The last issue of The Wealth Counselor addressed the significant need for clients to plan for the possibility of disability, and how proper disability planning more often than not involves the coordination of financial and legal solutions. This issue addresses a related and often misunderstood topic, Medicaid planning.

What is Medicaid?

Medicaid (Medi-Cal in California) is a federal government program that provides financial assistance to persons age 65 and over, or those under 65 who are disabled and who are in need of substantial medical assistance. Medicaid is a needs-based program – a person must have a medical need for the assistance and must be of limited financial means before he or she may qualify.

Planning Tip: Medicaid is very different from Medicare. Medicare is health insurance available to all persons over age 65 who qualify for Social Security, as well as those who are under 65 and who the Social Security Administration determines to be disabled. Medicare will not pay for nursing home, assisted living or home health care on a long-term basis. Medicare will only pay for this type of care for up to 100 days, and only for the purpose of providing rehabilitation following a three-day or longer hospital stay.

Unfortunately, with the rising costs of long-term care, many people cannot afford to pay privately for home health care, assisted living, or nursing home care. According to the 2006 Study of the MetLife Mature Market Institute, the national average cost for a private room in a nursing home is over $75,000 annually. The national average cost of in-home care is between $17 and $19 per hour. As noted in a recent Harvard University Study, 69% of single people and 34% of married couples would exhaust their assets after 13 weeks in a nursing home. For those whose assets won’t last 13 weeks – much less the rest of their lives – Medicaid planning becomes an important consideration.

Planning Tip: Most people do not have sufficient assets to pay privately for long-term care. Medicaid planning is most appropriate for these individuals, a growing segment of the population.

What is Medicaid Planning?

The term “Medicaid planning” involves either spending down or otherwise protecting a person’s assets so that he or she has minimal assets and can meet the financial criteria for Medicaid qualification (which can be as low as $2,000 for a single person). Although based on federal law, Medicaid rules are different from state to state, and even county to county, and therefore it is important to consult with a legal expert in the field of Medicaid. Furthermore, the transfer of assets, purchase of financial products, or otherwise disposing of assets has tax implications for the transferor as well as the recipient, necessitating the advice of a tax advisor. Finally, a financial advisor is a necessity to help clients choose the correct financial products as part of an overall Medicaid planning strategy.

Planning Tip: Medicaid planning requires input and a coordinated effort from the client’s legal, financial and tax advisors, all of whom should be knowledgeable in Medicaid planning.

Medicaid Pre-Planning

Medicaid planning can be divided into two types: pre-planning and crisis planning. Pre-planning is for those individuals who have not yet begun to spend their assets on private care, but may need to in the coming years. Crisis planning is for those individuals using their life savings for long-term care (either at home or in a facility) with a substantial risk that they will run out of money.

In pre-planning cases, life insurance can provide tremendous planning benefits when implemented correctly. The purchase of a single premium life insurance policy by an irrevocable trust, or subsequent transfer to such a trust, will not only replace a couple’s net worth, it will protect the cash value of that policy from Medicaid. Alternatively, if not owned by an irrevocable trust, the cash value of any life insurance policy will count against the amount of assets a person can keep and still qualify for Medicaid.

For example, assume Mr. and Mrs. Jones, both age 65 and in good health, have $450,000 of assets. At their age, a single premium of $100,000 would buy a second-to-die death benefit of nearly $450,000. If an irrevocable trust owns the policy and neither Mr. or Mrs. Jones have access to the trust assets, after a certain period (most likely 5 years), their entire net worth would be protected from Medicaid, and Mr. and Mrs. Jones would still have $350,000 left to live on. Mr. and Mrs. Jones could transfer more assets to the irrevocable trust, if they desire. In fact, if the couple also purchased a five-year long-term care policy (or a life insurance policy with a long-term care rider), they could protect all of their assets from Medicaid, even with a 5 year look-back period.

Planning Tip: With pre-planning clients, life insurance owned by an irrevocable trust, perhaps combined with long-term care insurance or a long-term care rider, can provide significant Medicaid planning benefits.

For those who choose to plan early, the use of an irrevocable trust combined with life insurance and/or long-term care insurance can provide optimum asset protection for an aging client. When gifting is used as a planning strategy, the person receiving the gift often needs advice on how to invest the money they receive. Thus, Medicaid planning also opens the door for the financial advisor to converse with younger family members about the need for proper planning, including the need for disability insurance and long-term care insurance.

Planning Tip: Medicaid planning can open the door for the financial advisor to begin working with and planning for younger generations, while establishing the need for disability insurance and long-term care insurance.

Medicaid Crisis Planning

Even with crisis planning there are significant planning opportunities for our clients. While transfers either outright to a family member or to an irrevocable trust create a penalty period for the person making the gift, sometimes a planned strategy involving gifting and the use of an annuity can provide a valuable crisis planning tool. For example, assume Mr. Jones suffers a stroke and ends up in a nursing home, and his cost of care exceeds the couple’s monthly income by $4,500 per moth. Since the couple has assets of $450,000, they are $346,360 over the allowable limit of $101,640 for a married couple. One under-utilized but very effective strategy is for the couple to purchase a Medicaid Qualifying Annuity (MQA) in favor of the healthy community spouse, Mrs. Jones. By converting the excess assets into an income stream, Mr. Jones can now qualify for Medicaid and the MQA provides Mrs. Jones with extra income to supplement the loss of her husband’s income (which must be paid to the facility).

For a single person in crisis planning, a plan of partial gifting plus the purchase of a single premium immediate annuity may be appropriate. Keep in mind that any time a Medicaid applicant makes a gift, whether it is to another person or to a trust, Medicaid will impose a penalty based on the size of the gift. The penalty is the equivalent of a waiting period – the larger the gift, the longer a Medicaid applicant must wait to obtain eligibility. Because of the severe penalties for gifting, clients should not undertake this type of strategy without the legal advice of a Medicaid planning attorney.

Planning Tip: Annuities play a crucial role in Medicaid planning, particularly with crisis planning.

Identifying Possible Medicaid Clients

In determining which clients are appropriate for Medicaid planning, it is important to consider the client’s age and life expectancy, monthly income, monthly medical expenses and other assets. Take Anna, a 72 year-old woman residing in an assisted living facility costing $3,500 per month. She has other medical expenses, including prescriptions, of $300 per month. Her only income is from social security, which amounts to $1,200 per month. Anna is depleting her savings at a rate of $2,600 per month, just for medical expenses. Anna has $450,000 in a brokerage account, which on its face sounds like a lot of money, given she is only spending approximately $36,000 per year on her care. But when we take into consideration the fact that Anna may very well need more care in the future, which could cost as much as $10,000 per month, and given her life expectancy of 13.96 years, it is clear that Anna’s assets may not be sufficient to cover her long-term care expenses for the rest of her life. Anna is not only an appropriate client for Medicaid planning, she is a crisis planning client.

Planning Tip: It is important to take a client’s age, medical needs, monthly expenses and income into consideration to determine whether Medicaid planning is necessary or appropriate.

Conclusion

Due in part to the rising costs of long-term care and the fact that we are an aging population, Medicaid planning is a growing area of practice for attorneys, CPAs, financial planners and insurance professionals. However, as evidenced by the content of this newsletter, Medicaid planning requires that these disciplines work together collaboratively to ensure that the client avoids the numerous pitfalls that exist in this area.

No one likes to think about the possibility of their own disability or the disability of a loved one. However, as we’ll see below, the statistics are clear that we should all plan for at least a temporary disability. This issue of The Wealth Counselor examines the eye-opening statistics surrounding disability and some of the common disability planning options. Disability planning is one area where we can give each and every one of our clients great comfort in knowing that, if the day comes for themselves or a loved one, they will be prepared.

