What Every Financial Planner Should Know About Estate Planning

WHAT EVERY FINANCIAL PLANNER SHOULD KNOW ABOUT ESTATE PLANNING

KAREN S. GERSTNER [email protected] (713) 520-5205

WHAT IS ESTATE PLANING?

• Estate planning is planning for the distribution of a person’s “Estate” on Death • Estate planning is planning to avoid the unnecessary dissipation of a person’s “Estate” during life if the person loses his/her mental capacity • Estate planning is NOT financial planning or retirement planning

GOALS OF ESTATE PLANNING

• Provide financial security for spouse and children (or other beneficiaries) • Make a final gift (i.e., leave a legacy) to charity • Eliminate, reduce or defer future estate taxes • Eliminate, reduce or defer future income taxes • Provide for a particular beneficiary (e.g., a second spouse), but control the ultimate disposition of the assets remaining on that beneficiary’s death • Protect assets from the claims of creditors • Reduce post-death difficulty and expense (probate costs, time and expense of administration, etc.)

1 Estate Planning Definitions

• Decedent = A person who has died

• Testator = A person who makes a Will

• Property = Any type of asset: real property, personal property, tangible personal property, intangible personal property, etc.

• Trustor/Grantor/Settlor = A person who creates a trust

• Donor = A person who makes a gift during life

• Donee = A person who receives a gift during life

Estate Planning Definitions, Continued

• Testamentary Trust = A trust created in a Will (testament) or upon the death of the trust creator

• Inter Vivos Trust = A trust created during the trustor’s life (inter vivos means “during life”)

• Per Stirpes = Equal shares to children (or 1st level), with a predeceasing child’s (or other person’s) share being divided equally between his/her children (and so on)

• Contingent Trust = A contingency (such as a certain age) determines whether the trust is created or not

WHAT CONSTITUTES A PERSON’S “ESTATE”– MARITAL PROPERTY CONSIDERATIONS

• Married Persons: A married person’s estate consists of his/her half of the community property plus his/her separate property, if any • Single Persons: A single person’s estate consists of his/her ownership interest in all property of any type

(Remember definition of “property”!)

2 WHAT CONSTITUTES A PERSON’S “ESTATE”– TRANSFER TAX CONSIDERATIONS IRS: • Property: A deceased person’s estate consists of his/her ownership interest in various types of property • Powers: A deceased person’s estate also includes property over which the person possesses certain powers (such as a general power of appointment or a retained power or interest) • Irrelevant as far as IRS is concerned: – Which transfer method or methods are used at death – When the transfer is made (during life or at death)

(Remember definition of “property”!)

LIST OF ESTATE ASSETS PER IRS

• Home and furnishings • Other real estate (vacation home/condo, farm, vacant lot, rental real estate) • Oil, gas and other mineral interests (including royalties) • Stocks, bonds (including “tax exempt bonds”), mutual funds, other securities • Bank accounts, brokerage accounts, investment accounts, certificates of deposit, cash • Amounts due you from others, such as a note or mortgage receivable, a tax or other refund • Life insurance (if insuring your life, value is the proceeds on your death; if insuring someone else’s life, value is the cash value) • Business arrangements (partnerships, limited partnerships, limited liability companies, C and S corporations, joint ventures, sole proprietorships) • Collections (guns, coins, stamps, etc.) • Retirement benefits, including “qualified” (IRAs, 401(k) plans, profit-sharing plans) and non-qualified (NQSOs) plans, deferred compensation and annuities • Other tangible personal property (cars, jewelry, boats, airplanes, etc.) • Intellectual property (copyrights, patents, etc.) • Powers treated as “General Powers of Appointment” or “Retained Powers” (technical)

TEXAS MARITAL PROPERTY REGIME: COMMUNITY PROPERTY

• Texas = Community Property State: Texas is a community property state—not a “title” state. Therefore, for married persons in Texas: – the title on an asset does not indicate or determine ownership – the title on an asset only tells us the manager of the asset • Community Property Presumption: Texas law presumes that all property on hand on dissolution of a marriage (by death or divorce) is community property – the person claiming certain assets as his/her separate property must rebut the legal presumption with clear and convincing evidence (the highest civil standard) • Ownership of assets for married couples is based on when and how an asset was acquired and what happened after that (not as simple as how is asset titled)

