Personal Wealth Law News

This title will be familiar to readers of the adventures of Sherlock Holmes. It’s a story mentioned in one of the Holmes stories as one for which the world was not yet ready. Apparently, the world was never ready for the story, because the author died without having written about a giant rat, from Sumatra or elsewhere.

I think of this passage in the works of Sir Arthur Conan Doyle as an example of things left undone. We often have plans we would like to carry out but for some reason can’t get to. Sometimes, like Doyle, we never get to them. In my practice, I see this kind of procrastination frequently when the subject of life insurance comes up. (By the way, I neither sell nor benefit from the sale of life insurance.) Life insurance is a product with many useful tax characteristics, and its use has become more…useful in recent years because of developments in the insurance industry and businesses related to the insurance industry.

Among the valuable tax benefits of life insurance is that the receipt of the proceeds is generally free of federal income tax. I say generally because it’s possible to lose that tax exemption if, for example, the insurance policy is transferred for value, such as by selling it. There are ways of avoiding that problem, depending on the type of transfer.

The proceeds of life insurance may be subject to federal estate tax, which could reduce the amount of the proceeds significantly. But there’s a way to avoid estate taxation that is frequently used, especially for large amounts of insurance. If the life insurance policy is not owned by the insured but instead by an irrevocable life insurance trust, the proceeds will escape federal estate taxation. The trust document will determine where the proceeds will go. Often they’re held in trust for the surviving spouse for life and then paid to the children. Not having to pay estate tax, in addition to the exemption from income tax, is a doubly valuable benefit.

But if the trust is irrevocable, it’s difficult, if not impossible, to change it. Suppose you change your mind about where the proceeds should go, which could happen for any number of reasons. Are you stuck leaving the proceeds to those you might consider the wrong people, or the right people but on the wrong terms? One solution that people have considered is to set up a new trust and sell the policy, for its fair market value, from the old trust to the new trust. But that creates the potential transfer for value problem described above. Is there a way around this problem?

The IRS has just issued a revenue ruling, 2008-22, which confirms the ability to make such a transfer without jeopardizing either the income tax or the estate tax exemption. If the new trust is a grantor trust, which means a trust that is treated effectively as the same person as the grantor, then the transfer for value rule won’t apply. (In this situation, the grantor would be the insured.) But how do you make the trust a grantor trust? The Internal Revenue Code says that one way is to give the grantor the right to substitute property of equal value for the property in the trust. The grantor might never make such a substitution, but the right to substitute is enough. The ruling just issued tells us that having such a power need not cause the proceeds to become subject to federal estate tax. It’s one of those intricate drafting situations that actually works very simply and preserves the excellent tax benefits life insurance offers.

Like writing a will, buying life insurance is something that people sometimes avoid, with its suggestion of mortality. There are some complexities to it, but careful planning can make it an important part of your financial “story.”

Republished with permission of The Legal Intelligencer.

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This was the remark made by John D. Rockefeller when he learned how much J.P. Morgan had at his death. I guess it’s all relative. Two recent reports on wealth in the world and America contain some interesting insights in those considered wealthy, whatever Mr. Rockefeller might have thought.

It was reported recently that there are 8,000,000 high net worth individuals in the world. For this report, issued by the Citi Private Bank, the threshold was investable assets of $1,000,000 or more, excluding the primary residence. The US still has the greatest number of millionaires, but there are now significant numbers of the high net worth group in Brazil, Russia, Australia and China, as well as the expected Japan and the United Kingdom.

A report from Northern Trust offers some demographics of the wealthy in America. A sample of just over 1,000 millionaires showed average investable assets of $3,600,000, with 86% of the group having such assets in the range of $1,000,000 to $5,000,000. The most common occupations were senior corporate executive and business owner/entrepreneur. In terms of age, 36% were 62 or older, while 53% were age 43-61. Despite having wealth, this group reported some worries, chief among them being rising health care costs and their own health or that of their spouse.

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There are so many books, guides, television shows, magazines and web sites on investing that it amounts to information overload. Sometimes, the reaction to so much information is to do nothing. The Morningstar web site has a short article with the author’s (David Kathman) suggestion for a handful of books for the beginner (which is most of us) who wants some guidance on investing:

The Only Investment Guide You’ll Ever Need, by Andrew Tobias

Buffet: The Making of an American Capitalist, by Roger Lowenstein

TheBogleheads’ Guide to Investing, by Taylor Larimore, Mel Lindauer & Michael LeBoeuf

A Random Walk Down Wall Street, by Burton G. Malkiel

Stocks for the Long Run, by Jeremy Siegel

All About Asset Allocation, by Richard A. Ferri

I would add two others: Against the Gods, by Peter Bernstein and Devil Take the Hindmost: A History of Financial Speculation, by Edward Chancellor.

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Every so often, a partner in my firm will approach me in a sheepish manner to say he or she hasn’t done any estate planning recently or, in extreme cases, doesn’t have a will at all. Sometimes clients admit the same. I suppose this has to do with a belief that planning for the inevitable brings it that much closer. No one has ever suggested that buying homeowner’s insurance makes it more likely that your house will burn down. Again, some people will say, “I’ll let my kids worry about it” or “I won’t be here, so why should I care?” As a lawyer with an active practice in estate disputes, I can only say, “Thank you.”