Most Clients Will Face At Least a Temporary Disability

Study after study confirms that nearly everyone will face at least a temporary disability sometime during their lifetime. More specifically, one in three Americans will face at least a 90-day disability before reaching age 65 and, as the following graph depicts, depending upon their ages, up to 44% of Americans will face a disability of up to 4.7 years. On the whole, Americans are up to 3.5 times more likely to become disabled than die in any given year.

Planning Tip: Many clients fear what will happen to them if they become disabled. Advisors who can help allay these fears will have more satisfied clients who move forward with their planning recommendations.

Many Clients Will Face a Long-Term Disability

Unfortunately, for many of our clients the disability will not be short-lived. According to the 2000 National Home and Hospice Care Survey, conducted by the Centers for Disease Control’s National Center for Health Statistics, over 1.3 million Americans received long-term home health care services during 2000 (the most recent year this information is available). Three-fourths of these patients received skilled care, the highest level of in-home care, and 51% percent needed help with at least one “activity of daily living” (such as eating, bathing, getting dressed, or the kind of care needed for a severe cognitive impairment like Alzheimer’s disease).

The average length of service was 312 days, and 70% of in-home patients were 65 years of age or older. Patient age is particularly important as more Americans live past age 65. The U.S. Department of Health and Human Services Administration on Aging tells us that Americans over 65 are increasing at an impressive rate:

Nursing home statistics are equally alarming. According to the 1999 National Nursing Home Survey, the national average length of stay for nursing home residents is 892 days, with over 50% of nursing home residents staying at least one year. Significantly, only 18% are discharged in less than three months.

While a relatively small number (1.56 million) and percentage (4.5%) of the 65+ population lived in nursing homes in 2000, the percentage increased dramatically with age, ranging from 1.1% for persons 65-74 years to 4.7% for persons 75-84 years and 18.2% for persons 85+.

Planning Tip: Many clients will require significant in-home care lasting, on average, close to a year. For clients requiring nursing home care, that care lasts, on average, nearly 2 1/2 years! Not surprising, the older the client or loved one, the more likely he or she will need long-term care – which is significant given that Americans are living longer.

Long-Term Care Costs Can be Staggering

Not only will many of our clients face prolonged long-term care, in-home care and nursing home costs continue to rise. According to the 2006 Study of the MetLife Mature Market Institute, national averages for long-term care costs are as follows:

• Hourly rate for home health aides is $19, higher than in 2004.
• Hourly rate for homemakers/companions is $17, higher than in 2004.
• Daily rate for a private room in a nursing home is $206, or $75,190 annually, a 1.5% increase over the 2005 rate.
• Daily rate for a semi-private room in a nursing home is $183, or $66,795 annually, a 3.9% increase over the 2005 rate.

These costs vary significantly by region, and thus it is critical that we know the costs where the client or his or her loved one will receive care. For example, the average cost for a private room in a nursing home is much higher in the Northeast ($346 per day, or $126,290 annually, in New York City) than in the Midwest (only $143 per day, or $52,195 annually, in Chicago) or the West ($199 per day, or $72,635 annually, in Los Angeles).

Planning Tip: Nursing home costs will consume many Americans’ assets. A recent Harvard University study indicates that 69% of single people and 34% of married couples would exhaust their assets after 13 weeks (i.e., 91 days) in a nursing home!

Clients Should Consider Long-Term Care Insurance to Cover these Costs

As the Harvard University study demonstrates, if a client, client’s spouse, or family member needs long term care, the cost could easily deplete and/or extinguish the family’s hard-earned assets. Alternatively, clients (or their families) can pay for long-term care completely or in part through long-term care insurance.

Most long-term care insurance plans let the client choose the amount of the coverage she wants, as well as how and where she can use her benefits. A comprehensive plan includes benefits for all levels of care, custodial to skilled. Clients can receive care in a variety of settings, including the client’s home, assisted living facilities, adult day care centers or hospice facilities.

Planning Tip: Absent financial insolvency, government benefits for long-term costs are extremely limited – typically only for skilled care and only for a short duration. Given the costs of long-term care, clients should consider a long-term care insurance policy that meets their unique planning objectives.

Planning Tip: Income-earning clients should also consider disability insurance to cover lost income as a result of a long-term disability. While long-term care insurance will cover in-home or nursing home costs, it will not replace the income lost due to the client’s inability to work.

Clients’ Estate Planning Should Thoroughly Address Disability

When a client becomes disabled, he or she is often unable to make personal and/or financial decisions. If the client cannot make these decisions, someone must have the legal authority to do so. Otherwise, the family must apply to the court for appointment of a guardian for either the client’s person or property, or both. Clients who are old enough to remember the public guardianship proceedings for Groucho Marx recognize the need to avoid a guardianship proceeding if at all possible.

At a minimum, clients need broad powers of attorney that will allow agents to handle all of their property upon disability, as well as the appointment of a decision-maker for health care decisions (the name of the legal document varies by state, but all accomplish the same thing). Alternatively, a fully funded revocable trust can ensure that the client’s person and property will be cared for as the client desires, pursuant to the highest duty under the law – that of a trustee.

Planning Tip: Clients need properly drafted and well thought-out estate planning documents that address both their property and their person in the event of disability.

Clients Should Also Add HIPAA Language and Authorizations

Under the Health Insurance Portability and Accountability Act of 1996 (HIPAA), absent a written authorization from the patient, a health care provider or health care clearinghouse cannot disclose medical information to anyone other than the patient or the person appointed under state law to make health care decisions for the patient. The penalty for failure to comply with these rules is severe: civil penalties plus a criminal fine of $50,000 and up to one year of imprisonment per occurrence, and worse if the disclosure involves the intent to use the information for commercial advantage, personal gain, or malicious harm.

These HIPAA rules became effective only recently. As a result, doctors, hospitals and other health care providers now refuse to release any information absent a release from the patient. For example, hospital staff will go so far as to refuse to disclose whether one’s spouse or parent has been admitted to the hospital. The inability to receive information about a loved one could become very troubling when the information concerns treatment as part of long-term care.

Planning Tip: A client’s “personal representative” for health care decisions has the same rights to receive information as the client. While it is arguably unnecessary, the safest approach to ensure release of information to a personal representative is to modify the document appointing him or her so that it expressly authorizes the release of HIPAA-protected information on behalf of the client.

The Regulations promulgated under HIPAA specifically authorize a HIPAA Authorization for release of this information to persons other than the patient or his or her personal representative. Thus, clients should consider creating such Authorizations so that loved ones and others can access this information in addition to the personal representative.

Planning Tip: Clients should prepare HIPAA Authorizations for loved ones and others who potentially need access to their medical information during a time of disability.

Conclusion

The above discussion outlines the minimum planning clients should consider in preparation for a possible disability. It is imperative that clients work with you and their team of professional advisors to ensure that, in light of their unique goals and objectives, their planning addresses all aspects of a potential disability.

Planning for tax-qualified plans, which includes IRAs, 401(k)s and qualified retirement plans, requires a careful examination of the potential taxes that impact these assets. Unlike most other assets that receive a “basis step-up” to current fair market value upon the owner’s death, IRAs, 401(k)s and other qualified retirement plans do not step-up to the date-of-death value.

Therefore, beneficiaries who receive these assets do so subject to income tax. If the estate is subject to estate tax, the value of these assets may be further reduced by federal and perhaps state estate tax. And if your clients name grandchildren or younger generations as beneficiaries, these assets may additionally be reduced by the generation-skipping transfer tax – at the highest federal estate tax rate. All told, these assets may be subject to 70% tax or more.

There are several strategies available to your clients to help reduce the impact of these taxes and to ensure that these assets meet each client’s unique planning objectives. This issue of The Wealth Counselor examines some of the more common planning alternatives for tax-qualified plans, as well as the advantages and disadvantages of each.