3 Community Property

• Community property is all property acquired by either spouse during the marriage, other than (i) property acquired by gift or inheritance, (ii) property defined by statute as separate property (very limited), and (iii) property acquired with separate property: – Personal Earnings of either spouse during marriage (salary, bonus, employee and employer contributions to 401(k) plans, stock option awards, etc.) – Earnings from All Assets--all income (interest, dividends, rent payments, delay rentals) during marriage from all of the assets, whether the assets are the community property of the spouses or the separate property of just one of the spouses – Assets acquired with Earnings and other Community Property

Separate Property • A married person’s Separate Property consists of

– Property received by gift or inheritance and kept separate during marriage* – Property owned prior to marriage and kept separate during marriage* – Property acquired while living in a non-community property (i.e., title) state and kept separate after moving to Texas* – Property specified as separate property by a specific state or federal statute (e.g., federal death benefits provided on behalf of service men and women, the pain and suffering portion of a personal injury award or settlement, and a few other items—very limited) ______

*NOTE: Putting separate property in a separate account (an account titled in just that person’s name) is NOT ENOUGH to maintain that property as separate property because (i) title is not determinative of ownership in Texas and (ii) the financial institution usually places income earned by those assets (which is community property) into that same account—so the account becomes commingled 11

METHODS FOR TRANSFERRING ASSETS AT DEATH • Probate – Will – Intestacy (no will) • Non-probate – Beneficiary Designation Forms: for Beneficiary Designation Assets – “Multi-Party Arrangements”: accounts and other assets titled or registered a certain way –Trusts(meaning, assets actually held in [titled in the name of] a trust before the person dies)

4 IRS’ VIEW ON HOW AND WHEN ASSETS ARE TRANSFERRED

• IRS doesn’t care which transfer method is used to transfer assets at death—the decedent’s interest in all assets owned at death being transferred to others upon death is part of the decedent’s estate for federal estate tax purposes • IRS doesn’t care when assets are transferred either—all assets owned by a person that are transferred to someone else (whether at death or during life) are subject to a “transfer tax” (estate or gift tax), with modest exceptions

PROBATE TRANSFERS

• Testate: The Will transfers the Probate Assets at death via the Probate Process • Intestate Succession: If there is no Will, the Probate Assets will be transferred by the state intestacy laws—i.e., a substitute Will (also a Probate Process)

• There is a big difference in the Probate Process between dying with a Will and dying without a Will--dying without a Will results in the worst transfer process of all. – If no Will, state decides who inherits your assets – If no Will, probate process is much more complex and expensive (could cost 10 x as much and take 4-8 x as long as with a Will) – If no Will, Court decides who should administer your estate – If no Will, Court decides who should become guardian of your minor children – If no Will, your children receive their share of estate at age 18

The Probate Process

• Application to Probate Will and for Appointment of Independent Executor is filed with Probate Court, together with original Will • After ten (10) day waiting period, Probate hearing is held: – Testimony of Witness (as to jurisdictional and death facts) is given by knowledgeable person in open Court – Probate Court signs Order Admitting Will to Probate and Appointing Independent Executor – Executor swears to perform all duties required by law, and executes Oath of Independent Executor in the presence of the probate clerk – Clerk issues Letters Testamentary to Independent Executor, evidencing his/her authority to act with respect to all matters involving the Estate • Executor Provides Required Notices: – Executor publishes Notice to the General Creditors of the Estate – Executor provides notice to all secured creditors of the Estate by certified mail – Executor provides notice to all “current” beneficiaries named in the Will – Executor files proof of giving the notices with the Probate Court • Meanwhile, Executor handles the estate administration matters (discussed later) • Inventory and List of Claims is prepared by the Executor, describing and valuing all probate assets being transferred by the decedent’s Will, and filed with the Probate Court • Court signs Order Approving Inventory and List of Claims, signifying conclusion of the probate process 15

