Women & Money Seminar
July 30, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
I’ll be speaking to the Southlake Chamber of Commerce WIN (Women in Networking) meeting at 11:30 am on Wednesday, August 26.
Women have unique opportunities and challenges with money! Women tend to live longer and earn less than men, but according to some recent studies may actually be better investors.
This interactive quiz will engage you in thinking about some of the biggest financial opportunities in your life and raise your antennae on some of the pitfalls to avoid. We’ll also discuss one of the biggest challenge Moms face – balancing saving for retirement and college.
Come prepared to have fun and participate — guessing at answers even if you don’t them will be encouraged! And after we throw out all the crazy answers, we’ll make sure everyone knows the right answer so you walk out the door with solid information to make smart financial decisions.
Where: Southlake Chamber of Commerce (1501 Corporate Circle, Suite 100, Southlake, TX)
When: Wednesday, August 26, 11:30 am
Limited Space. Reservations Recommended. Visit www.SouthlakeChamber.com to reserve your seat.
2nd income analysis
July 27, 2009 by Jean Keener, CFP, CRPC, CFDS · 1 Comment
If you’re like many folks right now, you may be trying to determine if having a stay-at-home spouse go back to work would be beneficial to your financial situation. The answer is not always clear-cut, so you want to make sure you do the math.
A second-income analysis involves an evaluation of the net after-tax benefit derived from a second income. For some couples, a second income is a financial necessity. For others, it is simply a means of achieving specific financial goals, such as ensuring a comfortable retirement.
There are two situations in particular that warrant a second-income analysis: (1) when a nonworking spouse considers entering the workforce, and (2) when a retired person considers full- or part-time employment to supplement Social Security and other retirement income.
If you wish to determine whether a second household income is advisable, you need to consider personal ramifications as well as the financial and tax aspects of your decision.
Personal ramifications
How will time spent away from the home impact you, your relationship with your spouse, and your children (if any)? For instance, if an at-home spouse with children is thinking about entering the workforce, the impact of such a move on the children may be a primary concern. In some cases, the economic benefit provided by a second income may not justify the loss in family or personal time. In other cases, of course, personal preference must take a back seat to financial necessity.
Financial aspects
Clearly, a second income can offer financial benefits. These advantages include: additional wages, salary, or self-employment income brought into the household, as well as additional fringe benefits (if any). You’ll want to look closely at the potential for saving additional income toward retirement and whether one spouse’s employer-provided health plan is more comprehensive than another.
There is also a financial downside to a second household income. Financial costs include possible extra expenses for commuting, parking, meals, clothing, child care, housecleaning, and dry cleaning.
Tax aspects
A second income could trigger certain unanticipated tax consequences, resulting in more or less after-tax income than you may have expected. Therefore, you must evaluate the overall tax impact of the second income, particularly if you’re collecting Social Security benefits.
What information must you gather to perform an analysis? You’ll need to obtain information about your current and projected financial and tax position. Regarding your current situation, you can review last year’s tax return and a recent pay stub for tax and salary information. You should also gather details about the second income, including estimated hours to be worked, wage rates, and benefits. Then, you’ll want to estimate expenses associated with the second income. Finally, you can fill out a worksheet to determine the net economic benefit of a second income. For information about how the net economic benefit of a second income affects your overall financial picture (as a couple), you might want to construct a cash flow analysis. This cash flow worksheet can get you started.
Which tax considerations are especially important? Generally, each additional dollar of income is subject to regular income tax, the 1.45 percent Medicare portion of the FICA tax (or 2.9 percent for self-employment tax), and the 6.2 percent Social Security portion of the FICA tax (12.4 percent for self-employment tax).
You’ll want to consider whether extra earnings will push your household into a higher marginal tax bracket (e.g., from the 15 percent bracket to the 25 percent bracket). But you’ll also need to consider how your increased adjusted gross income (AGI) affects the amount allowed for certain types of tax deductions. (Your AGI may be defined as your gross or total income minus certain deductions.) Common deductions that are subject to AGI limitations include the following:
- Phaseout of overall itemized deductions based on AGI (deductions reduced by 3 percent of AGI in excess of threshold amount)
- Miscellaneous itemized deductions subject to 2 percent AGI floor
- Medical expenses subject to 7.5 percent of AGI floor
- Phaseout of personal exemptions based on AGI (exemptions reduced by 2 percent of each $2,500 of AGI in excess of threshold amount)
- Phaseout of the child tax credit based on modified AGI
- Phaseout of deductible IRA contributions for certain qualified plan participants based on modified AGI
- Phaseout of exclusion of Social Security benefits based on modified AGI
- Phaseout of Roth IRA and Coverdell education savings account contributions based on modified AGI
Tax impact of second income on earned income credit
The earned income credit (EIC) is a refundable credit available to certain low-income individuals who have some earned income and meet certain other requirements. Because the EIC phases out as modified adjusted gross income increases, a second income may reduce or even eliminate your eligibility for the EIC, resulting in an after-tax benefit from the second income that is substantially less than you had anticipated.
