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· Family Limited Partnerships
· WeathBuilderú
Introduction to the Qualified Plan Rescue Strategy
Qualified retirement plans provide an excellent tax-favored environment in which to accumulate wealth. However, individuals that want to transfer as much as possible to their heirs find that without special planning, retirement plan assets are heavily taxed.
The objective of the Qualified Plan Rescue Strategy is to increase the total benefit passing to heirs from qualified plan assets. The strategy is appropriate for those that do not need some or all of their qualified plan balance to provide for their personal financial security.
The strategy involves three steps. First, establish a profit sharing plan and roll the existing qualified plan assets into this plan. Second, use the funds to buy a special life insurance policy in the plan. Third, sell the policy to an ILIT, taking advantage of friendlier tax circumstances.
It is important to note that there are many alternative ways to design the plan to work best, depending on the client's circumstances and preferences. As with any sophisticated strategy, it is critical for the client to engage competent legal counsel.
Typical Problems with Qualified Plans
- Plans require minimum distributions after age 70-1/2.
- Minimum distributions are subject to income tax during life.
- The plan balance is subject to estate tax on death.
- Plan distributions to beneficiaries are subject to income tax.
- The plan balance may be subject to generation skipping tax.
- The family may receive only 25% or less of plan balance.
Although the exact methods for determining the estate and income tax consequences of leaving qualified plan assets to heirs is complex, it could be represented by the following simple equation.
Value of qualified plan $1,000,000
Potential estate tax (500,000)
Estate tax rate 50%
Potential income tax (200,000)
Income tax rate 40% on balance
Net value to heirs $ 300,000
Recent tax law changes made it relatively easy to avoid paying the income tax in a lump sum at death provided that the estate taxes attributable to the plan are paid from another source. Thus, the so called "Stretch IRA" has become a popular planning technique and buying life insurance to provide a liquid source of funds to pay the estate tax attributable to the IRA is an attractive option, especially for those who need their IRA to live on.
The Qualified Plan Rescue Strategy will usually produce superior results to the Stretch IRA concept.
Qualified Plan Rescue Strategy Benefits to Clients
- Client can eliminate unwanted taxable distributions.
- Client minimizes and postpones income taxes.
- Client increases total benefits to heirs.
- Minimal client cash flow required to fund plan
Family Limited Partnerships (FLP)
Family Limited Partnerships are used to shift income and appreciation to your children. Assets are placed in an FLP in exchange for general and limited partnership units that are given to children or grandchildren. The partnership interests give them ownership, but no right to control activities. To achieve income, estate and gift tax advantages, the partnership should be funded with appreciating assets or assets that generate a current income stream.
Advantages
- Reduces taxable estate by giving away assets while retaining control of the assets and the income they produce.
- Owner doesn't give up control of assets and can receive a salary for management duties.
- If life insurance is a partnership asset, only a portion of the proceeds that relate to the ownership interest will be included in the estate.
The Basics of FLiPs
FLPs are set-up much like traditional limited partnerships. In the early 1980's, Limited Partnerships were sold left and right. Less than a decade later, their popularity plummeted, as investors disappointed by little or no growth of Partnership assets had difficulty getting their money out. The same features that made Limited Partnerships unattractive as investments make Family Limited Partnerships very attractive for estate planning purposes. There are two parties involved: "General Partners" which control the trust, and "Limited Partners" who have a share in the profits (but hold not control).
A typical FLP is set-up with two types of partners:
- The General Partners (you and/or a spouse) design the partnership to gift Limited Partner shares to family members. General Partners control the operations of the FLP and make day-to-day investment decisions. They can also receive a percentage of the FLP's income in the form of a management fee.
- The Limited Partners (your heirs) have an ownership interest in the FLP, but they have very limited control. They share in the income generated by the FLP, depending on how many shares of the FLP they own. But, as far as control goes, they have almost no say. When the FLP is dissolved, a proportionate amount of FLP property will pass to each Limited Partner.
Setting Up a FLP
Creating a FLP requires the help of an experienced estate planning attorney. You place your assets within the FLP using your unified credit. For instance, a husband and wife can each transfer up to $1,000,000 ($2 million total) into the FLP and allocate those assets to the Limited Partnership side. They can then place an additional $12,000 in the FLP for the General Partnership side. There are no taxes incurred when funding a FLP with your assets.
In the beginning, you and your spouse own both General Partner and Limited Partner shares. Over time, you gift to your heirs Limited Partner shares using your annual $11,000 gift exclusion. Don't worry about giving away too much of the shares. The General Partners may own as little as 1% of the FLP's assets and still retain control. That means you can still buy and sell assets, dispose of property, and declare any distributions of FLP shares.
