Tag Archives: beneficiaries

Estate Tax Laws Are In Flux - AZ Business Magazine Sept/Oct 2010

Estate Tax Laws Are In Flux — Start Strategizing Now

Let’s begin with a reasonably well-founded observation: The official repeal this year of estate taxes has seriously flawed most testamentary plans and created mild chaos for estate practitioners. Traditionally, estate planning attorneys have employed “word formula” dispositions phrased in terms of tax concepts for their drafted wills and trusts. For example, for people with larger estates, dispositions are divided into two categories:

One portion equal to the unused estate tax exemption often called the unified credit or the credit shelter trust for the benefit of a surviving spouse and descendents.

The other portion is allocated to equal the “optimum” marital deduction amount, usually expressed as the minimum amount necessary to reduce a person’s federal estate tax to zero.

In other cases, testators will cause a portion of their estate to equal the unused generation skipping tax (GST) exemption to pass in favor of or for the benefit of grandchildren. The word formula is applied because, historically, it has resulted in the optimal division or disposition of a decedent’s property.

Unfortunately, none of the above has any meaning if the concepts used to define them are no longer represented by federal statute. Accordingly, decedents of 2010 and their beneficiaries are confronted with impossible circumstances. An unintended outcome is the possible disinheritance of a surviving spouse or children.

Another interesting issue relates to existing generation-skipping trusts that are normally subject to GST on taxable distributions to “skip persons.” In
2010, none of the taxable distributions or “taxable terminations” will be subject to the tax. Possibly, the optimum outcome has arrived for GST trusts.

Within the current environment, grandparents can literally transfer fortunes to grandchildren and be subject to a one-time 35 percent gift tax.

Caution is appropriate, however, because it is impossible to predict what Congress will do. From a constitutional perspective, retroactive legislation remains a risk. If Congress retroactively reinstated estate and GST tax law, which Sen. Max Baucus (D-Mont.) has formally pledged to accomplish, then the above identified actions would be problematic.

Reinstatement of the estate tax system, notwithstanding a valid constitutional argument, would represent a symbol of poor legislation, in this author’s opinion. Here’s why: Executors and trustees of estates created in 2010, as fiduciaries, must act on current law and distribute inherited assets in a timely fashion. Would it not be legally awkward for Congress to force executors and trustees to rescind those distributions and formally adjust all 2010 estate tax returns?

So given the testamentary chaos resulting from the political process, what can we expect? Many practitioners believe legislation will occur that will reinstate the 45 percent tax rate for estate and GST applications with a $3.5 million unified exemption for each spouse. But, if Congress fails to act this year, then beginning in 2011, we will face the imposition of a 55 percent tax rate and a $1 million unified exemption. Given the current federal budget crisis, inaction will produce higher tax revenue.

This uncertain environment may provide compelling reasons for proactive folks to act. Seek qualified help with your own estate planning issues now — not later.

Philanthropic causes are becoming more meaningful to us
Everyone has been affected in some way by the deep recession. As a result, nonprofit service demand is up, but contributions are down. However, more people are contributing their time and efforts to help others. Due to a strong philanthropic lobby and the generous nature of American values, Congress has not tinkered with key charitable planning techniques. Many creative planning options exist that can help one accomplish their nonprofit objectives and enjoy enormous tax and estate benefits.

Source: Coyote Financial

Trends in Estate Planning:
More families are seeking qualified help with their financial lives

Interestingly, the revolution in technology and communication has not changed the desire or need for a personal advisory (coaching) relationship with someone deemed competent and trustworthy. Technology may help you find the right person, but no substitute is yet available for a caring, personal relationship.

Opportunities in Estate Planning

  • A grantor retained annuity trust (GRAT) is an estate planning technique that allows one to utilize the currently low federal discount rate to transfer assets to the next generation in exchange for a note. All appreciation, above the interest payment, inures in favor of the next generation. Short-term, zeroed out GRATs have been popular, resulting in significant estate tax savings for many wealthy families. The House Ways and Means Committee has passed a bill designed to eliminate short-term GRATs and zeroed out techniques. President Obama has proposed (endorsed) similar legislation that would require a 10-year term and no zero out gifting for GRATs. The opportunity for short-term, zeroed out GRATs could disappear in the next several months.
  • Congress has pending legislation to limit fractional discounts for lack of control and marketability applicable to intra-family transfers. Historically, when assets are placed into properly drafted limited liability companies (LLCs) and family limited partnerships (FLPs), discounts on the transfers to children of financial units or limited units, respectively, apply. For the present, case law and court verdicts honor the integrity of fractional discounts. As in the proposed GRAT legislation, the new rules will not apply retroactively and will only take effect coincidental to formal enactment. Keep in mind that the Treasury Department is desperately seeking methods to raise revenue. The opportunity to sell, transfer or gift assets inclusive of a fractional discount, especially among family members, may disappear in the next several months.
  • In 1995, the federal discount rate represented 9.5 percent. Today, the rate ranges between 3.4 percent and 3.6 percent. The discount rate is indirectly associated with the applicable federal rate (AFR), which can be utilized on an “arms-length basis” to make loans to children. For example, the current mid-term intermediate rate equals 2.85 percent, whereas demand-note interest rates are currently less than 1 percent. The opportunity to initiate intra-family personal or business loans at de minimis interest rates could disappear in the next several years.
  • Since generation skipping taxes have been repealed for the 2010 tax year, and the federal gift tax rate has been reduced from 45 percent to 35 percent, the opportunity to transfer/gift assets to grandchildren is economically advantageous, as noted previously. The opportunity to transfer assets to grandchildren without the imposition of estate and generation skipping tax may disappear under new legislative regulations in the next several months.
  • Because of recent market conditions, the valuation of business and real estate assets has potentially decreased. Accordingly, the cost to sell or gift assets to the next generation is lower than it may have been in 2007. The opportunity to transfer assets to family members using low valuations may disappear in the next several years.
  • Source: Coyote Financial

