Success Co. for life.
2. Business Real Estate: We created a charitable lead trust (CLT) and transferred the business real estate to the CLT, which will receive $1.2 million in annual rent from Success Co. The CLT was set up to last for 16 years and pay 7 percent per year (or $700,000) to charity. The Joe Family Foundation will receive the $700,000, a portion of which will pay the premium on a second-to-die life insurance policy on Joe and Mary for $10 million (and will ultimately go to Joe’s alma mater).
The real estate is now out of Joe’s estate for tax purposes. After 16 years, the balance in the CLT will go to the non-business kids—all tax-free.
3. Residences: We transferred a 50-percent interest in each of the two residences to Joe’s trust (from his existing estate plan). The other 50 percent went to Mary’s trust. This strategy provides a minority discount, lowering the value of the residences to $2.8 million for estate tax purposes.
4. Rollover IRA: We used a strategy called Retirement Plan Rescue to purchase $15 million of second-to-die life insurance, using the IRA funds to pay the premiums. The entire $15 million will go to the children tax-free. The $10 million term policy was allowed to lapse.
5. Stock Portfolio: We transferred the portfolio to a family limited partnership, lowering its value to $6 million for tax purposes because of discounts allowed by the tax law.
6. Estate Plan Trusts: Finally, we amended the current estate plan trusts with the appropriate language to make sure that the various assets, including the insurance, would treat the non-business kids fairly.
After 4 months the plan was done. In addition to accomplishing all of his lifetime goals, Joe got a huge dollar bonus—the plan gets all $44 million of his wealth to his kids with all taxes paid in full.
What’s the planning lesson to be learned from Joe’s story? Smart lifetime planning plus your old traditional estate plan prevent loss of wealth to the IRS.