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2011 Estate Planning Ideas

January 16, 2011

© 2011 Wells Fargo Bank, N.A. All rights reserved.

Nerre ShuriahVice President and Senior Financial Planner, Wells Fargo Wealth, Brokerage and Retirement Group

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I. 2010 Tax Relief Act

• What transfer tax changes did the law make, and how do the changes affect your estate plan?

II. Retirement Planning

• A look at the Defined Benefit Plan strategy

III. Business Succession

• The Combination Buy-Sell Arrangement – a strategy tailor-made for private medical practices

Estate Planning Ideas Agenda

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• Provide for your heirs

• Prepare a life insurance plan

• Protect your wealth

• Create contingency plans for unforeseen circumstances

• Philanthropy

• Choose a guardian for minor children

• Convey your burial/cremation plans

• Avoid lengthy & expensive court proceedings (Probate Court)

• Give clear direction regarding your asset distribution

• Minimize taxes

Trust and Estate Planning Is ImportantThere are many reasons to create an estate plan

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Impact of No Estate PlanCreating a comprehensive estate plan is critical to preserving and distributing your wealth, as well as protecting it from taxes and fees

When Elvis Presley died, he left a $6.2 million estate. However, he did not have an estate plan. As a result, nearly 85% of his estate was consumed by taxes and fees, leaving less than $1 million for his heirs.

Do you have anestate plan?

Reasons commonly given for not completing an estate plan include:

• I am busy with other priorities

• I am not old enough

• I do not need a plan

• It is too complicated

• Creating a plan is expensive and time-consuming

• I do not know how or where to start$3,339,520

Estate Taxes

$986,247to Heirs

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Common Estate Planning ToolsA will is typically just one element of a complete estate plan: your plan may include a combination of estate planning tools

Wills:Designate how your assets and property are distributed

Trusts:Help you protect and transfer your assets

Life Insurance:Financially protect your estate and assist your family

Ancillary Documents:Includes legal documents and agreements

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A Will Communicates Your Wishes

• Executor

You name an executor to carry out your requests. The executor is responsible for taking care of the estate, paying your debts and estate taxes and distributing money and other property by following the instructions in the will.

• Guardians

A guardian is given custody of both the property and the person of one who is unable to manage their own affairs, such as a child or mentally-disabled person. You may name two different guardians: one to care for property and one to care for the person.

• Beneficiaries

You choose beneficiaries to receive funds or property. A beneficiary can be any person(s) or entity capable of taking and holding property.

A will designates how your assets and property are distributed at your death and identifies the parties involved in settling your estate

Wills

What is not covered by a will?

Items not covered include:

• Assets held in joint tenancy with right of survivorship

• Assets for which you completed a beneficiary designation form, such as your IRA or retirement benefits

• Life insurance

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A Trust Transfers OwnershipA trust is a legal arrangement whereby you transfer ownership of assets to a trust: it is administered by a trustee and proceeds go to beneficiaries you designate

• Revocable- Can simplify management of your wealth during your lifetime- May provide ongoing management of your assets should you become incapacitated- Allows you to control the distribution of your estate

• Irrevocable- Minimizes estate and gift taxes- Allows you to control the distribution of your estate- Avoids probate for assets in trust

• Testamentary- Creates a trust by your will at the time of your death - Directs property into trust by your will- Does not exempt assets from probate

Trusts

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Ancillary Living Documents Prepare for Contingencies

• Power of Attorney

- Appoints a designee to make decisions on your behalf regarding issues such as health care and your financial affairs in the case that you are unable to do so

• Health Care Directive (Living Will)

- Provides instructions on the medical care you do or don’t want in the event you are incapacitated

• Separate Property Agreement

- Most commonly used in community property states to define the ownership of property acquired during marriage

• Prenuptial Agreement

- Establishes terms for a broad range of financial issues (money management, property rights, responsibility for debts, estate planning, etc.) between two people planning to wed

Ancillary living documents are legal documents and agreements that outline a plan in the case of any unexpected events regarding your property, health care or other personal issues

AncillaryDocuments

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Tax Relief Act of 2010 – Key Estate Tax Elements

1. After a one-year hiatus, the estate tax will be reinstated for 2011 and 2012, with a top rate of 35%. The exemption amount will be $5 million per individual in 2011 and will be indexed to inflation in following years.