Tax impact on retirees who receive Social Security benefits
Retirees receiving Social Security should consider the impact that supplemental earned income may have on those benefits before making the decision to work. In certain cases, taxpayers may have to include 50 percent to 85 percent of Social Security benefits in taxable income. In addition, Social Security recipients under full retirement age who have earnings in excess of an annual exemption amount are subject to a reduction in Social Security benefits.
Couples, Investing, and Risk
July 21, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
It’s pretty common for spouses to be at different points on the risk tolerance spectrum. If you’re one of these couples, you know that these differences can have varying effects on the relationship and your investing behavior.
Sometimes, the more conservative spouse just completely delegates investing decisions to the other spouse and just shuts their eyes when the statement comes. This is not the ideal solution because it’s important for both spouses to be educated on your investments in case something happens to the decision-making spouse. Lack of information can lead to stress and poor decisions with long-term consequences in this situation.
Other times, there’s a constant state of friction and stress whenever investments are discussed. The more conservative investor may veto anything that sounds the slightest bit risky. Or the more aggressive investor may rush to make investing decisions without fully explaining or researching the risk to the more conservative spouse. This approach is also clearly not what you want in your relationship!
The bottom line is … You can have differences in this area and still work quite productively together on investing. In fact, you can use your differences to prompt each other to thoroughly research and discuss each investment option resulting in better investment decisions. So how do you get to this point?
First, define your goals
Making good investment decisions is difficult if you don’t know what you’re investing for. Making sure you’re on the same page–or at least reading from the same book–when it comes to financial goal-setting is the first step toward dealing jointly with investments.
Make sure the game plan is clear
Making sure both spouses know how and (equally important) why their savings are invested in a certain way can help minimize marital blowback if investment choices don’t work out as anticipated. Second-guessing rarely improves any relationship; making sure both partners understand from the beginning why an investment was chosen, as well as its risks and potential rewards, may help moderate the impulse to say “I told you so” later.
If you’re the more aggressive investor …
Take time to understand your spouse’s concerns. You may need to provide additional information to increase his or her comfort level, but you won’t know what to supply if you automatically dismiss any objections. If you’re enthusiastic about an investment, concealing potential pitfalls could make future joint decisions more difficult if your credibility suffers because of a loss. A more cautious spouse may help you remember to assess the risks involved.
Remember that you can make changes in your portfolio gradually; you don’t have to become more aggressive all at once. And if you’re an impulsive investor, try not to act until you can consult your partner.
If you’re the more conservative investor …
If you’re unfamiliar with a specific investment, research it. Though past performance is no guarantee of future returns, understanding how an investment typically has behaved in the past or how it compares to other investment possibilities could give you a better perspective on why your spouse is interested in it.
Consider whether there are investments that are less aggressive than what your spouse is proposing but that still push you out of your comfort zone and might represent a compromise position. For example, if you don’t want to invest a large amount in a single stock, a mutual fund that invests in that sector might be a way to compromise. (Before investing in a mutual fund, carefully consider its investment objective, risks, charges, and expenses, which can be found in the prospectus available from the fund. Read it carefully before investing.)
What if you still can’t agree?
You could consider investing a certain percentage of your combined resources aggressively, an equal percentage conservatively, and a third percentage in a middle-ground choice. This would give each partner equal input and control of the decision-making process, even if one has a larger balance in his or her individual account.
Another approach is to use separate asset allocations to balance competing interests. If both spouses have workplace retirement plans, the risk-taker could invest the largest portion of his or her plan in an aggressive choice and put a smaller portion in an option with which a spouse is comfortable. The conservative partner would invest the bulk of his or her money in a relatively conservative choice and put a smaller piece in a more aggressive selection on which you both agree.
Or you could divide responsibility for specific goals. The more conservative half could be responsible for the money that’s being saved for a house down payment in five years. The other partner could take charge of longer-term goals that may benefit from taking greater risk in pursuit of potentially higher returns. You also could consider setting a predetermined limit on how much the risk-taker can put into riskier investments.
