Estate Planning Case

Studies
By Jeff Tegeler CLU, ChFC, CFP®
What We Will Discuss
• The arithmetic of taxable gifts. How they are not what many
clients think and how they may argue strongly for an inclusion
of life insurance.
• Case study Number 1 includes a number of conventional
estate planning techniques which can be complimented with
life insurance.
• Life insurance has long been used to pay the estate taxes at a
discount. Case study Number 2 will show that for certain
taxpayers the discount will essentially double. (Double
discount dollars).
What are Taxable Gifts?
• Gifts made after December 31, 1976, in excess of the
gift tax annual exclusion (currently $14,000 per
beneficiary).
• Taxable gifts do not include gifts that qualify for the
gift tax marital deduction or the charitable
deduction.
• For example a gift of $1,000,000 to a trust for a child
in a year that the $14,000, annual exclusion has
already been used.
• Such gifts do not result in gift tax until an individual’s
cumulative gifts exceed $5,430,000 (2015).
The Arithmetic of Taxable Gifts
• An unmarried Florida client has an estate of
$6,430,000. (Florida has no state estate tax.)
• His Federal estate tax will be $400,000.
• Now assume he makes a taxable gift of
$1,000,000 leaving an estate of $5,430,000
(exactly equal to the estate tax exemption).
What will his federal estate tax be?
• His federal estate tax will remain at $400,000.
• Taxable gifts are added back into the taxable
estate. So that only the appreciation after the
gift escapes the estate tax base.
It’s Not Totally True in Minnesota

• Assume the same client is a resident of

Minnesota.
• His state and federal estate tax will be
$737,344 without the $1,000,000 gift.
• His state and federal estate tax will be
$663,760 with the $1,000,000 gift.
• Taxable gifts are not added back into the
estate for state estate tax purposes. The
$1,000,000 gift saved $73,584.
What’s This Mean to You?
• Only the appreciation after the date of the gift escapes the
transfer tax system. (No appreciation, no benefit!)
• A gift has an income tax disadvantage.
• Property owned at death gets its income tax basis stepped
up to the value at death.
• Gifted property does not receive a stepped up income tax
basis.
• Life insurance is the only property where the appreciation is
dramatic and in many cases guaranteed.
• In addition, life insurance is the only property that can be
shifted out of the estate and receive the equivalent of a
stepped up basis since a life insurance death benefit is income
tax free.
CASE STUDY #1
 Essential Facts
• An estate of at least $32,000,000 consisting of:
– A jet worth $3,200,000;
– A home worth $3,500,000;
– $25,000,000 in tax free bonds
– An $800,000 IRA (He told us that he plans to name
his grandchildren beneficiary.)
• Client is a widower.
• Age 71
• He has about $3,000,000 of his gift tax exemption
remaining. He has all his generation skipping exemption
remaining.
Your Objectives
• Keep as much out of Obama’s hands as possible
• To the extent possible free your children of estate taxes at
their deaths
• Provide protection for your children and grandchildren from
creditors including former spouses
What We Will Discuss
• A qualified personal residence trust which could
compress the $3,500,000 home into an $886,000
transfer for gift tax purposes.
• A Roth IRA conversion which could, under
reasonable assumptions, increase the amount in
your IRA for the benefit of your grandchildren
from $886,000 (ultimately income taxable) to
$2,163,000 (ultimately income tax free)
assuming death in 17 years.
What We Will Discuss
• An income tax defective dynastic trust which,
under reasonable assumptions could create
$10,214,295 of tax exempt wealth for multiple
generations.
• A testamentary charitable lead annuity trust
which could create an estate tax deduction of up
to 80% of the property passing into the trust and
provide significant benefits to charity.
A Qualified Person Residence Trust

Home $3,500,000 QPRT After 17 Years Children

Matt $3,500,000 $6,817,652*

1. Right to Live in Home for 17 years $800,485

2. Reversion $1,800,925
3. Taxable Gift $898,590 Assumes 4% appreciation. This
is strictly hypothetical and not
guaranteed.

Risk: The property will be included

in your estate if you die within 17
years.
Roth IRA
• Client has an $800,000 IRA.
• He is considering naming the grandchildren beneficiaries of
the IRA.
• I wondered how a Roth IRA conversion would compare to the
current IRA.
• I also wondered how a Roth IRA conversion would compare to
simply gifting the amount equal to the tax he would pay on
the Roth IRA conversion to a trust for the grandchildren.
Roth Comparison
IRA Roth IRA
Taxes Paid Tax on Required Dists. $346,861
2030 Assumed Balance $885,860 $2,163,343
Status of Distributions Ordinary Income Tax Free
Net Dists 2030 to 2093 $4,333,337 $18,460,144

Assumes 6% growth. This is strictly hypothetical and not guaranteed.