5 Typical Probate Assets

• Texas home and other real estate, including mineral interests • Automobiles, Boats, Airplanes • Household furnishings and personal effects • Bank accounts, brokerage accounts and securities titled solely in the name of an unmarried decedent (with no multi-party arrangements) • Bank accounts, brokerage accounts and securities titled in both spouses’ names, without right of survivorship and without a designated death beneficiary (no POD or TOD) • Oil, gas and other mineral interests • Proprietorships, partnerships and other business interests • Decedent’s community property ½ interest in life insurance and IRAs in name of surviving spouse 16

NON-PROBATE TRANSFERS- THREE TYPES •First Type: Beneficiary Designation Assets—Unless the owner’s “estate” or “executor in Will” is listed as the beneficiary on the beneficiary designation form, the transfer of these assets at death will be a non-probate transfer. Examples include: – Life insurance on decedent’s life – IRAs and IRA rollovers in name of decedent – Qualified retirement plans (e.g., 401(k) plans, profit- sharing plans, thrift plans, etc.) in which decedent was a participant – Some non-qualified retirement plans (depends) – Annuities “owned” by decedent

NON-PROBATE TRANSFERS, continued

• Second Type: Certain “Multi-Party” Arrangements— these arrangements result in a non-probate transfer because of the form of title or particular wording used in the title or registration (i.e., wording with a legal effect). Examples include: – Joint Tenants With Right of Survivorship (“JTWROS”, “JT TEN”, “JT w/ROS”, etc.) Accounts or Assets – Accounts set up with a “POD” (pay on death) or “TOD” (transfer on death) designation – JTWROS accounts with POD beneficiary – “Totten trust” accounts (depositor as trustee for beneficiary)

6 NON-PROBATE TRANSFERS, continued • Third Type: Trust Assets (assets actually held in [titled in the name of] a trust before trustor dies).

– Revocable Trusts (sometimes also called “Living Trusts”). The assets already held in the trust prior to the death of the trustor are transferred to the beneficiaries upon the trustor’s death outside the probate process. These assets are part of the trustor’s estate for federal estate tax purposes at death, however, because the trustor retained the right to use the trust assets until his death (i.e., for his lifetime). A revocable trust is a grantor trust and, therefore, has no effect for tax purposes. 19

NON-PROBATE TRANSFERS, continued •Third Type: Trust Assets (continued)

– Irrevocable Trusts. These assets are not really being transferred at death—they were transferred prior to death (so not really correct to include them as a non-probate transfer at death). The assets in an irrevocable trust should not be included in the trustor’s taxable estate unless the trustor retained a lifetime interest in--or prohibited power over--the trust). NOTE: contributions made to an irrevocable trust are usually completed gifts for federal gift tax purposes when made and, if taxable, use up a portion of the trustor’s lifetime gift tax exemption, which simultaneously uses up the same amount of the trustor’s estate tax exclusion amount (which otherwise would be available to shelter transfers made at death from estate tax).

COMPARISON OF TRANSFER METHODS*

• Real Estate: A Will or the JTWROS form of titling (the latter not available for real estate in Texas) are more efficient methods for transferring real estate at death than a Living Trust (which requires two, and sometimes, three deeds). • Providing For Contingencies: A Will or Living Trust is the best method for providing for contingencies (such as an intended beneficiary predeceasing the decedent). • Creating Trusts for Beneficiaries: The only methods that can be used to place the assets in a trust for a beneficiary are a Will or Living Trust. • Tax Planning: Only a Will or Living Trust allow for the creation of a comprehensive estate plan, designed to reduce estate (and other) taxes and accomplish other estate planning goals (such as divorce protection for an inheritance passing to a child). • Beneficiary Designation Assets: No other method is available for transferring Beneficiary Designation Assets at Death—thus, completing beneficiary designation forms in a manner that is coordinated with the comprehensive estate plan in the Will or Living Trust is imperative. If forms are completed without regard to the overall estate plan, adverse tax and other consequences can result.