Nothing is more certain than that individuals have an obligation to their spouses and their children to make plans for what happens after they are gone. It’s not planning for your own death; it’s planning for what will happen to those you leave behind. Will the sum of what you have accomplished in your life cause happiness or heartache for your family? If you make no plans and tell no one what you want them to do, you will be throwing away much of what you have accumulated, because it will either be wasted in litigation or will have a negative impact on your family, making it, in effect, a negative asset. You wouldn’t do such a thing while you were still alive, so why leave that as a legacy?

This came to mind recently because we had a tragedy in my firm. One of my partners died last week after a long struggle with cancer at age 44 leaving a wife and three small children. I believe he had planned carefully, because his illness lasted several years and its eventual result became clearer in recent months. But it has made a number of us, myself included, think about what our spouses and children might be faced with if we died. Several colleagues have asked for assistance with estate planning. Others have asked if their retirement accounts and life insurance would be sufficient to support their spouse and family.

Here’s a suggestion that everyone should consider, especially if you are the one handling financial matters in your family. Begin a notebook of financial information to be available to your spouse or other family members. One page should list your assets: home, retirement accounts, bank accounts, etc. On this page should be contact information for your financial adviser, accountant or other people who should be contacted. Another page should have all of your insurance information: life, health, disability, long-term care, homeowners; again, with the necessary contact information. I suggest a page with a calculation of the income that will be available to survivors, and another that lists the monthly expenses that have to be paid. If you don’t know what it costs to manage your home and other living expenses, you should know that. Perhaps you will add other pages, adding burial plans and other things that the family should know.

Somebody, probably Lincoln, said that we cannot escape the future. I would add that we need not dwell on it constantly, but we should plan while we are alive to help the lives of those we love be as comfortable and happy as we can make them. So, careful estate planning is not planning to die; it’s planning to live.

Republished with permission of The Legal Intelligencer.

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The IRS has just issued Revenue Ruling 2008-22. The ruling states that giving a grantor of a trust the authority to substitute property of equal value will not, by itself, cause the trust to be included in the grantor’s estate for federal estate tax purposes. What’s going on here?

Giving a grantor of a trust the power to replace the property in a trust with property of equal value will make the trust a grantor trust for federal income tax purposes. That means that, for income tax purposes, the trust income will be considered the income of the grantor. Here’s what else it means. If a trust owns a life insurance policy on the life of the grantor, which is a common occurrence when large amounts of life insurance are purchased (because holding the insurance in an irrevocable trust can avoid inclusion of the policy proceeds in the estate for federal estate tax purposes), the grantor might decide after a while that he or she does not like the terms of the trust. But if it’s an irrevocable trust, the grantor can’t amend it. What to do?

What to do is to have the trust sell the policy to another irrevocable trust for the fair market value of the policy. The new trust could have the terms the grantor now prefers. But there are rules in the Internal Revenue Code that state that if an insurance policy is transferred for value, the bulk of the proceeds could be subject to federal income tax. That’s not good. But the IRS has ruled that a transfer from one grantor trust to another grantor trust (of the same grantor) will not create a problem under the transfer for value rules, so the insurance proceeds will continue to be exempt from federal income tax in the new trust.

This ruling helps to assure the success of a valuable planning technique. If a grantor has set up an irrevocable life insurance trust but now doesn’t like the dispositive provisions, a way is clear to get the policy into a new trust with the preferred provisions. This is especially helpful where the grantor has become much older since the original purchase of the insurance, or is having health problems, so buying new insurance could either be much more costly or not possible at all.

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For many people, their largest financial asset will be the balance in their retirement plan. The growth in 401(k) plans and the increases in the limits on deductible contributions to retirement plans have resulted in growth of such plans to overall levels of trillions of dollars. This growth has generated a number of issues, but a requirement covering all such plans and raising many issues is the necessity of taking withdrawals from such plans beginning at a specified age and at a specified rate.

Why are there such rules, called minimum distribution rules and imposed by Section 401(a)(9) of the Internal Revenue Code, and a mountain of IRS regulations? The ability to deduct contributions to such plans causes a loss of tax revenue to the Treasury, and they want the money back…eventually. The longer the wait to get the lost tax revenue, the less value it has to the Treasury. So the specified age for beginning distributions is 70.5, and the rate can be over life expectancies or a specified number of years. The failure to comply with these rules can result in a penalty of 50 percent of the amount that should have been taken out but was not. This creates a powerful incentive to take distributions as required by law.

But the rules are complicated, and it’s easy to make mistakes and to forget to take distributions when they are required. This is especially true when the plan owner dies and leaves the remaining benefits to family members. The naming of individuals as beneficiaries, or trusts for a group of beneficiaries, or separate trusts for each beneficiary can lead to different requirements for minimum distributions. Several books have been written on the subject of retirement plan distributions, and even they don’t cover every situation.

