A Case Study of Its Process and Benefits
As financial advisors, CPAs are often asked to guide business owners on increasing their profits, cash flows, and - ultimately - the value of their business. As estate planning advisors, CPAs are also asked to counsel individuals on how to decrease the size of a taxable estate. The more successful individuals are in growing the value of their assets, specifically their closely held businesses, the more difficult it can be to reduce the estate for transfer-tax purposes. Advisors utilize several different planning techniques, such as sales to intentionally defective grantor trusts (IDGT); other types of trust planning; discounted giving; structuring of grantor-retained annuity trusts (GRAT); charitable planning, including private foundations; donoradvised funds; and charitable remainder and lead trusts. These techniques, and many others, normally result in either a freeze or reduction in the taxable estate, while still transferring assets to the desired heirs or charities.
The "estate enhancement plan" discussed below is a different planning technique, designed to increase the assets that are available to the heirs while, at the same time, reducing the estate tax liability. This plan is not for everyone; it works best for an individual who has assets - preferably in a qualified plan - that are not needed for lifetime use. In addition, it benefits an individual who desires to increase the assets that will be transferred to heirs. The plan utilizes two insurance products: a singlepremium immediate annuity (SPIA) and a permanent life insurance product, usually a universal life (UL) policy. The plan derives its advantages from the favorable income taxation of life insurance and the detrimental taxation of individual retirement accounts (TRA) and 401 (k) plans in an estate.
The following case study illustrates the benefits of the estate enhancement plan.
This plan could work in several situations, but this sample case will assume that a CPA's clients, John and Judy, are a healthy, financially successful couple. (Exhibit 1 shows their net worth.) John and Judy - 64 and 63 years old, respectively - have four children; three are active in the family business, with plans to inherit it, and their fourth child, James, jointly owns a medical practice with his wife. John and Judy draw substantial wages from the business, which will continue throughout their lives and meet their cash flow needs.
John and Judy have decided that they want to leave approximately equal amounts to each of their four children, but they also want the family real estate - a vacation residence passed through the family for generations - maintained in the family for all to use. The problem is that after paying estate tax on their assets, segregating the real estate, paying income tax on their IRA, paying off their debt, and allocating the business to each of their children involved in it, there is only a residuary of $250,000 for James, plus his share of the real estate (Exhibit 2).
This could be resolved by leaving part of the business to James and having his siblings purchase his interest. But John and Judy do not want the other three children to incur any debt; moreover, they do not want to lower the business's worth as a result of the purchase of James's shares.
The estate enhancement plan, however, will turn the $1 million IRA owned by John - currently included in the taxable estate and ultimately subject to income tax - into a $3.9 million after-tax asset attributable directly to James. As an added benefit, the asset will be included in a trust that will afford liability protection to James and potential estate tax savings upon his demise.
The plan will use the IRA to purchase a SPIA, take the annuity amount received each year, pay all associated income and gift taxes on the distribution, and transfer the balance into an irrevocable life insurance trust (JUT) to purchase a second-todie life insurance policy. …