Structure Accounts to Provide the Longest Term Payout Possible

Structuring tax-qualified plans to provide the longest term payout possible is the most common option. With this strategy your clients name beneficiaries in a way that requires the beneficiaries to withdraw the least amount possible as required minimum distributions (those distributions that the beneficiaries must take in order to avoid a 50% penalty).

Frequently, married clients name the surviving spouse as the primary beneficiary so that the survivor may roll over the account into his or her name and treat the account as his or her own. The surviving spouse then names younger beneficiaries for stretch-out purposes.

To achieve the maximum “stretch-out,” your clients should name beneficiaries who are young (e.g., children or grandchildren, although there are special considerations when naming grandchildren or younger generations). The younger the beneficiary, the smaller the required minimum distributions. To achieve maximum income tax deferral, beneficiaries should take only their required minimum distributions.

Your clients can accomplish this strategy by naming the beneficiaries individually. Alternatively, if your clients are concerned about the loss of creditor or divorce protection that occurs when they name beneficiaries outright, they can name a beneficiary’s share of a trust as the designated beneficiary of their tax-qualified plans.

Planning Tip: Structuring tax-qualified accounts for maximum “stretch-out” makes sense from an income tax perspective. However, naming a beneficiary outright may subject the account to the beneficiary’s creditors or former spouse upon divorce. Consider naming a trust as designated beneficiary to ensure that the account passes to the client’s intended beneficiaries – and in the manner intended by the client.

Name a Retirement Trust as Beneficiary to Ensure the Longest Term Payout Possible

Naming a beneficiary outright to accomplish tax deferral with a tax-qualified plan has several disadvantages. First, if the beneficiary is very young, the distributions must be paid to a guardian; if the beneficiary has no guardian, a court must appoint one. Another disadvantage is the potential loss of creditor protection or bloodline protection, particularly where the named beneficiary is the surviving spouse.

A third, practical disadvantage is that many beneficiaries take distributions much larger than the required minimum distributions. In fact, studies show that beneficiaries consistently consume this “found money” in only a couple of years – regardless of the amount in the account or the age of the beneficiary.

However, by naming a trust as the beneficiary of tax-qualified plans, your client can ensure that the beneficiary defers the income and that these assets remain protected from creditors or a former son- or daughter-in-law. A stand-alone retirement trust (separate from a revocable living trust and other trusts) can further help ensure that it accomplishes your client’s objectives while also ensuring the maximum tax deferral permitted under the law. This trust can either pay out the required minimum distribution to the beneficiary or it can accumulate these distributions and pay out trust assets pursuant to the standards your clients set in advance (e.g., for higher education, to start a business, etc.)

Planning Tip: Consider naming a stand-alone retirement trust as beneficiary of tax-qualified plans to ensure that the account passes not only in the manner intended by the client, but while achieving maximum stretch-out if that is the client’s objective.

Planning Tip: Naming a trust as beneficiary also ensures consistent account management – in the manner desired by the client, using the client’s advisors – oftentimes over generations.

Give the Accounts to Charity at Death

Another relatively simple option is for your clients to name a charity as a designated beneficiary at their death or at the death of their survivor, if married. This strategy is particularly attractive for those clients who intend to make gifts to charity at death and the question is simply what assets should they select. As a tax exempt entity, a qualified charity does not pay income tax and therefore receives the full value of tax-qualified plans.

In other words, if the client’s beneficiary is in a 35% tax bracket, a $100,000 IRA is worth only $65,000 in his or her hands, but is worth the full $100,000 if given to charity. Therefore, it makes economic sense for clients to give these assets to charity and give to their beneficiaries assets that are not subject to income tax after death.

Planning Tip: Naming a charity as beneficiary of a tax-qualified plan is particularly attractive for clients who intend to make gifts to charity at death and the question is simply what assets should they select.

Planning Tip: By purchasing life insurance owned by a Wealth Replacement Trust, clients can give beneficiaries the full value of a tax-qualified plan in a manner that is free from income and estate tax, and protected from creditors and predators.

Take Lifetime Withdrawals, Buy an Immediate Annuity (plus Wealth Replacement Insurance)

Another option is for your clients to withdraw their IRA or qualified plan and purchase an immediate annuity, which will generate a guaranteed income stream during their lives (or during their joint lives if married). Your clients can use this income stream to pay the income tax caused by the withdrawal, and also pay the premiums on life insurance owned by a Wealth Replacement Trust.

This strategy makes the most sense if your clients are in good health and are able to obtain life insurance at reasonable rates. Unlike with an IRA or retirement plan, the beneficiaries will receive the life insurance proceeds from the Wealth Replacement Trust free of income and estate tax and, under certain circumstances, free of generation-skipping transfer tax.

Alternatively, it may make sense to use other assets to purchase the immediate annuity, saving the IRA for family members. This alternative strategy makes the most sense when your clients can name a very young beneficiary, thereby deferring the income tax on the IRA or qualified plan for many years.

Planning Tip: For clients who desire a steady and known income stream, an annuity purchased with a lump-sum withdrawal from a tax-qualified plan can meet those objectives.

Planning Tip: In many instances, the annuity income will provide additional cash flow sufficient to purchase life insurance that can replace or increase what would have passed to the beneficiaries.

Take Lifetime Withdrawals, Gift Remaining Cash through Life Insurance Trust

Another option for your clients is to take the money out during their lifetime and pay the income tax, then gift the remaining cash either outright via lifetime giving or, better yet, through an Irrevocable Life Insurance Trust. If your clients desire to make the gifts through an Irrevocable Life Insurance Trust, this strategy makes the most sense when they are in good health and able to obtain life insurance at reasonable rates. Unlike the IRA or retirement plan, the beneficiaries will receive the life insurance proceeds free of income and estate tax and, under certain circumstances, free of generation-skipping transfer tax.

Planning Tip: By using withdrawals from a tax-qualified plan to purchase life insurance owned by a Wealth Replacement Trust, clients can pass the full value of the assets to their beneficiaries in a protected manner – undiminished by income tax.

Name a Charitable Remainder Trust as Beneficiary

Yet another option is for your clients to name as beneficiary of the accounts a Charitable Remainder Trust, a type of trust specifically authorized by the IRS. These irrevocable trusts permit your clients to transfer ownership of assets to the charitable trust in exchange for an income stream to the person or persons of their choice, typically the client’s spouse with tax-qualified plans. The term can be for life or for a specified term of up to 20 years.

The survivor receives income that will help maintain his or her lifestyle should the income stream from other assets be insufficient. At the survivor’s death, the property passes to charity.

This strategy defers income tax until the survivor receives each income payment; there is no tax at the initial transfer to the trust. This strategy can also help reduce estate taxes for those clients subject to the estate tax.

With this option, your clients fund the Charitable Remainder Trust upon death. Therefore, it is only at death or incompetency that this aspect of the estate plan becomes irrevocable, giving clients the option to make changes in the future if their circumstances change.

Planning Tip: Naming a Charitable Remainder Trust as beneficiary of a tax-qualified plan can provide a steady income stream to a surviving spouse in a tax-deferred manner. Since the assets ultimately transfer to charity, this strategy also provides a charitable deduction for those clients subject to estate tax.

Give Up to $100,000 from IRAs Directly to Charity in 2007

For clients who are at least 70 1/2 years of age, it may also make sense for them to transfer up to $100,000 from IRAs to charity in 2007 to satisfy their charitable contributions. If the contribution is made by direct transfer from the IRA custodian to a public charity (for example, religious organizations, colleges and universities, etc.), the client need not report the distribution as taxable income. In other words, unlike a typical IRA distribution, the distribution will not appear as taxable income on the client’s income tax return. However, because the distribution does not appear as income, the client will not get an offsetting charitable income tax deduction to reduce the income created by the IRA distribution.