Consider: The lower rate and higher exemption amount is only for 2 years. Estate planning is usually a long-term consideration. Sunset rules ($1M exemption and 55% top rate) reinstate in 2013. Uncertainty requires flexibility in planning and more frequent oversight.

2. The estate tax exemption amount is portable – if not used by the first spouse to die, it can be used by the second spouse. Married couples can shelter $10 million from transfer taxes.

Consider: Utilizing the estate tax exemption amount at the first death is still a good idea due to appreciation during time period between deaths, and the ability to leverage that tax-free amount with life insurance.

2. Estates of people who died in 2010 can choose to follow either 2010’s or 2011's rules.

Consider: Without the estate tax, some estates of people who died in 2010 will be subject to higher capital gains taxes due to lack of stepped-up basis.

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1. Gifts made after 12/31/2010: reunified with the estate tax. $5 million shelter amount for gifts too (up from $1 million). Top gift rate is 35%.

Consider: You are allowed to make yearly gifts up to $13,000 ($26,000 if married) per donee. Gifts made directly to creditors for educational or medical expenses are not included in this threshold. A program of annual gifting will capture these benefits. Also, §529 plans allow you to frontload 5 years worth of annual gifts ($65,000/$130,000) for educational purposes. All §529 distributions are income tax free if used for educational needs (tuition, books, equipment, room & board).

Consider making gifts in excess of the annual limit in order to take advantage of the $5 million exemption. This higher limit may go away after 2012. (In past years the gifting limit never exceeded $1M, and it is set to return to that amount in 2013.)

Sophisticated strategies allow you to leverage the gift amount using:• Life Insurance• Estate Freeze Techniques – GRATs, QPRTs, IDGTs• Valuation Discounts – LLC or FLP interest

Tax Relief Act of 2010 – Key Gift Tax Elements

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1. GST Tax (generation-skipping transfer tax) – for gifts made to skip persons more than one generation below. Top rate is 35%, exemption amount if $5 million (No GST tax on gifts made in 2010, although may be subject to gift tax if exceeds $1 million.)

Consider: A skip person is more than one generation below you, such as grandchildren, or greater than 37½ years younger. This latter category is a pitfall when leaving devises to friends, employees, or extended family (cousins, nieces and nephews, etc.)

If you feel your children are already taken care of, or alternatively, you fear they will spend their entire inheritance, consider GST planning for your grandchildren. This can be accomplished by outright gifts or setting up trusts that benefit grandchildren and allocating your $5 million exemption to the gift.

You may also be able to create §529 plans for grandchildren and utilize the higher gift and GST exemption amounts available for the next two years.

Tax Relief Act of 2010 – Key GST Tax Elements

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Retirement Planning Ideas:The Defined Benefit Plan

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Why Implement a Defined Benefit Pension Plan?

Income taxes are due only when distributions made

Increased tax-deductible contributions (up to $200K/year)

Increased savings can be as high as $2M at time of retirement

At death, your pension plan can be left to your spouse/heirs

You can carve out the plan so select employees benefit most

You can roll over your DB plan to an IRA at retirement

The DB plan can be partially funded with life insurance

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Defined Benefit Plans – Sample ContributionsAnnual contribution examples using different funding methodsCurrent Age

Retirement Age*

Profit Sharing

Defined Benefit Level Funding

Defined Benefit Maximum Funding**

Defined Benefit Minimum Funding

30 55 $49,000 $34,451 $47,219 $9,253

35 55 $49,000 $49,299 $65,549 $12,845

40 55 $49,000 $74,434 $92,153 $18,059

45 55 $49,000 $123,950 $127,389 $24,963

50 60 $49,000 $157,909 $163,109 $32,622

55 62 $49,000 $207,144 $223,029 $36,864

60 65 $49,000 $202,871 $234,114 $43,830

*Retirement Age less than 62 is assumed to be Early Retirement Age. **Assumes that 3 years’ compensation history is available.