Future growth rates are not predictable.
What if You Make a Gift Equal to the Taxes?

• Gift of $346,861 to an Income Tax Defective

Trust
• Would grow to $934,018 by 2030.
• Would not be income tax sheltered to
grandchildren after his death
• The Roth IRA would be fully subject to estate tax
in your estate, the gift would effectively include
only $346,861 in your estate.
Alternative Plan for the IRA
• Leave the IRA to your Mayo Fund so
there will be no income or estate tax.
• Donate all Required Minimum
Distributions to charity
Charitable IRA Plan
• Total distributions to charity during
your life of $771,972.
• IRA to charity at death $885,860
Tax Cost Comparison
Charitable IRA Roth
Income Tax (45%) $0 $346,861
Estate Tax (40%) $0 $865,337
Benefits Charity Family
Income Tax Defective Trust
• This is simply a trust that is designed to be excluded from
your estate for estate tax purposes.
• However, it will be income taxable to you.
• The income tax you pay during your life is an untaxed
transfer to future generations.
• The trust can purchase assets from you in the future
without income tax. (In other words, you can deflect
future business opportunities to your family.)
 Matt Gift remaining Gift Exemption to
Income Tax Defective
Generation Skipping Trust
Trust
$3,000,000 - • Separate trust for each
$898,337 for QPRT child and that child’s
= $2,101,663 issue
Current
generation • Child can be trustee
skipping
• Child can get
exemption is
distributions from
$5,340,000.
income and principal for
Formula bequest of balance of maintenance education
your generation skipping support and health.
exemption with estate tax coming • Child can have the right
out of residue of estate which to appoint property to
goes to children. issue during life or at
death.
Assuming 3% inflation in
17 years exemption would
*Strictly 17 Years, 6%* Value: $5,659,301*
be $8,820,000 less
hypothetical and
$2,101,663 gift to trust less
not guaranteed.
$2,163,343 Roth = Income Tax Defective
$4,554,994 Trust
$10,214,295
• Passes estate tax free at
death if each child to that
child’s issue.

Grand children beneficiaries of Roth (assume $2,163,343)*

Will should provide that taxes will come out of the Grandchildren
residue which goes to the children.
 Testamentary Charitable Lead
Annuity Trust

$16,000,000 Charitable Lead Annuity 20 Years Children

Matt’s Trust $21,885,694
Estate 6%

Charitable Estate Tax $800,000 for

Deduction = 20 Years
$12,832,160

Charity
Lead Trust Comparison
Direct Bequest Lead Trust
Estate Tax Deduction $0 $12,832,160
Taxable Amount $16,000,000 $3,167,840
Estate Tax (40%)* $6,400,000 $1,267,136
Amount to Charity** $0 $16,000,000
Amount to Children at $9,600,000 NA
Death
Amount to Children in 20 NA $21,885,694
Years**
*Paid from other assets in the charitable lead trust scenario.
**Does not take into account the time value of money.
Present Value Analysis (6%)
Present Value of Children’s Interest $6,824,063
Less Taxes Paid Other Assets $1,267,136
Net Present Value to Children $5,556,927
Present Value Charity’s Interest $9,175,937
Total Present Value $14,732,864
Present Value to Children Without $9,600,000
Lead Trust
Nuances and Alternatives for $16M Charitable
Lead Trust
YR 1 Payment Increasing Term Estate Tax Value at End
Payments Deduction of Term
$800,000 No 20 Years $13,337,200 $21,885,696
$597,440 20% 20 Years $16,000,000 $18,225,598
$886,720 20% 15 Years $16,000,000 $10,815,325

Assumes a 6% growth rate. This is strictly hypothetical and not guaranteed. Assumes a 1.8% a
7520 rate.
An Under-appreciated Estate
Planning Tool?
• With a testamentary zeroed out charitable lead trust a
charitable individual can control the estate tax.
• It should at least be considered for older charitable
clients during times of low interest rates.
• Life insurance owned by an irrevocable trust may make
the waiting period more acceptable.
• Consider a zeroed out charitable lead trust for the
portion of the estate in excess of the estate tax
exemption.
Is there a risk?
• In the case of the a zeroed out charitable lead
trust, if the trust grows at the 7520 rate or less
(1.8% for March) the children will get nothing!
• The technique only makes sense for genuinely
charitable clients.
The Role of Life Insurance in Estate Planning

