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The Power of Year-End Planning

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Timing may be everything when considering planning for family money. The end of the calendar year provides opportunities not only to maximize contributions made to retirement plans, but to maximize the amount of wealth ultimately transferring to heirs, minimize transfer taxes and to benefit from tax savings associated with charitable gifts. A well-thought out gifting program implemented by year-end can make the difference between simply ‘giving money’ away and creating a lasting legacy.

The Power of Making Lifetime Gifts

Each individual is permitted to make annual exclusion gifts of $12,000 per person per year, free of gift taxes. Gifts can be made to anyone including children, grandchildren, distant relatives and friends. In addition to these annual exclusion gifts, which are indexed annually for inflation, lifetime gifts of up to $1,000,000 can be made to any number of people. Once the $1,000,000 threshold is met, gift tax of up to 45% is assessed.

A gifting plan provides an individual several important tax advantages. First, by taking funds from the estate to make gifts, the size of the estate is reduced and therefore estate taxes at death are minimized. Second, the appreciation of and income generated from assets removed from the estate will not be subject to estate taxation.

And when the assets are transferred to a properly drafted irrevocable trust, all or a portion of them may be invested in most types of investments including marketable securities, or they may be leveraged with life insurance to increase the amount transferring to heirs without transfer taxes. Furthermore, if the trust is established as a grantor trust, then the income taxes owed by the trust are attributable to the grantor of the trust, the person who created the trust. Essentially, this payment of the trust income taxes by the grantor is another indirect tax-free gift, above the annual exclusion amount and lifetime exemption.

Using an Irrevocable Trust to Make Annual Gifts

There are many ways to set up a gifting program. Outright gifts can be made to anyone. But gifts can also be made directly to a trust to benefit named beneficiaries. The gifts can be used by the trustee to purchase investments. And, depending on the type of asset transferred to the trust, such as an interest in a closely-held corporation or a partnership, the value of the gift may be discounted for gift tax purposes to account for a marketability or minority interest discount, allowing an individual to transfer more to heirs in a shorter period of time with minimal to no gift tax cost.

A trust can also be established as an irrevocable life insurance trust in which the gifts can be leveraged with life insurance to benefit heirs. If the ILIT is properly drafted, the trust can receive the life insurance death proceeds free of income and estate taxes. Moreover, the trust may include spousal access provisions in which a non-grantor spouse can take distributions from the trust and also benefit from the gifts made to it.

Using a Dynasty Trust to Make Annual Gifts

A Dynasty Trust is a great means to leverage gifts through the use of the generation-skipping transfer tax exemption for the benefit of multiple generations of heirs. The GSTT is a tax that is imposed on transfers, in addition to income and estate taxes. The GST tax applies to gifts made to beneficiaries that skip a generation, such as grandchildren. However, there is a GSTT exemption from GST tax that can be allocated to gifts made during lifetime or at death. In 2007 and 2008, the exemption is $2,000,000 per person.

The key to effectively using the GSTT exemption is to make a gift of the exemption during lifetime to a dynasty trust and to leverage the gift with life insurance. The life insurance proceeds and any growth inside the trust will be outside the taxable estate for future generations. Each generation can receive distributions from the trust while the trust keeps the assets outside of the taxable estate of the grantor and beneficiaries.

Using Oral Trusts to Make Year-End Gifts

If a written trust document is not completed by the end of the year, an oral trust agreement may facilitate year-end planning with an ILIT. An oral trust is recognized in many states as a valid agreement between a trust and a trustee that can be a temporary mechanism until the written trust document is finished. An oral trust may be appropriate in situations where a life insurance policy needs to be issued by the end of the year. Typically a brief document evidences the intention to create a written trust document.

Charitable Giving Opportunities

Charitable income tax deductions may be available by year-end for gifts made to charity. Fortunately, charitable gifts can be made with a variety of assets including cash, stock, real estate or life insurance. Depending on the type of asset transferred, such as long term stock, capital gain tax may be avoided as well. The gifts can be made directly to charity or through a vehicle like a charitable trust, charitable gift annuity or charitable life estate.

Although there are limitations on the amount of deductions available based on adjusted gross income, the phase-out of itemized deductions, and the type of asset transferred, a significant reduction in the amount of income tax paid may be achieved by making charitable gifts by year-end. Additionally, life insurance may be used to leverage a charitable trust’s assets, or to replace the value of the gift at a discount, for the benefit of heirs.

Charitable IRA Rollover

The Pension Protection Act of 2006 (PPA) includes a provision that allows for the tax-free distribution from an IRA, up to $100,000 annually as long as the distribution is made directly from the IRA account to a qualifying charity. To qualify for the tax-free distribution, the IRA must be a traditional or ROTH IRA account and the IRA participant must be at least 70 1/2 . Although there is no charitable deduction available for this distribution, it will count toward required minimum distributions. It may also be possible to have the charity leverage the gift of the tax-free IRA with life insurance on the donor’s life. This provision, known as the “charitable IRA rollover” is available in 2007 only.

Qualified Land Conservation Contributions

PPA 2006 also has planning benefits for landowners interested in preserving land. A donation of a conservation restriction placed on qualifying property that is made to a qualifying land organization provides the landowner with an increase in the federal charitable income tax deduction already available for such gifts.

This potential increase in tax savings is available only if the restriction is placed on the land in 2007. The amount of the potential federal charitable income tax deduction is 50% of adjusted gross income, increased from the usual 30%. In addition, any unused federal charitable deduction can be carried forward for 15 years, increased from the usual 5-year carry-over. Further, the tax savings achieved may be used to fund a much needed life insurance policy for the estate tax liquidity needs of the often illiquid landowner.

In summary, year-end tax and trust planning that includes the optimal use of tax exclusions and exemptions as well as time-sensitive tax deductions, is essential to achieve the overall wealth transfer objectives.

Lina Storm, CLU, ChFC, is a marketing manager in the Advanced Markets Group at John Hancock Financial Services, Boston, Mass. You may e-mail her at .