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Hypothetical Example: Surgical Practice

•Doctor – $700k salary

•Spouse – $100k salary

•10 Employees – $627k total salary

•Existing Profit Sharing Plan:

-Doctor – $36,700 contribution

-Wife – $25,000 contribution

-10 Employees – $151,000 contribution

•Problem: the employee cost is twice that of the owner

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•Solution:

- Layer “split-funded” defined benefit plan on top of profit sharing plan

•New contributions:

- Doctor: $237,393 (includes $40,813 for first 6 years to fund life insurance, dropping to $196,580)

- Wife: $92,000

- 10 Employees: $151,000 – NO CHANGE

•$125k of contribution used to purchase Life Insurance

Surgical Practice Example: Solution

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Defined Benefit Pension Plan Summary for Example Doctor

What did he give up?Total Contributions $2,541,740IRS Tax Savings (40% Rate) $1,016,695Net Contributions $1,525,043

What did he get?At Retirement (age 62):$3,040,876 (assuming 5% return), plus$1,619,005 of life insurance death benefit

What can he do with it? (age 90)A. Retirement Assets provide:$254,783 annually (age 62–90) (assuming 8% gross return)

B. Life Insurance (VUL – 8% yield) provides:$34,863 tax-free annual income (age 62–90), or

$3,451,229 death benefit (age 90) to family

Age DB PlanContribution

ProfitSharing

Total

52 $201,455 $36,700 $238,155

53 $237,393 $36,700 $274,093

54 $237,393 $36,700 $274,093

55 $237,393 $36,700 $274,093

56 $237,393 $36,700 $274,093

57 $237,393 $36,700 $274,093

58 $196,580 $36,700 $233,280

59 $196,580 $36,700 $233,280

60 $196,580 $36,700 $233,280

61 $196,580 $36,700 $233,280

Totals $2,174,740 $367,000 $2,541,740

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•How?

•Comparability Testing

-Performed by TPA actuaries

-25% of salary for 10 employees was already being contributed

•Percentage of salary required for contributions on behalf of rank and file employees can be different within limits

Example: Surgical Practice

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Business Succession Ideas:The Combination Buy-Sell Agreement

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Key Elements of Succession Planning• Common practice continuation problems:

- Death of the professional- Disability- Retirement- Loss of a key employee- Need certified/licensed successor

• Adverse effects/consequences of practice termination:- Loss of income from practice for the owner/family- Disruption of careers for remaining owners/employees- Loss of value due to a forced sale of assets

• Management succession and client retention- Increase loyalty of the client base- Recruit, retain, and incentivize key employees- Identify and groom potential successors or partners- Stabilize value

• Structure to facilitate and fund buyouts- Handle future, multiple, and continuing buyouts that will

arise from retirement, death, or disability- Determine insurance ownership

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Combination Buy-Sell ArrangementThe combination buy-sell is a nontraditional arrangement in which a general partnership (or limited liability company) is used to structure and fund a buy-sell agreement. This arrangement combines the benefits of both a cross-purchase and stock redemption, while avoiding their negative aspects. With this arrangement, the owners of the business establish a separate general partnership, which owns and names itself beneficiary of life insurance policies insuring the lives of the owners. Premiums are contributed by the owners (either from their own funds or bonused from the company.)

Owner A

Owner B

Owner C

Contribution

Partnership Life Insurance Policies on

A, B, C

Contribution

Contribution

Premiums

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Combination Buy-Sell Arrangement (cont.)

At death (or other triggering event) of one of the owners, and according to the terms of the buy-sell agreement, the death benefits can be:

• Distributed to the surviving owners to fund a cross-purchase buyout

• Lent to the business to fund a stock redemption, or

• Used by the partnership to buy the deceased owner’s interest

Owner A

Owner B

Owner C

Ownership interest in Partnership

Partnership Life Insurance Policies on

B, C

50% Death Benefit

50% Death Benefit

Death Benefit for A

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Combination Buy-Sell Arrangement (cont.)

A properly structured combination buy-sell arrangement provides benefits of both stock-redemption and cross-purchase agreements by:

• Requiring only one insurance policy per owner

• Dividing premium burden equitably among all owners

• Providing full cost basis for purchased shares of business to all surviving business owners

• Enabling business to deduct bonuses paid to owners, who then contribute same amounts to partnership for insurance purchase

• Avoiding possible levy of AMT on business from receipt of life insurance death benefit when an owner dies

• Facilitating ease of including or removing changing owners from the arrangement

Questions and Answers

Closing Remarks

Cheryl McDonald

Thank You