• The success of most estate planning techniques is dependent

on certain assumptions as to growth and performance. The
ultimate amount of wealth transmitted is unpredictable. Life
insurance delivers a specified dollar amount at death
regardless of when it occurs.
• Most of the estate planning techniques discussed work best if
the estate owner lives a long time. (Some don’t work at all if
death occurs too soon.) Life insurance performance is exactly
the reverse. Hence, it provides an important element of
diversification.
• Life insurance is the only asset that can be positioned outside
the estate and still provide the equivalent of a stepped up
basis at death since it comes in income tax free.
• Compared to most techniques, life insurance is relatively
simple.
The Role of Life Insurance in Estate Planning

• Life insurance positioned outside the estate provides little or

no audit risk.
• Life insurance can be a simple and efficient way to provide tax
free wealth replace assets left to charity. (In this context the
insurance trust is usually referred to as a wealth replacement
trust.) This can be very useful if clients who wish to eliminate
all federal estate taxes.
• Taxable gifts (gifts in excess of the annual gift tax exclusion)
accomplish nothing if the gifted asset does not appreciate
after the date of the gift. That is because taxable gifts are
added back into the tax base and only post-gift appreciation is
removed from the estate. Life insurance is the only asset
where appreciation at death is immediate, substantial and
guaranteed.
The Role of Life Insurance in Estate Planning

• Life insurance does not require the estate owner to give up

life-time access to significant assets and wealth.
 Case #2

Preventing a Charitable Meltdown

 Irrevocable Trusts – These Trusts Cannot be Changed - Pass without Estate Tax

Smith Family 2004 Irrevocable Trust

$13,000,000 Joint Survivor Policy
•Trust owns $13,000,000 joint survivor policy.
•John Smith and Ron and Joe Best are trustees.
•Paul and Sue make gifts to the trust to pay premiums. Each child has a temporary right to
withdraw gifts. (Necessary to qualify for the gift tax annual exclusion.) They should get annual
notice of these gifts.

Paul’s Death

$13,000,000 Joint Survivor Policy

•Policy does not pay off until second death.
•Trustee has discretion to distribute or retain any income. (No income is anticipated.)

Sue’s Death

$13,000,000
•Insurance pays off at the death of the surviving spouse
•Trust can either purchase assets from estate or loan assets to estate for estate liquidity.
•Income and principal to the children as the trustee deems advisable. (6.03(13))
•When the child attains age 30, the trust shall terminate and the remaining assets shall be
distributed to the child. (4.02(3))
•If any assets remain in the trust at a child’s death, that can “will” the property to anyone other
than the child, the child’s creditors, or the child’s estate. Otherwise it will pass to the child’s
issue. (4.02(3)Any trust created for a grandchild shall be similar to the child’s trust. (4.03)
 Paul’s Will Paul & Sue State Death Tax
$439,600
$65,000,000
Paul’s Death
$5,430,000

Sue Family Trust

$59,570,000 $4,990,400
•Sue is trustee. Successor trustee is John Smith.
•The trustee may in her discretion pay to, or apply to Sue’s benefit, such sums of income and
principal as the trustee may determine to be advisable to provide for the support and
maintenance of Sue in her accustomed manner of living.
•At death Sue can “will” to anyone other than herself, her creditors, or her estate. Otherwise it
will pass as described below.

Sue’s Death

Trusts for Children

Note: The plan works similarly if
Sue dies first provided she owns at $4,990,400
least $5,430,000 of property.
•John Smith and Joe Frank are trustees.
•One share for each child. Each share for a child who is forty years of age or older shall be
distributed outright. Each share for a child who is under age 40 shall be held in trust as a
separate trust for that child.
•The trustee may distribute to each child such sums of income and principal as the trustee in his
discretion may determine to be advisable. When a child attains age 40, the trustee shall
distribute any remaining assets to t he child.
•If a child dies prior to attaining forty years of age, the child can appoint the remaining trust
estate to anyone other than his creditor, his estate, or the creditors of his estate.
•If the forgoing power is not exercised the remaining trust estate shall pass to the child’s
descendants.
 Sue’s Will-Survived by
Estate Tax
Children Insurance in Sue
$12,663,168**
Force $59,570,000
Sue’s Death

Cash Bequests Bequests of Property Charitable Bequests

Beth Smith* $100,000 Smith Associates to Siblings $245,000 Residue to Foundation $29,012,000
Betsy Smith or her descendants $100,000 Real Estate to Children $22,013,000
Kathy Smith or her descendants $100,000 Total (subject to estate tax) $22,258,000
**Tax could be paid from
Children $3,000,000 insurance.
Smith Incorporated $5,000,000
Total $8,300,000

Note: If any assets are distributable from the two

insurance trusts, expenses and taxes will be paid from the
children’s share. If no assets are distributable from the
insurance trusts, expenses are payable from the
charitable residual bequest.
 Sue’s Will-Survived by
Children – No Insurance Sue Estate Tax
$25,125,333
$59,570,000
Kathy’s
Death

Cash Bequests Bequests of Property Charitable Bequests

Beth Smith* $100,000 Smith Associates to Siblings $245,000 Residue to Foundation $3,886,667
Betsy Smith or her descendants $100,000 Real Estate to Children $22,013,000
Kathy Smith or her descendants $100,000 Total $22,258,000
Children $3,000,000
Smith Incorporated $5,000,000
Total $8,300,000

Note: If any assets are distributable from the two

insurance trusts, expenses and taxes will be paid from the
children’s share. If no assets are distributable from the
insurance trusts, expenses are payable from the
charitable residual bequest.