Finally, a neutral third party with some expertise and a dispassionate view of the situation may be able to help work through differences.
If you and your partner have worked through investing differences, I’d love to hear what’s worked for you. Please feel free to post a comment!
Early Retirees & Health Insurance
July 17, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
Thinking about retiring early? As part of the decision, you’ve got to calculate whether you’ll have enough retirement income to meet your needs. While adding up the costs of customary living expenses, utilities, and an occasional vacation, don’t forget to include another important retirement expense: health insurance.
We’re living longer and health-care costs are surging. Unless you qualify for Medicare (you must be at least 65 for coverage) or you’re very wealthy, you probably can’t afford to go without health insurance. And, unless you’re lucky, you probably can’t rely on your former employer for coverage, since few companies offer retiree health-care benefits. Underestimating the impact of medical costs could significantly hamper your plans for a comfortable retirement.
Check out your working spouse’s insurance to see if you can be added to his or her policy. But adding you as an insured likely will increase the premium cost to your spouse.
Ask your employer if it’s possible to remain covered under its group plan. Usually, plans don’t extend coverage beyond active employees and their dependents. But, it’s sometimes possible to remain covered, though you’ll probably have to reimburse your employer for the cost to keep you on the plan.
COBRA may be another option allowing you to remain covered under your employer’s group health plan. If your retirement causes you to lose your health insurance, you can remain on your employer’s plan for a maximum of 18 months (with some exceptions). You’ll have to pay the entire premium amount, plus a possible 2% administrative fee. And keep in mind that employers with fewer than 20 employees don’t have to offer COBRA, so it might not be available.
Shop for individual coverage
If you’re going to buy an individual health insurance policy, you may find the premium cost to be quite steep, especially if you’re also insuring your spouse and dependents. And there’s no guarantee you’ll even receive coverage. In most states, insurance companies can examine your health history and medical records (called underwriting) in order to determine whether you qualify for insurance and at what cost.
Saving a few premium pennies
Here are a few suggestions that might help you lower the cost of individual health insurance. Group rates are usually less expensive, so look for health insurance plans offered by trade associations or churches. Be aware that while coverage might cost less, you may have to pay a membership or association fee to the group offering the coverage. Also, the plan may have high deductibles and co-payments, and the benefits and options, including your choice of physicians and medical facilities, may be limited.
Also, in states that allow underwriting (Texas is one of them), the cost of an individual policy of health insurance is based, in part, on your age and health. A preexisting medical condition could affect your premium or even cause you to be denied coverage. So before applying for new health insurance, consider getting in better shape, especially if you think you’re a little overweight. Smoking is also a ticket to a higher premium, so quit if you can. Since the insurance company will examine your medical records, review them first with your doctor to remove any inaccuracies, and to clarify the reasons for examinations or treatments.
Finally, if you’re denied coverage because of poor health, don’t despair; you may still be able to get insurance if your state sponsors a high risk pool (Texas does). However, this is truly the option of last resort because of the high costs. As an example, pricing for a 60-year-old non-smoking male in some of the NE Tarrant County zip codes is $894 per month as August 1 for a $2,500 deductible plan. To see all the Texas high risk pool premiums, go to the Texas Department of Insurance website.
Do you need disability insurance?
July 15, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
Lack of long-term disability insurance is one of the most common issues I see in my practice.
First, please note that I don’t sell disability insurance. I’m a fee only financial planner, so I don’t receive any commissions on insurance or other products I recommend. My interest is in helping my clients make the best financial decisions for their lives.
Second, I’m licensed to provide insurance advice and help people figure out what kind of policy they need in the state of Texas. So if you don’t live in Texas, this isn’t directed at you.
Why is disability insurance important?
For most of us our ability to earn an income is our single biggest asset. This remains true until late in our careers. But most of us are far more likely to have life insurance than adequate disability insurance — and the odds of needing disability insurance are far greater:
So, how do you know if you need disability insurance?
There are two kinds of disability insurance — short term and long term.
You need short-term disability if you don’t have an adequate emergency fund that would cover your expenses until long-term disability started paying. If you determine you need short-term disability, first look at your employer benefits. Your company may be providing it to you already, or you may have enough built-up vacation time that you don’t need any additional income during the first 3 to 6 months of a disability. If none of these are true, then you either need to build an emergency fund or get short-term disability. Check with your employer to see if it’s available through them before you look to purchase it privately because group policies are usually less expensive.