In private letter rulings, the IRS responds to inquiries by and on behalf of taxpayers. The responses they give are to the particular taxpayer and fact pattern, and they cannot be relied upon as authority for other transactions. Despite this limitation, they are useful in showing the thinking of the IRS on difficult tax questions. A recent private letter ruling, No. 200811028, illustrates a solution to a problem of late distributions. In this ruling, a decedent’s IRA was left to a beneficiary. The IRA indicated that distributions were to be made to the beneficiary over his life expectancy, unless he elected a faster payout over five years. The beneficiary did not make such an election, but he also forgot to start taking distributions over his life expectancy. Those distributions should have begun a year after the year of death of the IRA owner, and the first few payments were missed. When this error was discovered, the beneficiary caught up on the late payments, and he paid the 50 percent penalty tax on the late payments. The IRS ruled that he could continue payments over his life expectancy, enjoying the stretched-out deferral of tax, despite having missed the first few payments. In effect, the IRS said that the failure to take the necessary payments was not an election of the shorter five-year payout method.

The lesson of this private letter ruling, and many others on the subject of required minimum distributions, is that considerable care is needed in choosing how and when retirement benefits are to be paid, especially to beneficiaries. But if the distribution process gets off to a rocky start, there are some techniques available to preserve the favorable tax treatment for retirement distributions.

Republished with permission of The Legal Intelligencer.

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In 2001, Congress passed, and the President signed, a strange law regarding the federal estate tax. The plan was to gradually reduce the tax rate and gradually increase the exemption from tax. In 2010, the tax was to disappear entirely, but only for people who died in that year. You can imagine the planning that was contemplated. In the following year, 2011, the tax was to be restored to where it was before the change in the law, a much higher rate and a much lower exemption. This couldn’t be right. Everyone who thought about this situation thought that Congress would have to make some change in this scheme of taxation. But, surprisingly, the two political parties couldn’t agree on what the change should be. One party thought the tax should be abolished entirely, because, after all, it was mostly a tax on rich people. The other party thought it should stay as it was, because, after all, it was mostly a tax on rich people.

Now, we’re actually getting close to 2010, and some leaders in both parties have begun talking about a change to make sense of this law. The federal estate tax next year will be at a rate of 45% and the exemption from tax will be $3,500,000 ($7,000,000 for married couples). The proposal is to extend these numbers into the indefinite future. That’s probably not the end of the discussion of the federal estate tax, but it sounds like a sensible place for the tax to be for a while.

The federal estate tax is not, as it has been called, a death tax, nor is it a tax on death. It’s a tax on the accumulation of wealth, as compared with a tax on income, and it’s imposed when a person has died. No tax is imposed on amounts passing to a surviving spouse, nor on amounts given to charity. There are plenty of opportunities to transfer wealth during life at little or no tax cost. In a sense, it’s a tax imposed on those who try to hold on to their wealth, and the control it brings, until death. It shouldn’t be imposed on wealth that people might need to live on in later years, and that’s the point of the exemption from estate tax. It shouldn’t be the cause of destroying family businesses and farms, and there seems to be no evidence that the tax does so. To ensure that neither of those problems arise, the exemption might be a little larger, such as $5,000,000, and it probably should be indexed to inflation.

There is an excellent short book on the subject of the federal estate tax, called “Wealth and Our Commonwealth: Why America Should Tax Accumulated Fortunes” by William H. Gates and Chuck Collins. Mr. Gates’ son knows something about accumulating wealth. The book makes this point, which is worth considering: if people who have accumulated wealth under this country’s favorable economic system had been born elsewhere, they probably would not have acquired that wealth, or at least not as much. So, say the authors, perhaps something is owed to the country for the ability to accumulate and enjoy wealth.

The question of whether we should have a federal estate tax and at what level it should be imposed will remain unsettled for some time, but it’s helpful to see members of Congress talking about a reasonable compromise to avoid the absurd result that would occur under current law.

Republished with permission of The Legal Intelligencer.

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Unless you’ve been on a deserted island for the past two weeks (today is April 3, 2008), you will know of the near-collapse of the investment bank Bear Stearns.  Bear Stearns stock closed at $169.61 per share on January 12, 2007. The initial sale price to JP Morgan was $2 per share, since raised to $10, but this still represents a 94% decline from the high to the sale price. Many very wealthy investors in Bear Stearns are much less wealthy. Perhaps there isn’t a great deal of sorrow over their plight, but losses have been suffered by many people working at Bear Stearns who weren’t in the multimillionaire category, or in any case aren’t anymore.

Several lawsuits have already been filed as a result of the decline in value of Bear Stearns.  One investor has sued, alleging that the company issued false and misleading information about its financial situation.  A second was filed by a Bear Stearns employee, claiming that the company and its executives breached their fiduciary duty, causing losses to the employee stock ownership plan that is a principal shareholder of the company. A day later, another employee sued on similar grounds. Many people at Bear Stearns who had much of their retirement funds in Bear Stearns stock are facing a grim retirement picture, and it’s almost certain that more suits will be filed. Sometimes it’s a good idea to put all of your eggs in one basket, but if you drop the basket, it might be difficult to find more eggs.

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