*Except for Beneficiary Designation Assets, all other assets can be transferred at death by any of the transfer methods 21

7 COMPARISON OF TRANSFER METHODS, CONTINUED

• Multi-party arrangements: These arrangements (called the “poor man’s Will”) should be avoided in most cases because they – Override the estate plan in the Will – Can result in unintended consequences/litigation – Do not lend themselves to contingency planning – Thwart the tax and trust planning in the Will or Living Trust – May preclude the Executor/Trustee from having sufficient funds to pay the decedent’s debts, final income taxes, funeral expenses, administration expenses, estate taxes and other post- death charges

– OK to use in 2 cases: (i) married couple with small estate, no real estate, estate plan=100% outright to surviving spouse (ii) single person with small estate, no real estate, only 1 child, estate plan=all to only child 22

Post-Death Administration Matters

• Certain matters must be handled when someone dies, regardless of the transfer method (or methods) used at death and regardless of whether the estate is taxable • These matters are handled by the Executor (with respect to probate assets) and/or the (successor) Trustee of the Living Trust (with respect to assets held in the Trust at death) NOTE: None of the matters listed on the next slides are “probate matters” (meaning, you do not avoid these matters by “avoiding probate”)

Post-Death Administration Matters, a list

• Pay debts, funeral expenses, final medical bills, and other bills that come in after the decedent’s death. • Make a complete and accurate list of all assets and liabilities of the decedent, with all assets being valued based on IRS regulations. • Prepare and file a final Income Tax Return (Form 1040) for the decedent and pay any income taxes due. • If a Federal Estate Tax Return (Form 706) must be filed, prepare and file the Form 706 with the IRS by the due date (and if the decedent owned any real property in one or more states with an estate or inheritance tax, prepare and file those state death tax returns also). • If any federal estate or state inheritance taxes are due, assess the liquidity situation and raise the funds that will be needed to pay the taxes (i.e., sell/liquidate assets, if necessary). • Handle all claims against the decedent or his estate, finish litigation in which the decedent was involved and resolve any title problems. • Prepare and file with the IRS a U.S. Fiduciary Income Tax Return (Form 1041) for the Estate or Trust for each year in existence and pay any income taxes due. 24

8 Post-Death Administration Matters, continued

• When a "closing letter" is received from Internal Revenue Service with respect to the Federal Estate Tax Return that was filed (if applicable), send a copy to each state in which an inheritance tax return was filed. • Conclude all other outstanding matters involving the decedent and his estate (e.g., settle health insurance claims, obtain refunds due the estate for overpayments, settle inheritance tax issues with other states, handle ancillary probate and estate administration matters in other states). • Distribute the decedent’s assets to the beneficiaries per the Will or Trust-- this step involves retitling all of the assets and placing the appropriate taxpayer identification number on the retitled assets. If the decedent created any trusts for any beneficiaries in the Will or Trust taking effect at death, obtain a taxpayer identification number from the IRS for each new trust (except for a “survivor’s trust” that will hold assets owned by a surviving spouse under a Living Trust). Retitling the decedent’s assets may require preparing and filing new deeds to change the title to real estate or minerals, providing numerous documents and instructions to stock transfer agents and other companies to re-title securities and other financial assets; closing accounts and dividing the funds and then opening new accounts for the beneficiaries [including trusts], etc.). • Prepare and file with the IRS a final Form 1041 for the Estate or Trust when all administration matters are concluded. 25

Planning for Disability and “Old Age”

• Statutory Durable Power of Attorney (financial matters)

• Medical Power of Attorney (health care decisions)

• Directive to Physicians (Living Will)

• Declaration of Guardian (for self) in Event of Later Need

• Revocable Management Trust ("Living Trust“)

• HIPAA Authorization (disclosure of medical information)

Other Estate Planning Matters

• Designation of Guardian for Minor or Incapacitated Child or Children by Parent • Appointment of Agent to Control Disposition of Remains • Prenuptial and Postnuptial Agreements • Lifetime Transfers Designed to Avoid Future Estate Taxes • Special Needs Trust for disabled child

9 When should an estate plan be changed?

• Financial situation has changed (e.g., you had a taxable estate before but no longer do or vice versa) • Personal situation has changed (e.g., you were single before and are now married or vice versa) • Persons named in fiduciary positions have died or are no longer close • Beneficiaries have died or you no longer want to make gifts to them • You move to another state or purchase (or inherit) real estate (including minerals) in another state 28

Qualities of Persons Appointed as Fiduciaries in Estate Planning Documents

• Trustworthy • Responsible • Diligent • Good judgment • Family knowledge • Cooperative • Decisive • Good Communicator

NEVER APPOINT A PROCRASTINATOR!