Once you’ve got the short-term question answered, then you need to look at long-term disability. This 
is the area I see most people lacking in. Long-term disability starts after a waiting period of usually 3 to 6 months and policies can provide benefits for as little as 2 years to as much as age 67.
To determine how much long-term disability coverage you need, you need to figure out how much of your income you or your family would still need in the event of your disability. If you have two earners in the household but only need one income for your ongoing expenses, you might decide to forego the expense of disability insurance. However, most people would need at least part of their income replaced to continue paying their bills.
After you’ve determined whether you need long-term disability, look at your options. Do you already have it through your employer? As with short-term, getting long-term disability through your employer will usually be less costly than purchasing it through a private insurer. And sometimes employers even provide it as a benefit at no cost to the employee.
If you already have it or have access to it, then assess whether it’s adequate for your needs. Insurance policies vary dramatically in terms of how they define disability, elmination periods, benefit periods, whether you can go back to work part-time and still receive partial benefits, and more. The benefits can also be taxable or tax-free depending on how the premiums were paid. So it’s important to look closely at what you have and really understand the level of coverage in relationship to your individual needs.
You should also be aware of some other benefits you may already have:
Social Security: Although you shouldn’t overlook the disability benefits you may be eligible to receive from Social Security, you shouldn’t rely on them exclusively, either. Social Security denies many claims, in part due to its strict definition of disability. Even if you are deemed eligible for benefits, you still won’t begin receiving them until at least six months after you become disabled because Social Security imposes a waiting period. In addition, your benefit may replace only a fraction of your predisability income.
Workers’ compensation: If you’re injured at work or get sick from job-related causes, you may receive some disability benefits from workers’ compensation insurance. When you review your disability income insurance needs, remember that workers’ compensation pays benefits only if your disability is work related, so it offers only limited disability protection. Also note: employers in Texas are not required to provide workers compensation insurance. For more information on Texas-specific workers compensation laws, visit the Texas Department of Insurance website.
Pension plans: Some government and private pension plans pay disability benefits. Often, these plans pay benefits based on total, permanent disability, or reduce your retirement benefit in proportion to what you have already received for a disability. In addition, remember that these benefits are usually integrated with Social Security or workers’ compensation, so your benefit may be less than you expect if you also receive disability income from these government sources.
Free Financial Webinars
July 10, 2009 by Jean Keener, CFP, CRPC, CFDS · 3 Comments
The National Association of Personal Financial Advisors is starting a new series of free webinars on various financial topics including Money 101, Kids & Money, Investing Basics, Protecting What you Have, and more. These sessions are designed to provide a convenient, accessible way to get financial information to help you most effectively manage your finances. Each one is instructed by one of my fellow NAPFA members. The first session is August 7. For the full schedule and to RSVP, visit NAPFA’s website.
Should You Consolidate Student Loans Now?
July 8, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
If you have a federal Stafford Loan or PLUS Loan issued on or after July 1, 1998 and before July 1, 2006, consider yourself lucky. Beginning July 1, 2009, the interest rates on these variable-rate loans are set to drop to the lowest rates in the history of the federal student loan program. These new rates will be in effect through June 30, 2010, after which they will reset again.
Just how low are these rates? Well, starting July 1st, the new interest rate on Stafford Loans in repayment status is 2.48%, down from 4.21%; the new interest rate on in-school, grace period, or deferment status Stafford Loans is 1.88%, down from 3.61%; and the new interest rate on PLUS Loans is 3.28%, down from 5.01%. Remember, you are only entitled to these rates if you have a federal Stafford or PLUS Loan that was issued on or after July 1, 1998 and before July 1, 2006.
Consolidation
If you have more than one of these variable-rate federal student loans, you can convert your variable interest rate to a fixed interest rate by consolidating your loans under the federal government’s loan consolidation program. The interest rate on a consolidation loan is a fixed rate that’s equal to the weighted average of the current applicable interest rates on the loans being consolidated, rounded up to the nearest 1/8th of a point (and capped at 8.25%). Lowering your interest rate can potentially save you hundreds or thousands of dollars over the life of the loan.
