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[There are three possible beneficiaries of an estate: heirs, charity, and the IRS - and with proper planning, a client gets to pick two. In this article we re-examine an extraordinary planning technique called the Zero Estate Tax Plan, a concept that completely disinherits the IRS.] A New Look at a Zero Estate Tax Plan This issue continues our review of the effect of recent changes in estate tax law on some of the most powerful charitable estate planning strategies. As we have discussed, there are three possible beneficiaries of an estate: heirs, charity, or the IRS -- and with proper planning, you get to pick two. In previous articles we have examined this logic relative to a Charitable IRA, Charitable Bequests of Deferred Annuities, and a Charitable Remainder Unitrust (Click on any of these subjects to review the article). Let's see what happens if we try this approach with all estate assets -- in other words, a Zero Estate Tax Plan. Here is how it works: A wealthy couple: 1) determines in advance a reasonable inheritance for their children; 2) makes gifts to an irrevocable wealth replacement trust of the funds necessary to purchase a life insurance policy in that amount; and 3) arranges at death to leave all other estate assets to favored charitable causes. The financial magic of this arrangement is that, even though the IRS is frozen out of the inheritance loop, all the estate assets remain available to this couple during their lifetime should they be needed to support the lifestyle (or healthstyle) they want. This produces what is truly a "have your cake and eat it too" scenario. The only way to sensibly measure the impact of such a concept is to compare the results of "doing it" to "not doing it". Case Study Background: To illustrate the concept, we will analyze the estate of Ken and Jennifer Hudson, ages 55 and 50. If they were both to die today, their estate would total $4,275,000. Please take a moment to examine the breakdown of all their assets on the Client Information Summary by clicking here. Ken and Jennifer are still adding to their asset base; however, they intend to retire in five years at which time they have planned for $150,000 a year in after tax retirement cash flow in today's dollars (assuming a 4% rate of inflation). In addition, in order to support their annual travel plans, they typically withdraw $10,000 a year from their assets for this purpose. They want to continue this pattern -- also assuming a 4% rate of inflation. They also want to be very certain they maintain a growing cushion of Net Worth in case unforeseen emergencies occur. The Analysis: In this evaluation, Strategy 1 involves preparing a Status Quo scenario to determine if the Hudsons' current asset base can support their desired cash flow requirements. Strategy 1 is then compared to a Strategy 2 scenario in which the Zero Estate Tax planning technique is introduced. This approach addresses the fundamental step that most wealth preservation plans miss -- "How does the plan compare to not doing it?" How much life insurance should go into the wealth replacement trust? This is a very subjective decision that will change on a case-by-case basis, but let's assume that Ken and Jennifer decide that $5,000,000 is sufficient inheritance for their children. They are reviewing a universal life policy illustrated at 6.5% with an annual premium of $25,000. Below are the comparative results. (Since the end of 2001 is approaching, the analysis has a date of January 1, 2002, assuming the Hudsons might not implement the plan until early in 2002.)
The upper left graph shows the impact of the Zero Estate Tax Plan on living Net Worth. (It reflects additions to Net Worth the Hudsons expect to make during their pre-retirement years.) The upper right graph shows the IRS totally disinherited with Strategy 2. (The blank slot reflects the one year of scheduled estate tax repeal.) The lower left graph shows the dramatic Strategy 2 results for the charity -- a long-range gift of in excess of $22,000,000. The lower right graph shows the effect of the Zero Estate Tax strategy on their heirs. This plan has met Ken and Jennifer's wealth transfer target in all years -- $5,000,000. Strategy #3: Is there a way to increase the children's inheritance? Let's add a Strategy 3 analysis in which their share tops their portion of both Strategy 1 and Strategy 2. We produced the Strategy 3 variation shown below by increasing the face amount of the policy to $10,000,000 with a corresponding increase in its annual premium to $50,000. As you can see from the upper left graph, this further decreases the Hudsons' living Net Worth from that shown for Strategy 2. What is most interesting about Strategy 3 is that, in all years, the heirs inherit more than they would with Strategy 1 (the non-Zero Estate Tax Plan) or 2, yet Strategy 3 also provides long-range funds in excess of $20,000,000 for charity. In all years, the total of the Wealth to Heirs and Wealth to Charity exceeds the parents' projected living Net Worth by a considerable margin.