The Federal Transfer Tax System (U.S. Estate, Gift and Generation-Skipping Transfer Taxes)

• A transfer tax is an excise tax, imposed on the privilege of transferring assets to others • Gift Tax—applicable to taxable transfers made during life • Estate Tax—applicable to taxable transfers made at death • Generation-Skipping Transfer Tax—applicable to taxable generation-skipping transfers made during life and at death

10 Federal Gift Tax • Gift = A transfer made by a donor during life of something of value to the donee (beneficiary) • IRS construes term gift very broadly (e.g., loans and guarantees) • The gift is valued at fair market value on date gift is made • The donor’s tax basis in the gifted asset carries over to the donee • Taxable gifts must be reported to IRS on Form 709 by April 15 of year after gift (unless deadline extended) • Modest exclusions from the gift tax: • Annual Exclusion Gifts ($13,000 per donee for 2009)—must be “present interests” (outright gifts or transfers to certain trusts) • Annual Exclusion Gifts to Non-Citizen Spouse ($133,000 for 2009) • Direct payment of tuition &/or medical expenses on donee’s behalf • Lifetime Exemption: Every person has a $1 million (cumulative) lifetime exemption from the gift tax • No gift tax is payable until all taxable gifts, in the aggregate, exceed $1 million • Use of lifetime gift tax exemption reduces amount of estate tax exclusion available at death to shelter transfers from estate tax • No change in lifetime gift tax exemption for 2010 31

Federal Estate Tax • Estate Tax = An excise tax on the transfer of assets at death (if no transfer, no tax—e.g., decedent’s burial plot) • Gross Estate = Fair market value of all assets owned (and taxable powers possessed) by decedent at death • Estate Tax Return (Form 706) must be filed if Gross Estate (assets) exceeds $3.5 million (2009 amount) • Asset Valuation Date = Date of death or, if it will reduce estate taxes, date which is 6 months after date of death (alternate valuation date) • Allowable deductions reduce Gross Estate to Tentative Taxable Estate – Funeral Expenses – Administration Expenses – Debts and Liens – Unlimited Marital Deduction for gifts to Spouse who is US citizen* – Unlimited Charitable Deduction 32

Federal Estate Tax, continued

• Adjusted Taxable Gifts (cumulative taxable gifts made during life after 12/31/76) are added back to Tentative Taxable Estate to produce Taxable Estate • Estate tax rate (currently 45%) is applied to the Taxable Estate to produce the Tentative Tax • Unified Credit (currently $1,455,800—amount needed to shelter $3.5 million from estate tax) is subtracted from Tentative Tax to produce Estate Tax payable • Estate tax must be paid due 9 months after death • Estate tax return (Form 706) must be filed 9 months after death—return due date can by extended by 6 months but tax must still be paid 9 months after death • Executor of Estate (and/or Trustee of Living Trust) has personal liability for all taxes owed by decedent

11 Current Estate Tax Regime

Exclusion Year Starting Rate Top Rate Amount 2001 37% 55% $675,000 2002 41% 50% $1,000,000 2003 41% 49% $1,000,000 2004 45% 48% $1,500,000 2005 45% 47% $1,500,000 2006 46% 46% $2,000,000 2007 45% 45% $2,000,000 2008 45% 45% $2,000,000 2009 45% 45% $3,500,000 2010* N/A N/A (Unlimited) 2011 and thereafter 41% 55% $1,000,000