For example, suppose you have three separate variable rate Stafford Loans that you’re currently repaying. If you consolidate them, your new fixed interest rate for the life of the loan would be 2.5% (2.48% rounded up to the nearest 1/8th of a point). Let’s assume your balance is $20,000. Over the course of 10 years, your monthly payment on a $20,000 loan at 2.5% would be $189, and the total amount of interest you would pay over that 10 years would be $2,625. By contrast, if you had a $20,000 balance at a 6.8% interest rate (the current fixed rate for unsubsidized Stafford Loans), your monthly payment would be $230 and the total amount of interest you would pay over the life of the loan would be $7,619–a savings of $4,994 in interest. Over an extended 20-year repayment term, the savings would be even greater.
There are some things to keep in mind about loan consolidation:
- You can only consolidate your loans once, so if you did so previously, you can’t do so again
- You can’t add private student loans into a federal consolidation loan
- If you’re still in school, you can’t consolidate your loans until you graduate
If you are eligible to consolidate your loans, you’ll need to go through the Federal Direct Loan Consolidation program. For more information, visit www.loanconsolidation.ed.gov.
Loans issued on or after July 1, 2006
If you have a Stafford or PLUS Loan issued on or after July 1, 2006, you aren’t eligible for these new low rates. Instead, your loan will have a fixed interest rate for the life of the loan–the exact rate will depend on the type of loan you have. For unsubsidized Stafford Loans (”unsubsidized” means the federal government does not pay the interest while you are in school, during grace periods, or during deferment periods), the interest rate is 6.8%. For PLUS Loans, the interest rate is 8.5%. And for subsidized Stafford Loans (”subsidized” means the federal government does pay the interest while you are in school, during grace periods, and during deferment periods), the interest rates are as follows:
- 5.6% for loans first disbursed on or after July 1, 2009, and before July 1, 2010
- 4.5% for loans first disbursed on or after July 1, 2010, and before July 1, 2011
- 3.4% for loans first disbursed on or after July 1, 2011, and before July 1, 2012
Summary
The following table highlights the interest rates on different types of federal student loans.
| Stafford Loan: subsidized | Stafford Loan: unsubsidized | PLUS Loan | |
| Issued on or after July 1, 1998, and before July 1, 2006 |
|
same as subsidized Stafford Loan | 3.28% (down from 5.01%) |
| Issued on or after July 1, 2006 | 6.8% fixed |
|
8.5% fixed |
401(k) options when you change jobs
July 6, 2009 by Jean Keener, CFP, CRPC, CFDS · 1 Comment
If you’ve lost your job, or are changing jobs, you may be wondering what to do with your 401(k) plan account. It’s important to understand your options.
What will I be entitled to?
If you leave your job (voluntarily or involuntarily), you’ll be entitled to a distribution of your vested balance. Your vested balance always includes your own contributions (pretax, after-tax, and Roth), and any investment earnings on those amounts. It also includes employer contributions and earnings that have satisfied your plan’s vesting schedule. In general, you must be 100% vested in employer contributions after 3 years of service (”cliff vesting”), or you must gradually vest 20% per year until you’re fully vested after 6 years (”graded vesting”). Some plans have 100% immediate vesting. You’ll also be 100% vested if you’ve reached your plan’s normal retirement age.
Special vesting rules apply to certain plans, so make sure you understand how your particular plan’s vesting schedule works. This is important, because you’ll forfeit any employer contributions that haven’t vested by the time you leave your job. If you’re on the cusp of vesting, it may make sense to wait a bit before leaving, if you have that option.
Don’t spend it, roll it!
While this pool of dollars may look attractive, don’t spend it unless you absolutely need to. If you take a full distribution you’ll be taxed, at ordinary income tax rates, on the entire value of your account except for any after-tax or Roth 401(k) contributions you’ve made. And, if you’re not yet age 55, an additional 10% penalty may also apply to the taxable portion of your payout. (Because of the 5-year holding period requirement, there won’t be any tax-free qualified distributions from Roth 401(k) accounts until 2011 at the earliest. And special rules may apply if you receive a lump-sum distribution and you were born before 1936, or if the lump sum includes employer stock.)
If your vested balance is more than $5,000, you can leave your money in your employer’s plan until you reach normal retirement age. In some cases, however, your best bet will be to roll the funds over to an IRA. It really depends on the investment options in your old employer’s plan, the fees, and how many other prior employer’s plans you still have money in. Consolidating 401(k) balances from multiple former employers can make it much easier to maintain your desired asset allocation, keep costs low, and reduce paperwork for you.