Planning Tip: Giving up to $100,000 from IRAs directly to charity is particularly attractive for clients who intend to make gifts to charity in 2007 and the question is simply what assets should they select.

Conclusion

These are only a few of the more common planning solutions for tax-qualified plans. The right solution for your clients will depend upon their particular goals and objectives as well as their particular circumstances.

This issue of The Wealth Counselor explores many of the common misperceptions about trust owned life insurance – plus a process for you to add significant value for your clients by incorporating policy reviews of trust owned life insurance.

Although trust owned life insurance (TOLI) is a common planning vehicle for high net worth individuals and families, relatively few TOLI policies ever meet their initial projections. Industry studies reveal that TOLI portfolios rarely receive the required vigilant fiduciary oversight routinely associated with other assets held in trust, such as equities, real estate, etc.

Seven Common Client Misconceptions – and Facts – about Life Insurance

• Misconception #1: Unlike other assets, life insurance policies do not need management and regular review to avoid risk and optimize performance.
  Fact: Policy performance can change dramatically over time. Without regular review by an insurance expert, policies – especially older ones – can pose very significant risk or not achieve their original goals.
• Misconception #2: If the client pays premiums according to the schedule in the original insurance illustration, the policy will pay at death.
  Fact: Even with regular payment of premiums projected from the original policy illustration, policies can fail if not monitored properly.
• Misconception #3: If the policy was in jeopardy, the carrier would notify the client in advance.
  Fact: Carriers will not necessarily provide advance notice of policy problems to trustee owners of TOLI policies.
• Misconception #4: If one carrier has turned down the client for insurance, it is not possible to get adequate coverage from another carrier.
  Fact: The competitive nature of the insurance industry means that it is often possible to secure appropriate coverage from a highly rated carrier even if another carrier has already rejected the client.
• Misconception #5: Premiums will remain level for the life of the policy regardless of economic conditions or interest rates.
  Fact: Premiums are always a reflection of the insurance carrier’s cost of providing coverage, current interest rates, and other economic conditions. Any of these changing factors can cause the premium rates to change.
• Misconception #6: Policies purchased many years ago are cheaper than current policies because the insured is older.
  Fact: Improved mortality rates as well as better underwriting and policy features created by industry competition often produce less expensive coverage on new policies (or increased coverage for the same premium).
• Misconception #7: If the client no longer needs the insurance coverage provided by a policy, the only option is to surrender it to the carrier for relatively little value.
  Fact: A variety of alternatives, including improved life settlement opportunities, make it possible to gain substantially greater value than that provided by cash surrender to the carrier.

What is a Trust Owned Life Insurance Review?

A TOLI review is an objective review of the policies owned by a trust to ensure that those policies perform as the client intended. A TOLI review also examines options for reducing premiums or selling policies that the client may no longer need because of changed circumstances, increased exemptions, etc.

Why should advisors tell their clients about TOLI review?

Advising your clients of a TOLI review will give immediate value during your interview. Few clients get excited about spending time or money on estate planning. By incorporating a “Life Insurance Policy Review,” the estate planning advisor can now create opportunities for immediate cash savings or profits for clients in addition to the standard planning and “projected estate tax savings at death.”

Planning Tip: A TOLI policy review not only benefits the client, it also makes good business sense for the advisor. Such a review generates good will, gives the client a real appreciation of the advisor’s concern for the client, and frequently generates more than enough savings to pay for the advisor’s fees.

Why do the clients like the idea of a TOLI Review?

Nobody likes paying premiums and very few clients understand life insurance. When their advisor suggests an objective “audit” of insurance policies to determine if they could reduce their premiums, clients are receptive. They appreciate that you are trying to help them and that you are not selling them anything.

Why are trust companies rushing to implement TOLI Reviews?

Nearly every week banking journals publish articles on the fiduciary issues related to Trust Owned Life Insurance as institutional trust companies develop “best practices” to manage and monitor trust owned policies. Over 40% of institutionally trusteed policies reviewed have serious deficiencies or problems. Few institutional trustees have the necessary level of insurance expertise for proper policy review. Trust companies fear a lawsuit for improper management of their trust owned insurance policies.

Planning Tip: Your clients need their advisors’ guidance to better understand both the risks and the improved opportunities from TOLI. The potential risk for your clients is substantial. Policy grantors and trustees need to recognize that life insurance is an asset that must be periodically reviewed by an independent expert to avoid risk and to optimize asset performance.

What are the results of reviewing Trust Owned Life Insurance policies?

Facts about TOLI policy reviews – there is a high likelihood that:

• The TOLI policy represents a considerable percentage of the client’s total estate.
• The TOLI policy has not been reviewed or managed since purchase.
• The TOLI policy is not performing as originally projected.
• The client must pay additional (unexpected) premiums before death.
• The client can get more insurance for the same premium (despite being older).
• The client can get the same insurance coverage for less premium outlay.
• The trustee has never reviewed the policy.
• The agent who sold the policy is no longer in touch with the client.
• The insurance coverage is no longer appropriate for the client.
• The policy provisions and guarantees are obsolete.

The client and the trustee do not really understand the impact of falling interest rates since policy inception.

Planning Tip: The average non-institutional trustee (for example, brother-in-law, friend, etc.) is even less informed than is an institutional trustee – and even less likely to audit policy performance. Therefore, the insurance risk is even greater with non-institutional trustees, but they may be less likely to act upon that risk.

What features are important in a reliable provider of TOLI review service?

• Insurance expertise
• Independence
• Objective advice

Planning Tip: Look for a turnkey TOLI review service that can offer not only an expert policy review and a clear comparison of all policy solutions, but also a cost-effective, comprehensive program to manage client policies.

Conclusion

Offering your clients an objective TOLI review provides them with significant value added and peace of mind as to their wealth planning; specifically, it increases the likelihood that their planning will achieve their stated objectives. Consider working with an advisor who can perform an objective TOLI review to accomplish this much needed – and often overlooked – analysis.

This month’s issue of The Wealth Counselor examines the unique planning requirements of families with children, grandchildren or other family members (such as parents) with special needs. There are many misconceptions in this area that result in costly mistakes in planning for these special needs beneficiaries. It is therefore incumbent upon us – the client’s advisors – to ensure that clients understand all of their options.

COSTLY MISTAKE #1: Disinheriting the child.

Many disabled people rely on SSI, Medicaid or other government benefits to provide food and shelter. Your clients may have been advised to disinherit their disabled child – the child who needs their help most – to protect that child’s public benefits. But these benefits rarely provide more than basic needs. And this “solution” does not allow your clients to help their child(ren) after the client becomes incapacitated or is gone. When a child requires, or is likely to require, governmental assistance to meet his or her basic needs, parents, grandparents and others who love the child should consider establishing a Special Needs Trust.

Planning Tip: It is unnecessary and in fact poor planning to disinherit a special needs child. Clients with special needs beneficiaries should consider a Special Needs Trust to protect public benefits and care for the child during the client’s incapacity or after the client’s death.

COSTLY MISTAKE #2: Procrastination.

Because none of us knows when we may die or become incapacitated, it is important that your clients plan for a beneficiary with special needs early, just as they should for other dependents such as minor children. However, unlike most other beneficiaries, a child with special needs may never be able to compensate for a failure to plan. A minor beneficiary without special needs can obtain more resources as he or she reaches adulthood and can work to meet essential needs, but a child with special needs may never have that ability.

Planning Tip: Parents, grandparents, or any other loved ones of a special needs child face unique planning challenges when it comes to that child. This is one area where the client simply cannot afford to wait to plan.