*If Beth does not survive the gift shall lapse.

Estate Tax Calculation When Charitable Share is Reduced

Increase in
Estate Tax Tax
30,558,000 12,663,168
43,221,168 18,944,099 6,280,931
49,502,099 22,059,441 3,115,342
52,617,441 23,604,651 1,545,210
54,162,651 24,371,075 766,424
54,929,075 24,751,221 380,146
55,309,221 24,939,773 188,552
55,497,773 25,033,296 93,523
55,591,296 25,079,683 46,387
55,637,683 25,102,691 23,008
55,660,691 25,114,103 11,412
55,672,103 25,119,763 5,660
55,677,763 25,122,570 2,807
55,680,570 25,123,963 1,393
55,681,963 25,124,654 691
55,682,654 25,124,997 343
55,682,997 25,125,167 170
55,683,167 25,125,251 84
55,683,251 25,125,292 41
55,683,292 25,125,313 21
55,683,313 25,125,323 10
55,683,323 25,125,328 5
55,683,328 25,125,330 2
55,683,330 25,125,332 2
55,683,332 25,125,333 1
55,683,333 25,125,333 -
Rules for Payment of
Estate Taxes
Payment of Estate Taxes
• The general rule is that the estate tax is due nine months after
the date of death.
• However, a number of provisions allow for the deferral of
payment of all or part of the tax.
Discretionary Extensions
• The IRS may allow an extension of time to pay any part of
the estate tax for up to 12 months for reasonable cause.
• In addition, the IRS may enter into a written agreement
to allow payment of tax in installments, when the IRS
determines that such an agreement will facilitate the
payment of tax.
• The IRS may for reasonable cause extend the time for
payment of estate tax up to ten years.
• Interest is compounded daily at 45% of the rate charged
by the IRS for underpayments. That interest rate would
currently be 1.35%
Special Extension if the Estate
Includes a Closely Held Business
• If the decedent’s interest in a closely held business
exceeds 35% of the adjusted gross estate, the estate tax
attributable to the business interest can be paid in ten
annual installments and the estate can elect to delay the
beginning of the installments up to five years.
• Two or more closely held businesses can be combined
provided you own at least 20% of each business.
• The election terminates and the estate tax becomes due
if any portion of the business interest is sold and the sale
is 50% or more of the the value of such interest.
An Example
• The following example shows how this provision would
operate under the following assumptions:
• The adjusted gross estate is $89,219,496;
• The portion of the estate qualifying for deferral is $44,000,000;
• The federal and state estate tax is $34,105,990
Graegin Loan
 What is It?
• A Graegin loan is a loan from a third party
to pay estate taxes.
• The loan could be from a bank, or it could
be from an irrevocable life insurance trust.
• All the interest that is payable over the life
of the loan may be currently deductible.
 Requirements from Case Law
• The estate must be made up of illiquid
assets.
• Where the lender is a related party, the
deductibility of the loan interest is subject
to special scrutiny.
• The terms of the loan must be
commercially reasonable.
 Requirements from Case Law
• The term of the loan should be tied to the
time the estate is likely to remain illiquid.
• The interest rate should be a market rate.
• The terms of the loan must restrict
prepayment.
• In Estate of Duncan v Commissioner, a
revocable trust borrowed funds from a
nearly identical irrevocable trust.
 Graegin Loan
Rate 4%
Term (Years) 10
Taxable Estate Tax at Total
Illiquid Asset Deduction Amount 40% Interest
34,850,000 - 34,850,000 15,682,500 6,273,000
34,850,000 6,273,000 28,577,000 12,859,650 5,143,860
34,850,000 5,143,860 29,706,140 13,367,763 5,347,105
34,850,000 5,347,105 29,502,895 13,276,303 5,310,521
34,850,000 5,310,521 29,539,479 13,292,766 5,317,106
34,850,000 5,317,106 29,532,894 13,289,802 5,315,921
34,850,000 5,315,921 29,534,079 13,290,336 5,316,134
34,850,000 5,316,134 29,533,866 13,290,240 5,316,096
34,850,000 5,316,096 29,533,904 13,290,257 5,316,103
34,850,000 5,316,103 29,533,897 13,290,254 5,316,102