Federal Estate Tax, continued

• Beneficiaries who inherit assets from decedent at death obtain a new (income tax) basis in assets equal to 706 value (stepped “up” basis) • Under current law, married couples only get one estate tax exclusion amount per couple unless they use a “Bypass Trust” (a/k/a a “Credit Shelter Trust”)—if no Bypass Trust in Will or Living Trust, a 45% estate tax applies to combined estate above $3.5 million on second spouse’s death (stacking problem)

SIMPLE WILLS – DEATHS IN 2009

Husband $3,500,000

Both Alive Both US citizens Wife $3,500,000

Total Estate $7,000,000 (All CP)

•Outright to Wife ON Wife •JTWROS with Wife HUSBAND'S •Wife is 100% beneficiary DEATH $3,500,000 of non-probate assets $3,500,000

No estate tax on husband's death due to marital deduction (estate tax is deferred until wife dies) Total Estate Tax $0

Wife's Estate inherited Wife's Estate ON WIFE'S from Husband DEATH $3,500,000 $3,500,000

Estate Tax $787,500 Estate Tax $787,500

Total Estate Tax $1,575,000 36 Total Distribution To Heirs: $5,425,000 Wife's "Heirs" Husband/Wife's "Heirs" $2,712,500 $2,712,500

12 BYPASS TRUST WILLS – DEATHS IN 2009

Husband $3,500,000 Both Alive Both US citizens Wife $3,500,000 Total Estate $7,000,000 (All CP)

ON Bypass Trust Wife HUSBAND'S For Wife $3,500,000 DEATH (and children) $3,500,000

Estate Tax $0 due to application of Husband's exemption Total Estate Tax $0

Bypass Trust Wife's Estate terminates ON WIFE'S DEATH $3,500,000 $3,500,000 (plus growth)

Estate Tax $0— Estate Tax $0 already covered due to application of Total Estate Tax -0- Wife's exemption

Husband's "Heirs" Wife's "Heirs $3,500,000 $3,500,000 37 Total Distribution to Heirs: $7,000,000. Tax Savings over Simple Wills: $1,575,000.

Gift Tax Versus Estate Tax*

• Although tax rate is same (45%), effective gift tax rate is less than effective estate tax rate because gift tax is “tax- exclusive” while estate tax is “tax inclusive” (paying tax on the tax) • Paying gift tax during life reduces size of estate at death • Making gifts of appreciating property during life removes post-gift appreciation and post-gift income from estate (but, reminder--value of taxable gift uses up exemption) • Person with taxable estate and large IRA rollover should consider Roth conversion or IRA withdrawal on death bed • Taxable gifts should be “leveraged” gifts (versus simple gifts)

*Important considerations for clients with taxable estates

Examples of “Leveraged” Gifts

•GRATs •QPRTs •CRTs •CLTs • Sale to IDGT • Making gifts with FLP or LLC interests • Making gifts of minority or undivided interests

13 Generation-Skipping Transfer Tax

• Applicable to all “generation-skipping transfers” after October 22, 1986 (and to GSTs from trusts not irrevocable prior to September 25, 1985) • Extreme caution warranted when adding anything or making changes to irrevocable trust that is grandfathered from GST tax • Three types of GSTs –Direct Skips – Taxable Distributions – Taxable Terminations

Generation-Skipping Transfer Tax, continued • History (super-wealthy avoiding estate taxes) • GST exemption: $3.5 million (2009) • GST Tax = Penalty tax—flat tax at the highest rate • Transferor should affirmatively allocate GST exemption to GSTs (and not rely on deemed allocations) • Trusts should be either GST exempt (0 inclusion ratio) or non-exempt (inclusion ratio of 1) and not in between • Can do a Qualified Severance (per state and federal law) to divide a trust for GST purposes 41

Trust as Beneficiary of Qualified Plan or IRA

• If trust is a “Qualified See-Through Trust”, post-death minimum required distributions (MRDs) can be made over life expectancy of oldest beneficiary of trust (meaning, trust gets “DB” treatment)

