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When the Economy Gives You Lemons Make Wealth Preservation Lemonade.

By Ralph C. Wileczek, CPA, CFP^®, CTFA, AEP

Almost mid way through 2009 and we are at one of those wealth transfer, protection, and wealth creation perfect storms again. Simply put, now is one of those rare times that the elements that make for great family wealth planning are all in alignment and it is a very good time to implement strategies that will perpetuate your legacy in ways not available just a few short years ago.

If you are interested in being sure that your wealth goes to who you wish while slashing the estate tax burden to almost nothing then this article may provide a wonderful foundation for constructing a plan.

Three basic tenets of wealth transfer planning are:

1. “Reduce” the estate taxable value of your assets,
2. “Freeze” these assets by not allowing them to increase in your taxable estate, and
3. “Indemnify” your heirs to the extent of any taxes that might be unavoidable after step 1 and 2.

How has the current economic climate helped with these three things?

Reduce

Reduce is self explanatory. Your personal and business assets are likely to be valued somewhat lower that they were a few years ago... lemons. Additionally you may be holding on to these assets in hopes of recovery. If you gift an asset today that is worth half as much as it was in 2007 you save 50% on your gift tax bill. Let’s say the asset was a home that was worth $100,000 more than your available exclusions and you gifted it to your child. This gift would have cost you about $45,000 in gift taxes in 2007. If instead you waited until 2009 the home is now only worth $50,000 more than your available exclusion then the gift taxes due are around $22,500. Same home gifted half the gift tax… lemonade. When the home appreciates back to its previous price it is still as valuable to your child, is it not?

Freeze

Freeze is a little more convoluted but still quite understandable. Let’s say that the home above was “sold” to your daughter for a note instead. The house is out of your estate but the note is in. As the house appreciates the note does not so in essence you “froze” the value of the house in your estate for the original sale price. Presumably you would want to charge your daughter the lowest interest rate available to transfer more of your wealth to her and that is where the second part of the perfect storm comes in. The Applicable Federal Rates (AFR) used to calculate interest on such sales are very, very low now. In fact June 2009’s Mid-Term Rate is 2.25%. Low interest rates might be considered more lemons but in a wealth transfer strategy… more lemonade. These rates are also very favorable in wealth transfer strategies that involve sales to trusts and gifts to different types of annuity trusts.

Indemnify

Indemnify is generally life insurance proceeds that would be payable income and estate tax free if combined with the right trust structures discussed above. However, here too we have lemons but the lemonade is just as easy to squeeze. In this environment many insures have suffered financial setbacks that make it more important than ever to seek very reliable insurance companies to live up to their promises. Fortunately, finding the cream of the crop when it comes to insurance companies is relatively easy. Look for a very high Comdex.

Comdex is not a rating, but a composite of all ratings that a company has received. Comdex percentile ranks the companies, on a scale of 1 to 100 (with “1” being the weakest and “100,” the strongest), in relation to other companies that have been evaluated by the four independent rating services.

Additionally it is important to seek coverage from a mutual company. Unlike publicly held companies, mutual companies have no stockholders and therefore no conflicts between the short-term, quarter-to-quarter financial demands of Wall Street and the long-term interests of policyholders. Not surprisingly, the top four Comdex ranked insurance companies are mutual companies.

So in these trying times you may want to consider arranging things so that when you inevitably see your assets grow again your family legacy will be preserved.

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