Leverage Your Unified Credit
FLPs allow you to pass on more than the maximum $1 million ($2 million per couple) Unified Credit.
Discounting
A gift of Limited Partnership assets of $1 million, in some cases, may be appraised at a substantially lower dollar amount. After all, the shares lack any control and cannot be sold to others. In other words, there is no "market" for Limited Partner shares. This lower appraisal is called "discounting" the value of Limited Partnership units.
Thanks to discounting, some grantors are able to gift approximately $800,000-$900,000 to your children as Limited Partners, and still have it qualify as gift tax-free and estate tax-free.
Hedge Against Creditors
Because of their lack of control, Limited Partner shares are very undesirable to creditors. Creditors also cannot seize Limited Partner shares, since they are not publicly traded. Creditors also don't want to pay tax on income they don't receive. If the Partnership has earned income, but the General Partner does not declare a distribution, each General and Limited Partner is required to report a proportionate share of the earned income on his or her personal tax return, without actually receiving any dollars with which to pay the tax. This creates "phantom income" for the Limited Partners. Imagine how upset a creditor would be to learn that he seized Limited Partner units, only to be deprived of control, income, and dissolution rights... and then find out he must pay tax on a significant amount of income that technically doesn't even exist yet!
FLPs Offer Other Advantages
Another important feature of FLPs is that they are considered an "intangible asset." Thus, chances are that only the state of your domicile will be able to impose any inheritance tax on Partnership units. This is ideal for real property owners that own property in several states.
Another Source of Retirement Income
FLPs, as mentioned before, can provide General Partners with a stream of income as a "management fee." This fee reflects the work you do as the General Partner, and is considered earned income.
You may also draw income from your FLP through a Preferred Payment Provision. Such a provision could allow you to pull a pre-determined amount each year from the Partnership's income. For instance, you could structure a FLP to pay you $50,000 per year for 10 years, for a total of $500,000. Just like the management fee, preferred payments are subject to income tax. Preferred payments reduce the value of the FLP, allowing you to possibly utitlize other wealth transfer strategies.
WealthBuilderú
Wealth Builder is a unique strategy that allows our client to sell appreciated assets, such as real estate or closely-held stock, defer the income tax for up to 30 years, obtain a market rate of return on the reinvested assets, and generate benefits for heirs. WealthBuilderú is a creative and conservative strategy suitable for clients who want to:
- Defer income tax from the sale of certain appreciated assets
- Defer the tax attributable to certain settlements, lawsuits and bonuses
- Earn a market rate of return on the pretax proceeds
- Invest a portion of the pretax funds in a life insurance program
Opportunities to use this strategy include:
- Real estate sale
- Business sale (C Corp, S Corp, Partnership)
- Athletes and entertainers
- Highly compensated executives and sales representatives
What is WealthBuilderú
WealthBuilderú permits a seller of a qualified asset to defer all taxes on sale proceeds for up to 30 years and self-direct 100% of the pre-tax proceeds in a diversified portfolio. It is built on the chassis of an installment sale.
Advantages of a Traditional Installment Sale:
- No tax due at closing
- Tax due only at the time of each installment payment
- Interest earned on the entire outstanding balance due
Disadvantages of a Traditional Installment Sale:
- Credit risk of the buyer
- Because of credit risk concern, most notes are of short duration (3-5 years) and results in a reduction of the pre-tax growth potential
- Fixed and low interest rate
WealthBuilderú Installment Sale
WealthBuilderú is simply a Self-Directed, Institutionally Guaranteed Installment Sale.The Seller, in consultation with SFI, directs the investment of the balance of the WealthBuilderú Note in a diversified portfolio (stocks, bonds and mutual funds). The rate of return on the portfolio determines the amount the Note increases (or decreases). Each payment due under the Installment Note is guaranteed by a Standby Letter of Credit issued by a major financial institution (e.g. Deutsche Bank). The Asset is purchased with an Installment Note. Each Note is tailored to meet the client's specific requirements. Installment payments may be received quarterly, semi-annually, annually or virtually any other required time frame. The maximum duration of the Note is 30 years and the value of the Note grows on a tax-deferred basis.
Wealth Builder Steps in the Transaction
- Buyer purchases asset from seller with an Installment Note.
- Buyer deposits cash at Deutsche Bank and assigns Installment Note to Peachtree Financial Solutions.
- Deutsche Bank issues Standby Letter of Credit.
- Seller receives installment payments due under the Note.
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