The funds to charity could be paid to a private foundation; however, a private foundation is expensive to set up and maintain. Some public operating charities offer the virtual equivalent of a private foundation using donor-advised accounts that include name branding such as the Hudson Family Charitable Foundation. Two organizations offering this very low cost alternative are: Global Gift Fund, a division of the Million Dollar Round Table Foundation (847-692-6378), and National Heritage Foundation (800-986-4483). Both GGF and NHF allow account management of charitable funds by appropriately licensed representatives, and NHF also allows current and future generations of family members of the donor to be compensated for approved charitable work performed on behalf of the account. (Both features could also be available at either GGF or NHF through a support organization.) Using snap-shots of three different points in time, the three sets of bar graphs that follow illustrate the power of Ken and Jennifer's Zero Estate Tax Plan alternatives.
Frequently Asked Questions About Zero Estate Tax Plans: What is the source of the funds for Ken and Jennifer's gifts to the wealth replacement trust? The funding is done via asset allocation, and Ken and Jennifer are not scheduled to use their pre- or post-retirement cash flow as the source for gifts, i.e., the funding is cash flow neutral. Can a spouse be designated as beneficiary of estate assets ahead of the charity? The charity is named as the ultimate beneficiary of estate assets. The surviving spouse is typically named as primary beneficiary, and this avoids estate taxes due to the unlimited marital deduction. When the surviving spouse dies, the charitable bequests become operational. Can a Zero Estate Tax Plan be revoked? Should future circumstances dictate, the charitable arrangements can be revoked prior to the death of the second-to-die of Ken and Jennifer. Are there restrictions on any of the funds that make up living Net Worth -- even though there is a charitable beneficiary for the entire estate? No -- the funds are freely accessible at any time prior to the death of either spouse. What if Ken and Jennifer live longer than the 30 years shown? You can infer the continuance of the trend lines shown in the graphics. Conclusion: John Rutledge, the well-known Merchant Banker, has stated: "Control of wealth is the virtual equal of ownership of wealth." Certainly the power of ownership and the power of control is virtually identical. Assuming the distribution of the charitable funds will be advised by current and future generations of family members, the overall wealth controlled by the family -- directly through their inheritance and indirectly through the charitable funds -- is significantly greater using the Zero Estate Tax technique than any other wealth planning device. It is rumored that Bill and Melinda Gates' daughter will inherit only $10,000,000 directly, and the balance of the $50,000,000,000+ fortune is scheduled for the Gates Charitable Foundation. Who do you think will undoubtedly be the next-generation CEO of that Foundation? I leave it to you to analyze the power of that position -- both financially and otherwise. Working With Charities: Most charitable organizations welcome help in making an effective case for naming themselves as beneficiaries of all or a portion of an estate. A good place for you to start might be to have them read this article. Better yet, InsMark has developed a new CD presentation entitled Wealth Preservation Leverage that features Ken and Jennifer Hudson using a variety of charitable estate planning techniques -- including the Zero Estate Tax Plan but also covering Charitable IRAs, Charitable Bequests of Annuity Assets, and Charitable Remainder Trusts. We are marketing this presentation directly to charities, and we would be glad to have any of our licensees help. The presentation is customized charity-by-charity and is designed to be distributed by a charity to its donor base on CD Business Cards. (Separate versions are available for charities that offer donor-advised accounts and those that don't.) Interested donors will need professional guidance in setting up their plans, and this is where you come in if the charitable contact is made through you. (We are making the presentation available to the 400+ members of our Power Producer Marketing Group, and non-member InsGift licensees can have access to a personalized copy by contacting an InsMark Account Executive at 1-888-InsMark (467-6275), or by clicking here. Note: When we distribute directly to a charity, we provide the leads that develop to our Power Producers.) Illustration Data: We used InsGiftâ -- the Wealthy and WiseÔ System ("InsGift") for the evaluation in this article. (InsGift is the source of all the graphs shown above). Space prevents us from including all the reports generated; however, InsGift users can review all reports and menu inputs by downloading the InsGift Workbook named MA132.!IG from the Workbook Download section of this website. On our main webpage, click on Producer's Center, then click on the Workbook Download icon at the top of the next page. To download the Workbook now, click here. After downloading the Workbook, you can import it into your InsGift System by clicking on Client Workbook/Import Workbook on the Main Toolbar of your InsGift System. Note: The previously mentioned additions to Net Worth that Ken and Jennifer expect to make during the five years prior to their scheduled retirement can also be reviewed in the InsGift Workbook referenced above. If you are not licensed for InsGift, please contact InsMark at 1-888-InsMark (467-6275) (or click here) for licensing information. |
