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[One of the major problems of advising clients with substantial wealth is a mind-set called "economic disassociation" - a condition in which the advisor views a client's wealth from a personal vantage point. This often leads to cases that may be mathematically elegant but never close. This article deals with both the financial and psychological aspects of presenting a Charitable Remainder Trust and offers a technique that will help prevent economic disassociation from affecting your cases.] Testing Financial
Tolerance Recently, this series has been reviewing charitable and family wealth preservation strategies for Nathan and Greta Baier. The last two articles examined the "Charitable IRA" technique and the "Zero Estate Tax Plan". One of the Baiers' assets is $5,000,000 of low growth, closely-held stock. This issue deals with the donation of that stock to a Charitable Remainder Trust (CRT) along with a study of a potential "pothole" that may lie in certain CRT recommendations. Case Study Background: Nathan and Greta are age 65 and 60 respectively. If they were both to die today, their estate would total almost $12,000,000 (plus $1,000,000 of paid-up, irrevocable trust-owned life insurance). Please take a moment to examine the breakdown of all their assets on the Client Information Summary. On that Summary, you can see they have a fairly diversified portfolio which includes the $5,000,000 of stock in a family-owned business noted above (which they assume will grow in value by 5% a year). Consistent with the prior studies, Nathan and Greta want $200,000 a year in spendable cash flow in their retirement years -- increasing by 3% a year as an inflation offset. The analysis runs until their ages 95/90 and, over this term, they will require cumulative after tax cash flow of $9,515,084. They also want to be certain to maintain a growing cushion of net worth in case unforeseen emergencies occur. They would like to sell the stock back to the business and invest the proceeds for a higher return - but have not done so due to the $1,000,000+ of capital gains tax that will be generated. (They are counting on the step-up in basis at their death to eliminate the capital gains tax.) Their advisors have recommended placing the stock in a tax exempt charitable remainder trust -- thereby creating an immediate income tax deduction of $900,000. If the business redeems the stock from the charitable trust, the capital gains tax is avoided, and the entire proceeds of $5,000,000 can be reinvested by the trust. At their death, the Baier Family Foundation will be the beneficiary of the assets in the charitable trust. During their lifetime, the Baiers are willing to assume that the charitable trust will earn 10% to be allocated as follows:
There is concern that the charitable transaction will substantially reduce the children's inheritance. To offset the loss, the advisers have recommended that the Baiers create a wealth replacement trust drawn in favor of their children. This trust will purchase $5,000,000 of second-to-die life insurance on Nathan and Greta to be funded by gifts of $50,000 a year to the trust. Click here for an example of a policy they might use. Potential Pothole: The donation of $5,000,000 in stock to a charitable trust represents almost half of the Baiers' Net Worth. They may be concerned that the loss of access to this asset may leave them short of funds later in life and, if you ignore this issue, you may do so at your peril. To address this often undisclosed issue, you need an analysis that takes into account:
Analysis: In the InsGift graphic below (Figure 1), Phase 1 of the analysis shows the current situation, and Phase 2 reflects the utilization of both the charitable and wealth replacement trusts. 
Figure 1 Initially, Phase 2 reduces the Baiers' Net Worth (caused by the gift of stock to the charitable trust as well as the gifts to the wealth replacement trust); however, their Net Worth in Phase 2 is gradually reinstated and ultimately exceeds Phase 1. (This is largely due to the income generated by the charitable trust.) Let's see in Figure 2 below if the interim reduction is worthwhile . . . 
Figure 2 As expected, Phase 2 of the analysis produces superb results for charity. As shown in Figure 3 below, the heirs are considerably better off in Phase 2 as well -- since the $5,000,000 in stock no longer goes through the estate tax grinder at death. (The stock has been replaced by the $5,000,000 income and estate tax free life insurance death benefit that is part of the Phase 2 solution.) 
Figure 3 Conclusion: This evaluation has been designed to produce a tolerable temporary reduction in Nathan and Greta's Net Worth (only they can say for sure), a significant increase in the wealth passed to heirs, and a major deferred endowment for favored charitable causes. The power of the analysis allows Nathan and Greta to make informed decisions about the value of the technique in the context of their own needs and desires as well as those of their children and charity. The reasoning behind the analysis is based upon this simple fact -- many people are more concerned with running out of money than they are in saving taxes. Although a presentation may well contain what appears to be irresistible mathematics, without the assurance of a Net Worth comfort zone analysis, the response may well be when in doubt, do nothing. One of the major problems of advising clients with substantial wealth is a mind-set called economic disassociation -- a condition in which the adviser views a client's wealth from a personal vantage point. This often leads to cases that may be mathematically elegant but never close. The strategy discussed not only deals with both the financial and psychological aspects of presenting a Charitable Remainder Trust but also uses a technique that will tend to prevent economic disassociation from affecting your cases. Working With Charities: Most charitable organizations welcome assistance in becoming beneficiary of deferred gifts. You can help them do so convincingly with our InsGift System using the strategy examined in this issue or, perhaps, the Charitable IRA or the Zero Estate Tax Plan technique discussed in the previous two articles in this series. Downloading Data: InsGift 4.0 users can review all reports and related menu inputs we used to create the analysis in this issue by downloading the InsGift Workbook named MA113Wor.!wb from the Workbook Download section of our website. Either download now, or visit our website at www.insmark.com. (On our main webpage, click on Producer's Center, then click on the Workbook Download icon at the top of the next page. After downloading the Workbook, you can import it into your InsGift 4.0 System by clicking on Client Workbook/Import Workbook on the Main Toolbar of Version 4.0 of your InsGift System.) If you are not licensed for the InsGift System and would like more information, please contact an InsMark Account Executive at 1-888-InsMark (467-6275), or click here. Note: The InsGift System does not perform CRT calculations. If you are in this market, we assume you have access to other software such as Numbers Cruncher, Philanthrotec, Crescendo, etc., in order to calculate the income tax savings generated by a CRT as well as the after tax income to the donor. InsGift has menu inputs for this data but does not calculate it. |