COSTLY MISTAKE #3: Failure to coordinate a planning team effort.

It is critical that the advisor assisting with special needs planning include in the planning team: an attorney who is experienced in this planning area; a life insurance agent who can ensure that there will be enough money to maintain the benefits for the special needs child; a CPA who can advise on the Special Needs Trust’s tax return; an investment advisor who can ensure that the trust fund’s resources will last for the child’s lifetime; and any other key advisors that may support the goals of the trust going forward.

Planning Tip: Special needs planning dictates that the client’s advisors work together to ensure that there are sufficient trust assets to care for the child throughout his or her lifetime.

COSTLY MISTAKE #4: Ignoring the special needs when planning for the child’s benefit.

Planning that is not designed with the child’s special needs in mind will probably render the child ineligible for essential government benefits. A properly designed Special Needs Trust promotes the special needs person’s comfort and happiness without sacrificing eligibility.

Special needs can include medical and dental expenses, annual independent check-ups, necessary or desirable equipment (for example, a specially equipped van), training and education, insurance, transportation, and essential dietary needs. If the trust is sufficiently funded, the disabled person can also receive spending money, electronic equipment & appliances, computers, vacations, movies, payments for a companion, and other self-esteem and quality-of-life enhancing expenses: the sorts of things your clients now provide to their child or other special needs beneficiary.

Planning Tip: When planning for a child with special needs, it is critical that the client utilize a Special Needs Trust as the vehicle to pass assets to that child. Otherwise, those assets may disqualify the child from public benefits and may be available to repay the state for the assistance provided.

COSTLY MISTAKE #5: Creating a “generic” special needs trust that doesn’t fit.

Even some “special needs trusts” are unnecessarily inflexible and generic. Although an attorney with some knowledge of the area can protect almost any trust from invalidating the child’s public benefits, many trusts are not customized to the particular child’s needs. Thus the child fails to receive the benefits that the parent provided when they were alive.

Another frequent mistake occurs when the Special Needs Trust includes a “pay-back” provision rather than allowing the remainder of the trust to go to others upon the death of the special needs child. While these “pay-back” provisions are necessary in certain types of special needs trusts, an attorney who knows the difference can save your clients hundreds of thousand of dollars, or more.

Planning Tip: A Special Needs Trust should be customized to meet the unique circumstances of the child and should be drafted by a lawyer familiar with this area of the law.

COSTLY MISTAKE #6: Failure to properly “fund” and maintain the plan.

When planning for children with special needs, it is absolutely critical that there are sufficient assets available for the special needs beneficiary throughout his or her lifetime. In many instances, this requires utilization of a funding vehicle that can ensure liquidity when necessary. Oftentimes permanent life insurance is the perfect vehicle for this purpose, particularly if the clients are young and healthy such that insurance rates are low.

Also, because this is an ever-changing area, it is also imperative that the clients revisit their plan frequently to ensure that it continues to meet the needs of the special needs beneficiary.

Planning Tip: Clients should consider permanent life insurance as the funding vehicle for special needs beneficiaries, particularly when the beneficiary is young given the often staggering costs anticipated over that beneficiary’s lifetime.

If the client may be subject to estate tax, consider having an Irrevocable Life Insurance Trust own and be the beneficiary of the policy, naming the Special Needs Trust as a beneficiary. Alternatively, in a non-taxable situation, consider naming the client’s revocable trust as the beneficiary to help equalize inheritances if that is the client’s objective.

COSTLY MISTAKE #7: Choosing the wrong trustee.

During your client’s life, he or she can manage the trust. When the client is no longer able to serve as trustee, they can choose who will serve according to the instructions that they have provided. They may choose a team of advisors and/or a professional trustee. Whomever they choose, it is crucial that the trustee is financially savvy, well-organized, and, of course, ethical.

Planning Tip: The trustee of a Special Needs Trust should understand the client’s objectives and be qualified to invest the assets in a manner most likely to meet those objectives.

COSTLY MISTAKE #8: Failing to invite contributions from others to the trust.

A key benefit of creating a Special Needs Trust now is that the beneficiary’s extended family and friends can make gifts to the trust or remember the trust as they plan their own estates. For example, these family members and friends can name the Special Needs Trust as the beneficiary of their own assets in their revocable trust or will, and they can also name the Special Needs Trust as a beneficiary of life insurance or retirement benefits.

Planning Tip: Creating a Special Needs Trust now allows others, such as grandparents and other family members, to name the trust as the beneficiary of their own estate planning.

COSTLY MISTAKE #9: Relying on siblings to use their money for the child with special needs’ benefit.

Your client may be relying on their other children to provide for their child with special needs from their own inheritances. This can be a temporary solution for a brief time, such as during a brief incapacity if their other children are financially secure and have money to spare. However, it is not a solution that will protect the child with special needs after your client has died or when siblings have their own expenses and financial priorities.

What if the inheriting sibling divorces or loses a lawsuit? His or her spouse (or a judgment creditor) may be entitled to half of it and will likely not care for the child with special needs. What if the sibling dies or becomes incapacitated while the child with special needs is still living? Will his or her heirs care for the child with special needs as thoughtfully and completely as the sibling did?

Siblings of a child with special needs often feel a great responsibility for that child and have felt so all of their lives. When your clients provide clear instructions and a helpful structure, they lessen the burden on all their children and support a loving and involved relationship among them.

Planning Tip: Relying on siblings to care for a special needs beneficiary is a short-term solution at best. A Special Needs Trust ensures that the assets are available for the special needs beneficiary (and not the former spouse or judgment creditor of the sibling) in a manner intended by the client.

COSTLY MISTAKE #10: Failing to protect the child with special needs from predators.

An inheritance from parents who fund their child’s special needs trust by will rather than by revocable living trust is in the public record. Predators are particularly attracted to vulnerable beneficiaries, such as the young and those with limited self-protective capacities. When you plan with trusts rather than a will, your client decides who has access to the information about their children’s inheritance. This protects their special needs child and other family members, who may be serving as trustees, from predators.

Planning Tip: A Special Needs Trust created outside of a will ensures that information about the inheritance is not in the public record, protecting the special needs beneficiary from predators.

Conclusion

Planning for special needs beneficiaries requires particular care and the participation of all of the client’s wealth planning advisors. A properly drafted and funded Special Needs Trust can ensure that the beneficiary has sufficient assets to care for him or her, in a manner intended by the client, throughout the beneficiary’s lifetime.

Last month’s issue of The Wealth Counselor examined the various educational savings vehicles available to clients, including 529 plans, UGMA/UTMAs, Coverdell Education IRAs and life insurance. Using life insurance as an education savings vehicle prompted several questions about other uses for life insurance. Therefore, this issue of the Wealth Counselor examines some of these other common uses for life insurance, the only asset class that can ensure the completion of proper funding for a myriad of unique planning needs – regardless of the state of the federal estate tax!

Income Replacement (“How will my family eat if I die?”)

Even if the client is not subject to estate tax, life insurance can replace lost income if the client dies unexpectedly (more policies pay out for income replacement than for liquidity to pay estate tax). For example, clients with young children should consider using life insurance to ensure that there are sufficient funds available to pay for child-rearing or college and post-graduate expenses in the event of a parent’s premature death. For these income replacement policies, the estate tax, including the possibility of estate tax repeal, has no significance.

Planning Tip: Clients should consider life insurance to replace income from the premature death of a breadwinner spouse or parent.

Wealth Creation (“What if I die before I build an estate for my family?”)

Another need for life insurance unaffected by the estate tax is the use of life insurance to create wealth. Examples of this need are families who wish to add to their wealth for future generations or to fund their philanthropic objectives.

Planning Tip: Consider life insurance to create wealth or additional wealth for the client’s family and future generations.