• To be a Qualified See-Through Trust: – Trust must be a valid trust under state law – Trust must be irrevocable – Trust beneficiaries must be human beings or other qualified see- through trusts for human beings – All trust beneficiaries who could receive distributions from plan or IRA must be clearly identifiable from trust instrument* – Trust documentation is timely provided to plan administrator or IRA custodian

* Hardest requirement—if not a Conduit Trust, must take into account remainder beneficiaries and beneficiaries of powers of appointment 42

14 CONDUIT TRUST

$X $X Qualified Trust Current Plan/IRA Beneficiary MRD (or other distribution)

Trustee has no discretion: must distribute 100% of plan/IRA distribution ($X) out of Trust to Current Beneficiary

Current Beneficiary = DB

(All remainder/other beneficiaries can be ignored)

ACCUMULATION TRUST

? distribute all or $X Trust part of $X? Qualified Current Plan/IRA ? retain all or Beneficiary MRD (or other distribution) part of $X? (Remainder Trustee has discretion Beneficiary) regarding current distribution from trust of at least some portion of plan/IRA distribution received

All beneficiaries who might end up with any part of distribution ($X) must be taken into account in determining qualification for DB treatment and who is DB 44

Sophisticated Technique: Estate with large IRA - Fund Bypass Trust with After-Tax Assets (and none of IRA)

• No prior marriages • All assets, including husband's IRA rollover, are community property • Couple must use joint revocable trust as their primary estate planning vehicle • Per trust instrument, Bypass Trust is created upon death of first spouse • Trust clearly authorizes Trustee to make non pro rata distributions--important! 45

15 Assets of Jack and Helen Johnson (all community property)

Home (no mortgage) $600,000 Joint Money Market Acct $200,000 Joint Investment Acct $2,500,000 IRA in Husband's name $2,500,000 Household furnishings, personal effects, cars, etc. $150,000 TOTAL ESTATE $5,950,000

Planning Prior to Death

• Trustors execute Joint Revocable Trust • Joint after-tax accounts are titled in name of Joint Revocable Trust shortly after execution of trust instrument • Beneficiary designation for husband's IRA is set up with wife as Primary Beneficiary and (Trustee of) Joint Revocable Trust as Contingent (Secondary) Beneficiary (to allow disclaimer by wife to Trust)

Husband Dies First- Assume Estate Tax Exemption is $3,500,000

• Wife disclaims IRA, with result that disclaimed IRA passes to Trustee of Joint Revocable Trust per beneficiary designation form on file for IRA (i.e., form names Trust as contingent beneficiary) • Trustee of Trust makes a non pro rata distribution and places 100% of after-tax investment account in Bypass Trust and allocates disclaimed IRA (husband’s interest) to wife in exchange for her interest in investment account • Wife does spousal IRA rollover of entire IRA, and names children as beneficiaries, preserving “stretch IRA” for children after her death

16 Supportive Rulings: 1) No Income Tax on Non Pro Rata Distribution, 2) No Acceleration of IRA income, and 3) No “2036 problem” in wife’s estate re: portion of wife’s assets placed in Bypass Trust

• PLR 8037124 (June 23, 1980) • PLR 8016050 (January 23, 1980) • PLR 9422052 (March 9, 1994) • PLR 199912040 (March 29, 1999) • PLR 199925033 (June 28, 1999)

Documentation of Non Pro Rata Distribution

• Documentation memorializes the non pro rata distribution made by the Trustee of the Joint Revocable Trust (consent issue) • Values of “swapped” assets must be equivalent • Result of non pro rata distribution: – Bypass Trust owns 100% of after-tax investment account: $2,500,000 – Wife owns 100% of IRA rollover: $2,500,000

Estate Tax Result on Wife’s Death— Assume wife dies next year and no change in tax laws or asset values

Wife’s Estate: Bypass Trust Owns: All of Home $600,000 ½ of money market $100,000 All of investment account $2,500,000

IRA rollover $2,500,000 ½ of money market $100,000 TOTAL $2,600,000 Furnishings, car, etc $150,000 TOTAL $3,350,000

No estate taxes payable on entire $5,950,000 and children inherit IRA (separate shares) with ability to stretch distributions over each child’s life expectancy 51

17 THE END