Your employer must allow you to make a direct rollover to an IRA. As the name suggests, in a direct rollover the money passes directly from your 401(k) plan account to your IRA. This is preferable to a “60-day rollover”–where you get the funds and then roll them over to an IRA yourself–because your employer has to withhold 20% of the taxable portion of a 60-day rollover. You can still roll over the entire amount of your distribution, but you’ll need to come up with the 20% that’s been withheld from other funds until you recapture that amount when you file your income tax return.
If you really do need to use some of the money, and you have nontaxable after-tax or Roth contributions in your account, keep in mind that you may be able to roll over the taxable portion of your distribution to an IRA, and take a distribution of just the nontaxable portion of your account. Again, avoid using retirement plan savings if at all possible. It can do permanent damage to your retirement funding, and it’s really hard to catch back up!
What if I have an outstanding plan loan?
In general, if you have an outstanding plan loan, you’ll need to pay it back, or the outstanding balance will be taxed as if it had been distributed to you in cash. If you can’t pay the loan back before you leave, you’ll still have 60 days to roll over the amount that’s been treated as a distribution to your IRA. Of course, you’ll need to come up with the dollars from other sources.
July 2009 Newsletter
July 1, 2009 by Jean Keener, CFP, CRPC, CFDS · Leave a Comment
The July 2009 newsletter is now available online. It reviews some blog information on FDIC insurance limits, establishing an emergency fund, and down market estate planning opportunities. It also covers new information on whether or not you should refinance your mortgage and considerations in diversifying your investments. Click here to read it.
Estate Planning Opportunities in a Down Market
July 1, 2009 by Jean Keener, CFP, CRPC, CFDS · 1 Comment
Note: This article discusses federal tax rules only. Individual states impose their own property transfer taxes using rules that may be different from the federal rules.
Basic Gifting
Each year, you can make gifts of up to $13,000 to anyone you want, to as many people as you want, tax free under the annual gift tax exclusion. You can give away twice that amount if both you and your spouse make the gifts together (this is called gift splitting). And, you can give away an unlimited amount if you pay tuition or medical bills on behalf of another person (just be sure to make these payments directly to the school or health-care provider
Family loans
You can lend money to your children at the current IRS minimum interest rate (known as the AFR, which changes monthly), and then potentially forgive an amount equal to the gift tax exclusion each year. (The gift tax exclusion amount is adjusted for inflation; $13,000 is the figure for 2009.
Grantor retained annuity trust (GRAT)
A GRAT is an irrevocable trust with a specified term (e.g., 10 years) into which you gift assets that you expect will greatly increase in value in the future. You receive annuity payments during the trust term, and at the end, your beneficiaries receive any remaining propertyThe transfer of assets to the GRAT is a taxable gift to the trust beneficiaries. The value of the gift for tax purposes is determined based on the current IRS rate (known as the 7520 rate, which also changes monthlyTax savings are achieved because the annuity payments are calculated to result in a gift tax value of zero. It’s anticipated, however, that the actual interest earned will be higher than the 7520 rate, leaving a substantial value in the GRAT at the end of the term. This remaining value is passed on to your beneficiaries tax free.
Intentionally Defective Grantor Trust (IDGT)
An IDGT is an irrevocable trust that has a purposeful flaw (i.e., you retain some control over the trust) so that you, and not the trust entity, pays the income taxes on trust income (thus, an IDGT is ideal when you want to transfer income-producing assets). Even though you retain some control over the trust, IDGT assets will generally not be included in your taxable estate at your deathYou sell assets to the IDGT in return for an installment note, with interest calculated based on the current AFR. There is no gift tax because it is a “sale” (except for an initial gift that “seeds” the trust). However, because you and the trust entity are considered the same taxpayer, no gain is recognized on the sale, and interest you receive under the note is not considered taxable income>Tax savings are achieved because, hopefully, the value leaving your estate via the sale will exceed the value returned to your estate via the note. You also reduce your estate by paying the income taxes on IDGT income.
Charitable lead trust (CLT)
A CLT is an irrevocable trust with both charitable and noncharitable beneficiaries. It’s called a lead trust because it is the charity that is entitled to the first or lead interest from the trust property. After the specified term, the remaining trust property passes to you or another named noncharitable beneficiaryAt the time assets are placed into the CLT, you receive a current gift tax deduction equal to the present value of the income stream that will be going to the charity. The interest rate used is based on the current 7520 rate. The lower the interest rate, the higher the deduction. As with a GRAT or IDGT, it is hoped that the CLT assets will appreciate beyond the 7520 rate, allowing the excess to pass tax free.
These gifting strategies, and others, can turn this economic downturn into a mixed blessing.