Wealth Replacement (“How can my family receive the full value of my assets?”)

Traditionally, life insurance has been used to replace wealth lost to the federal estate tax. However, with an increasing federal estate tax exemption (currently $2 million per individual, $4 million per married couple), fewer clients are subject to federal estate tax. Thus, fewer clients need traditional wealth replacement policies. However, many clients have significant other wealth replacement needs.

For example, many clients’ most significant assets are tax-qualified plans (such as IRAs, 401(k)s and pension plans). Because these assets are Income in Respect of a Decedent (IRD), they will be subject to ordinary income tax when distributed to beneficiaries. While we often discuss with clients maximum income tax deferral (“stretch out”), many beneficiaries will deplete these assets quickly, incurring significant income tax. Recognizing this, many clients would benefit from life insurance designed to replace this lost wealth.

In addition to traditional wealth replacement needs, wealthier clients would benefit from wealth replacement for assets transferred to a charitable remainder trust (CRT) or to a charitable lead trust (CLT), which is often used to eliminate estate tax.

Planning Tip: Consider life insurance for non-traditional wealth replacement purposes, such as to replace income tax paid for significant IRAs and other tax-qualified plans, or where the client has used a charitable lead trust to avoid estate tax.

Planning Unrelated to the Federal Estate Tax (“I didn’t know there were so many other situations where only life insurance will assure me my goals will be reached even if I die!”)

Clients often use life insurance in planning that is wholly unrelated to the estate tax. There is a continuing need for life insurance as a funding vehicle in numerous situations, including:

• buy-sell planning;
• key employee coverage;
• nonqualified deferred compensation;
• death-benefit-only plans;
• liquidity to pay debts;
• liquidity for state death taxes; and
• inheritance equalization.

Income-Tax-Free Status of Death Benefits (“What a difference not paying taxes can make on the amount to which my premiums can grow.”)

With increasing federal estate tax exemption amounts, there is now an increased emphasis on income tax planning, with a particular emphasis on assets that combine basis step-up with tax-free or tax-deferred growth. Life insurance proceeds paid upon the death of the insured, as well as proceeds attributable to investment appreciation on the cash value portion of the policy, are excluded from gross income. As a result, not only is the death benefit of a life insurance policy tremendous compared to the premiums paid if the insured dies prematurely, in a properly designed policy the death benefit remains quite handsome even if the insured lives past life expectancy.

Planning Tip: The unique character of life insurance allows a capable and competent life insurance agent to design a product providing excellent results over a long time frame.

Irrevocable Life Insurance Trusts (“A little planning can provide enormous tax savings.”)

Even though the insurance death benefit is not subject to income tax, the life insurance proceeds will likely be included in the client’s gross estate and, therefore, be subject to federal and/or state estate tax absent a properly drafted and maintained Irrevocable Life Insurance Trust (ILIT). As a result, many clients create ILITs for the purpose of owning life insurance to avoid federal and state estate tax on the death proceeds.

Planning Tip: Use an Irrevocable Life Insurance Trust to purchase, own and be the beneficiary of life insurance to avoid having the death proceeds subject to estate tax. A good lawyer with prompt turnaround of a trust document is a critical component of the planning team.

Planning Flexibility (“How can I deal with the uncertainty of estate taxes?” “Will I need the extra cash at my death, or not?”)

The uncertainty surrounding the federal estate tax and the exemption equivalent amount may suggest the use of the most flexible types of cash value policies, such as universal life policies. These policies permit the policy owner to vary the amount of premium payment, the level of death benefit, and the amount of cash value (in exchange for this flexibility, the client may give up the guarantees that the premium will provide a guaranteed death benefit for the life of the policy). No other single asset provides the same degree of planning flexibility. However, it is incumbent on the planning professional to ensure that the product selected fits the needs of the particular client.

Planning Tip: Permanent life insurance is a unique asset that provides the highest degree of flexibility for changes in the law or changes in the client’s circumstances. The quality of the life insurance agent and the life insurance company he or she selects are among the most important choices a client can make.

Conclusion

Life insurance is the only asset class (other than cash) that a client can remove from his or her gross estate, yet it still provides liquidity (e.g., for federal or state death tax or capital gain tax) or wealth replacement (e.g., to make beneficiaries “whole” for large IRD items like IRAs, 401(k)s, and pension plans) without itself incurring income tax. All other assets removed from the client’s gross estate for estate tax purposes must be sold and the gain realized to net the required amount.

Last month’s issue of The Wealth Counselor examined the many benefits of 529 Plans, including the income tax and gift and estate tax benefits of these popular educational savings vehicles. There are, however, several other educational savings vehicles that clients should consider; this issue examines some of these other vehicles – and the advantages and disadvantages of each.

Why is saving for education so important? According to the College Board, the average cost of a four-year college or university is increasing at two to three times the rate of inflation. For the 2006-2007 school year, costs average $5,836 per year for an in-state four-year college and $22,218 per year at a private four-year college. Therefore it is no surprise that advisors who understand the options bring significant value to their clients.

Planning Tip: Saving for college is often the most significant savings goal for adults facing college costs in the future.

UGMA/UTMA Accounts

The simplest form of education savings vehicles, and perhaps the most common, is an account created under the Uniform Gift to Minors Act (UGMA) or, its successor, the Uniform Transfer to Minors Act (UTMA) in the child’s state. While simple and inexpensive, there are considerable disadvantages to UGMA and UTMA accounts.

Most clients’ biggest concern with these accounts is that a gift made to an UGMA or UTMA account vests absolutely in the beneficiary. In other words, neither the custodian nor the donor can change the beneficiary after establishment of the account, and, significantly,the custodian must deliver the balance of the account outright to the beneficiary when he or she reaches the age of majority (18 or 21, as defined by state law). For a beneficiary receiving government benefits, this required outright distribution may cause the beneficiary to lose his or her government assistance upon attainment of majority. Until the beneficiary reaches majority, the custodian has a fiduciary duty to spend the income or principal for the benefit of the minor.

Planning Tip: UGMA and UTMA accounts are the simplest education savings vehicles, but upon attaining the age of majority, the beneficiary has the absolute right to the account and can spend it as he or she pleases, not limited to education.

Effective May 17, 2006, the “kiddie tax” may also come into play for beneficiaries who are younger than 18 (it previously applied only to beneficiaries younger than 14). With the kiddie tax, if the parents claim as a dependent a child under age 18, all of that child’s unearned income above $1,700 per year (for 2006), including UGMA or UTMA income, will be taxed at the parent’s income tax rate, whether or not the parent is the custodian. For children 18 years and older, the income on assets in a UGMA or UTMA account is generally taxed at the child’s rate, typically much lower than the parents’ rate.

Planning Tip: The “kiddie tax” applies to UGMA and UTMA accounts if the beneficiary is under 18 and has unearned income greater than $1,700 in 2006. If so, the beneficiary child must complete and attach IRS Form 8615 to his or her income tax return and pay this tax at the parents’ income tax rate.

While a transfer to a minor under UGMA or UTMA constitutes a completed gift for federal gift tax purposes at the time of the transfer, if the donor names himself or herself as custodian of the account and that person dies before the child reaches majority, the UGMA or UTMA account assets will be includible in the donor/custodian’s gross estate for estate tax purposes.

Planning Tip: A donor should not name himself or herself as custodian of the UGMA or UTMA account to avoid the account assets from being included in the donor’s estate for federal estate tax purposes.

Coverdell Education Savings Accounts (ESAs)

Education Savings Accounts, formerly Education IRAs, were of little significance until passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). EGTRRA increased the maximum annual contribution limit from $500 to $2,000 per beneficiary, while also increasing the AGI limits for maximum contributions to these accounts. Significantly, as a result of EGTRRA, a donor can make contributions to an ESA and a College Savings Plan for the same child in the same year. Moreover, while 529 Plans are limited to paying for higher education, ESAs can be used to fund primary and secondary school.