    Arizona Business Magazine Sept/Oct 2010

    Investing man

    Changing Investment Management Firms Can Be Costly

    Patience, it turns out, can be indeed a virtue — especially for retirement plan sponsors. Sunil Wahal, professor of finance at the W. P. Carey School of Business at Arizona State University, and his co-authors compiled a database of hiring and firing decisions made by more than 3,700 plan sponsors between 1994 and 2003. The reasons plan sponsors change investment management firms vary, but often the sponsors hire firms that have recently earned significant excess returns.

    However, Wahal and his team found that those high fliers do not perform as well after they are hired, and the fired firms sometimes go on to turn in impressive numbers. If plan managers had stayed with their original managers, Wahal says, their excess returns would have been larger than those delivered by the newly hired managers.

    “When firing decisions are made, one needs to be very careful and cognizant of the costs involved,” Wahal says.

    Factor costs into decisions
    Wahal’s study of the selection and termination of investment management firms by plan sponsors looked at 9,684 hiring decisions by 3,737 plan sponsors between 1994 and 2003. The plan managers hired by the sponsors were responsible for delegating $737 billion in investments. The study also examined 933 firing decisions by 515 plan sponsors between 1996 and 2003. Nearly $117 billion of investments were impacted by those decisions.

    “There is an enormous amount of money that is invested in the market by plan sponsors. These organizations make a lot of decisions about who gets to manage the assets for the beneficiaries,” Wahal observes. “Sometimes the hiring and firing decisions they make work well. Sometimes they don’t. The frictions involved in these decisions are costly to beneficiaries.”

    The rationale for a change varies. Plan sponsors usually fire investment management firms for poor performance, but sometimes they act because of an organizational change. For example, the investment management firm may have gone through a merger, or a star stock picker or portfolio manager may have left. The plan sponsor also may decide to change direction with its investments, such as switching from running a large-cap stock portfolio to a bond portfolio.

    Factors that point to success
    Wahal found that consultants are hired to assist plan sponsors in nearly two-thirds of all hiring decisions. Excess returns from consultant-supported decisions are higher, consistent with the notion that a consultant’s expertise adds value when selecting managers. But there’s a downside to consultants. They often take the blame, in place of the firm’s treasurer, when a company with a defined benefits plan selects a plan manager that performs poorly. Even so, using a consultant led to a 3.7 percent increase in three-year, post-hiring returns.

    The researchers also found that returns were higher as the size of the plan increased, presumably because the sponsors of bigger plans have more experience selecting investment managers. In addition, they discovered that plan sponsors like to hire investment management firms within their own states. The study found that those in-state, post-hiring returns were positive.

    Despite evidence that a number of factors can predict success, plan sponsors typically selected investment management firms by screening their performance based on excess returns. Firms are usually hired after investment managers have done very well, with an average excess return of 13.8 percent three years before the hiring decision.
    Yet, after an investment management firm was hired, the study found the excess returns were close to — or below — zero.

    “It’s not that they do poorly,” Wahal explains, “they don’t do as well as they had been doing prior to being hired. In other words, when you chase returns, you chase hot hands. But those hot hands don’t seem to persist.”
    Wahal also learned that three years after the firing decisions, excess returns were sometimes up, with performance-based firings resulting in bigger return reversals. In fact, it was discovered that had plan sponsors stayed with the fired investment managers, excess returns would be more than what the newly hired managers delivered at some horizons.

    Transition costs can add up
    When a plan sponsor decides to fire an investment manager, the sponsor then has to take those funds and provide them to the newly hired investment management firm. This process entails what are commonly referred to as transition costs, that is, the cost of selling the old portfolio and creating a new one. Wahal says that “such costs can frequently be as much as 2 percent, and add to any other losses that the plan sponsor might suffer.” So, the newly hired manager is expected not only to deliver superior returns, but also perhaps to recover the 2 percent transition costs. Wahal argues that “to the extent that we do not live in Lake Wobegon, this is quite a challenge.”

    “What’s really important is that the firing and hiring process be set up very well,” he says. “You can’t be too quick to jump the gun on firing and hiring because those costs have to be factored into the decision. Someone’s going to bear that loss and typically it’s the beneficiaries of the plan sponsors.”