Planning Tip: Clients should consider contributions to both 529 plans and Education Savings Accounts for the same beneficiary in the same year, to cover educational expenses of primary through higher education.

Life Insurance

The inside cash buildup of permanent life insurance policies such as whole life, universal life, and variable life offer another opportunity to accumulate funds that can be used for educational expenses. This strategy usually makes sense when the client has an already existing need for life insurance (such as protecting a family’s income in case of death). A very simplified explanation of this technique is for the client to pay into the life insurance policy more than is needed to support the policy through the life of the client. These extra funds accumulate inside the life insurance policy on an income tax free basis and can be accessed by the client when his or her children reach college age (or if there is an emergency or other need).

Flexible premium universal life and variable universal life policies typically include the option to take partial withdrawals from, or loans against, the cash value of the policy (some policies even have a “wash” loan feature that makes loans even more attractive). When the time comes, the client will either withdraw or borrow the necessary college funding from the accumulated cash value of the life policy.

Withdrawals from a cash value life insurance policy (other than a modified endowment contract) are not subject to income tax until the cumulative withdrawals exceed the cost basis, or the aggregate premium payments on the policy. Loans from such policies are likewise not taxable at the time of the loan nor are they taxable if they are repaid from the death benefits when the policy “matures.”

Careful planning is needed to determine the premium structure, the best method to access the cash buildup in the life insurance policy, and to make sure the viability of the policy is not endangered. Usually making withdrawals to basis first and then borrowing from the cash value is the preferred method to access the cash value of a policy having any loans repaid at death from the income tax free proceeds of the life policy.

An added benefit of this technique is that if the client dies prematurely the death benefit from the life policy becomes available to pay for college or other family expenses.

As with most sophisticated planning, there may be traps for the unwary. For example, there can be very negative tax effects if the plan is not designed properly or the policy doesn’t perform as expected and there isn’t an adequate cushion so that the life policy lapses before death. And of course there are estate tax considerations to be taken into account. That said, in the hands of an experienced life insurance professional, this technique can be quite beneficial and allow for several potential needs to be met with one planning device.

Planning Tip: Clients should consult a knowledgeable and experienced life insurance professional and tax counsel when considering the use of permanent insurance to fund higher education or provide additional cash benefits in the event of a bread winner parent’s premature death.

Demand Trusts

Demand rights convert what would otherwise be a gift of a future interest to a gift of a present interest, thereby qualifying the gift for the $12,000 gift tax annual exclusion. To qualify, the trustee must adhere to the strict procedure requirements for Crummey trusts: the trustee must immediately notify the minor beneficiary through the child’s legal guardian that the donor has made a gift to the trust. The beneficiary then has a specified period of time (typically 30 days) to demand a distribution from the trust in the amount of the gift. If the specified number of days lapses, the gift will stay inside the trust and continue to be governed by the trust terms.

This demand right allows the trust maker to make contributions of up to $12,000 per year, free of gift tax and possibly generation-skipping transfer (GST) tax.

Demand trusts remove the trust assets from the trust maker’s estate, even if the trust maker acts as trustee, as long as the trust instrument limits the trustee’s discretion to make distributions to “ascertainable standards;” i.e., the education, health, maintenance and support of the beneficiary (and provided the trust instrument does not give the trust maker too much control over the trust). If a demand right beneficiary dies during the time that a demand right is outstanding, the amount of the outstanding demand right is includible in the beneficiary’s gross estate for estate tax purposes.

Planning Tip: Demand trusts are a flexible savings vehicle for education expenses and other expenses set forth by the trust maker in the trust agreement. While typically funded with life insurance, the trust maker can also fund a demand trust with other assets.

Direct Payments to an Educational Institution

Another educational funding option is for the donor to make transfers directly to an educational institution. Under the Internal Revenue Code, these transfers are not subject to gift, estate, or GST tax. Therefore, prepaid tuition payments by a donor can achieve a significant estate tax reduction. Direct payments are not deductible as a charitable contribution for income tax purposes, however, because they are made for a particular student.

Since only direct payments to the educational institution qualify, it is highly recommended that the donor make contributions to the school while the child is presently enrolled. If the donor wishes to make advance payments for numerous years’ tuition, the donor (and the parent(s) if the donor is the student’s grandparent) should enter into a written agreement with the educational institution providing that (1) the donor and/or parent will pay any future tuition increases; (2) the prepayments are non-refundable; and (3) the prepayment does not afford the child any additional rights or privileges over any other student.

Impact on Financial Aid

For some clients, the impact on needs-based financial aid may play a role in the selection process, because assets placed in the student’s name may reduce (or even eliminate) the amount of otherwise available financial aid. The needs based financial aid rules state that 5% of the parent’s assets (special rules determine this amount for financial aid purposes) and 35% of the child’s assets are available for education. Therefore, shifting assets from the parent to the student through the use of UGMA/UTMAs, ESAs, and 529 plan distributions may reduce the student’s needs based financial aid. Alternatively, life insurance should not impact needs based aid, whereas a demand trust will depend upon the child’s access through the trust terms.

Planning Tip: Avoid shifting assets to the child if the client is concerned about the potential impact on needs based financial aid.

Conclusion

There are numerous education savings options. Most often, the “right” choice for the client will depend upon his or her unique goals and objectives. It is therefore incumbent upon all wealth planning professionals to help the client determine those objectives and advise accordingly.

Whether your client is a parent with future educational obligations for young ones, or perhaps a loving aunt, uncle, grandparent, or stepparent, now more than ever 529 plans are an attractive tool for the escalating costs of education, as well as for income and estate planning purposes. This is because one of the hidden gems of the new Pension Protection Act of 2006 (signed into law on August 17, 2006) is a provision that makes permanent the income-tax-free growth of Section 529 plans used for qualified higher education expenses. Prior to this new law, these provisions would have expired December 31, 2010.

Planning Tip: The new Pension Protection Act makes permanent the income-tax- free growth of 529 plans, but only for withdrawals used for qualified higher education expenses. Funds used for other expenses are tax deferred (like an IRA) and subject to a 10% penalty.

Most wealth planning professionals (and clients for that matter) understand the value of investing in 529 plans. 529 plans are by far the most popular college savings vehicle, but they’ve just become even more popular. According to a recent survey, 54% of parents with young children who do not currently own a 529 account are more likely to open one now, due to the new law, and 36% who already own a 529 plan say they are now more likely to increase the amount they contribute to existing plans. And another recent survey confirmed that older clients may want to learn more about college savings.

Income Tax Benefits

While many clients understand the educational savings benefits, many do not understand the benefits of investing in 529 plans for income tax purposes. Just like with an IRA, the power of tax-deferred growth makes 529 plans worthwhile even if not used for educational expenses. The ability to frontload up to five years of annual exclusion gifts, or $60,000 per beneficiary ($120,000 per beneficiary for married couples), without paying gift tax creates the ability to grow a significant amount of money tax free. In addition, many states offer residents a state income tax deduction for an investment in their state’s 529 plan.

Planning Tip: Clients should consider an investment in a 529 plan even if it is not anticipated that the funds will be used for educational purposes. The income tax benefits alone of 529 plans make these very worthwhile investments.

Estate Planning Tax Benefits

529 plans are unique in that you can invest in a 529 plan, retain absolute control over the assets, and yet remove those assets from your estate for estate tax purposes. This type of control typically means that the asset would be subject to estate tax at a 46% rate (in 2006) at death, but not with a 529 plan. Thus, clients can invest up to $60,000 per beneficiary ($120,000 per beneficiary for married couples) without paying gift tax and, if the client lives for at least five years, all of these assets will not be subject to estate tax. More importantly for many clients, a 529 plan allows them to use the 529 plan assets in a financial emergency.

Planning Tip: Clients should also consider 529 plans for estate planning purposes to remove significant wealth from the estate tax while retaining the ability to use the assets in a financial emergency.

Educational Trusts

Many 529 plans permit a trust to be the owner and beneficiary of accounts set up under that states plan. A 529 plan combined with an Educational Trust may provide more flexibility to ensure that the 529 meets the client’s objectives by, for example, moving assets between siblings or providing a smooth transition should the client become incapacitated or die.

This combination of 529 plans and specially designed trusts can also provide divorce and creditor protections, even for those states’ 529 plans that do not provide their own asset protection; for example, to ensure that the 529 plan’s assets do not end up in the hands of a former son-in-law or daughter-in-law. And the client still retains the ability to use the funds in a financial emergency.

Planning Tip: Consider combining 529 plans with Educational Trusts to provide the greatest flexibility and to ensure that the 529 plan assets meet each client’s particular planning objectives.

Conclusion

Now more than ever, clients should consider 529 plans for educational savings, income tax benefits and estate tax benefits; and when combined with a carefully-crafted Educational Trust, they will provide added flexibility to control this asset and to ensure that it meets the client’s planning objectives.

The new Pension Protection Act of 2006 (signed into law on August 17, 2006) creates significant planning opportunities for advisors and their clients who understand it. This newsletter focuses on two key provisions: (1) non-spousal rollovers from a qualified plan to an inherited IRA and (2) charitable contributions of IRAs during lifetime.

Non-Spousal Rollovers from Qualified Plans

In the past, only a surviving spouse could roll over a qualified plan (for example, a 401(k)) to an IRA after the plan owner’s death. Once rolled over, it is as if the surviving spouse created the IRA. He or she can defer required minimum distributions from the IRA until reaching age 70 1/2 and can withdraw these required minimum distributions over his or her lifetime.

Planning Tip: The new law does not impact spousal rollovers. A spouse can still rollover a qualified plan to his or her own IRA after the death of the owner.

Alternatively, a beneficiary other than a surviving spouse (for example, a child or unmarried partner) has been forced to withdraw the qualified plan in full – and pay income tax on this amount – over the period set forth in the plan agreement, typically within one to five years of the plan owner’s death. Thus, a non-spouse beneficiary could not defer income tax by “stretching out” distributions over his or her life expectancy.

Beginning January 1, 2007, a non-spouse beneficiary can roll over a qualified plan to an “Inherited IRA” after the plan owner’s death. If the owner names a trust as beneficiary of the qualified plan, the trustee of that trust can roll over the qualified plan to an inherited IRA for the benefit of the trust beneficiary.

Planning Tip: Clients who name a trust as designated beneficiary can protect the assets from creditors (including former spouses of the beneficiary) and spendthrift beneficiaries, who often withdraw far more than the required minimum distributions. Naming a trust also allows the owner’s financial advisor to continue to manage the assets as the owner desired.

With an Inherited IRA, a non-spouse beneficiary can use his or her own life expectancy to determine required minimum distributions. This significantly reduces the amount that the beneficiary must withdraw each year, thereby deferring income tax and allowing the account balance to continue to grow income tax free.

Planning Tip: A non-spouse beneficiary must begin taking required minimum distributions from the Inherited IRA by December 31 of the year following the year of the owner’s death. This is different from a spousal rollover, where the surviving spouse can defer required minimum distributions until attaining 70 1/2.

A rollover to a non-spouse beneficiary must be directly from the trustee of the qualified plan to the trustee of the Inherited IRA (a trustee-to-trustee transfer). In addition, and unlike a spousal rollover, the IRA must remain in the name of the deceased owner.

Planning Tip: Avoid re-titling the qualified plan in the name of the non-spouse beneficiary. Also avoid transferring the qualified plan to an existing IRA in the non-spouse beneficiary’s name. Both constitute a taxable distribution of the entire account. The Inherited IRA should be titled like this: Susan Participant, deceased, IRA f/b/o Emily Participant (beneficiary).

Planning Tip: Any distribution to a non-spouse beneficiary is a taxable distribution, subject to income tax. Therefore, the check should be made payable directly to the Inherited IRA.

Until January 1, 2007, a non-spouse beneficiary must continue to use the payout schedule dictated by the qualified plan agreement. Thus, if the plan agreement provides that all funds must be distributed within three years of the owner’s death, the beneficiary must withdraw, and therefore pay income tax on, the entire plan balance within three years, thereby eliminating potentially significant growth through income tax deferral.

Planning Tip: If possible, delay post-death distributions from a qualified plan to a non-spouse beneficiary until after December 31, 2006 to take advantage of these new provisions.

Example

On October 1, 2006, Susan Participant dies having named a trust for her daughter Emily’s benefit as the death beneficiary with her 401(k) plan. Anytime after December 31, 2006, the trustee of Emily’s trust can request a trustee-to-trustee transfer of the 401(k) to an inherited IRA for Emily’s trust’s benefit, using Emily’s life expectancy to determine the required minimum distributions from the inherited IRA.

Clients Impacted by This Change

All clients with qualified plans and clients named as the beneficiary of a qualified plan will potentially benefit from this new provision.

Charitable Contribution of IRA During Lifetime

In 2006 and 2007 only, a taxpayer who is at least 70 1/2 years old can contribute to charity up to $100,000 per year from one or more Individual Retirement Accounts (IRAs).

Planning Tip: Distributions from a SEP IRA, SIMPLE IRA or qualified plan do not qualify because they are not distributions from an IRA. Consider rolling out qualified plan assets into an IRA where appropriate to take advantage of this opportunity.

If the contribution is made by direct transfer from the IRA custodian to a “public” charity, the taxpayer need not report the distribution as taxable income. In other words, unlike a typical IRA distribution, the distribution will not appear as taxable income on the taxpayer’s income tax return. Because the distribution does not appear as income, the taxpayer does not get an offsetting charitable income tax deduction to reduce the income created by the IRA distribution.

Planning Tip: The check must be made payable to the charity. If the check is made payable to the IRA owner who endorses it to the charity, the owner must report the distribution as taxable income.

Planning Tip: Public charities include religious organization, schools, etc. Unfortunately, Donor Advised Funds, Supporting Organizations and Charitable Remainder Trusts are not public charities, and therefore distributions to these types of charities do not qualify.

Significantly, charitable contributions that meet these requirements satisfy the taxpayer’s required minimum distributions for the year of distribution.

Clients Impacted by This Change

There are two critical questions: (1) Does the client have IRAs from which they can make direct contributions to charity or, alternatively, can the client roll out of a qualified plan into an IRA; and (2) Is the client currently making or contemplating charitable gifts. Consider the following classes of clients who will benefit from this provision.

1. Clients Who Claim the Standard Federal Income Tax Deduction
   For clients who do not itemize, this new law provides the equivalent of an unlimited federal charitable income tax deduction for up to $100,000 of the charitable gifts that they make from an IRA.
2. Clients Who Would Lose Phased-Out Deductions with Increased Income
   Under the new law, a direct contribution of an IRA up to $100,000 does not increase the taxpayer’s Adjustable Gross Income (AGI). Correspondingly, it does not impact other deductions.
3. Clients Who Are Subject to the 50% Limitation on AGI
   A direct contribution to charity of up to $100,000 is not subject to the typical 50% of AGI cap for cash contributions to a public charity.
4. Clients Who Live in States That Do Not Permit State Income Tax Charitable Deductions
   For clients in Indiana, Michigan, New Jersey, Ohio and Massachusetts, direct contributions from IRAs will result in the highest possible net state tax savings.