PERSONAL FINANCIAL PLANNING
DEFERRED GIFT ANNUITIES
By Mary Ellen Spiegel
What if a taxpayer does not have earned income but wants to take advantage of the benefits of an IRA? Or, what if she has the good fortune of receiving an unusually large bonus and wants to shelter some of the income from tax? Taxpayers can shelter this year's income while increasing their future retirement income through a unique charity gift arrangement called a deferred gift annuity. A deferred gift annuity involves a simple contract between a donor and a charity.
In exchange for an irrevocable gift of cash or securities, a charity agrees to pay the taxpayer or one to two other annuitants a fixed sum each year for life, beginning at least one year after the gift date. The older the designated annuitants are at the time of the gift and the longer the payments are deferred, the greater the fixed income the charity can agree to pay. In the majority of cases, a portion of each payment is tax-free, which will increase each payment's after-tax value, depending upon the taxpayer's bracket.
A minimum gift is usually $5,000, payable in cash, mutual fund shares, or appreciated securities. In return, the taxpayer will receive an immediate income tax deduction for a substantial portion of the value of the gift. The deduction can reduce the taxes payable that year on earnings, a bonus, or the sale of an asset or business.
The annuity rate the taxpayer receives depends upon her age at the time of the gift and the deferral period between the gift date and the year the payments will begin. The longer the deferral period, the higher the payments and tax savings will be. Consider the case shown in the Exhibit, which demonstrates the annuity rates and tax savings for gifts made at age 45 and payments made at ages 55, 60, 65, 70, and 75.
For example, if the taxpayer makes a $10,000 gift at age 45 with payments to begin at age 65, the annuity would be $2,180 per year for the rest of her life. The taxpayer's immediate deduction would be $4,162.50. If the taxpayer donates appreciated stock or mutual fund shares, the annuity payment would be based on their full market value.
Some people make one gift; others make gifts each year until retirement. Unlike other retirement savings vehicles, there are no limits on the amount that may be gifted (i.e., $2,000 or $30,000). If the taxpayer decides to make several gifts, she can arrange for payments from each gift to begin on the same date or select different start dates. In effect, she can "ladder" the payments from many gifts to keep pace with inflation or to provide income during a period of semiretirement.
Gifts of long-term appreciated property will be limited to 30% of the donor's adjusted gross income (AGI) and gifts of cash will be limited to 50% of AGI. Any unused deductions may be carried over for five years. The donor's estate may benefit from reduced probate costs and estate taxes. *
Mary Ellen Spiegel, CFP, is founder of Fiscal Plus, a registered investment advisor. She can be reached at (212) 319-6590.
By Michael A. Kirsh, CFP,
The Wealth Management Group
Family limited partnerships (FLPs) have become increasingly popular in recent years as a means to transfer family wealth to successive generations. FLPs can facilitate lifetime gifting while allowing the donor to remain in control of the assets as the general partner.
As effective as FLPs are, there are limitations on their use with certain assets such as S corporation stock, personal residences, and IRAs. Although other estate planning tools such as the grantor retained annuity trust and the qualified residence trust can be used to transfer S corporation stock and personal residences, there have not been any effective estate planning vehicles used for lifetime planning with IRAs.
By using an FLP as an IRA asset, it might be possible for taxpayers to achieve the best of both worlds for estate and income tax planning purposes. The idea is illustrated as follows: A taxpayer with an IRA forms a family limited partnership in which she, her IRA, and an irrevocable trust are partners. The IRA must own more than 50% of the partnership. The irrevocable trust will be the general partner. Each partner will be required to make a nominal capital contribution to the partnership in return for its initial partnership interest.
The irrevocable trust would have sole authority to manage the partnership assets as general partner. The general partner would be permitted to invest partnership assets in any investment permitted by the partnership agreement. The partnership would be authorized to invest in an insurance policy that insures the life of the participant. The following requirements would be imposed by the partnership agreement relating to insurance policies purchased:
* The partnership would be the designated beneficiary of the policy.
* The general partner (the irrevocable trust) would contribute that amount toward the purchase of the insurance contract which is equal to the P.S. 58 amount. The balance of the premium would be paid by the limited partners, in proportion to their percentage interest in the partnership.
* Upon the death of the insured, the IRA's interest in the partnership will equal its investment plus a specified rate of return. The balance of the insurance proceeds would be distributed to the general partner.
The IRA will make an in-kind distribution of its limited partnership interest to the owner of the IRA at age 59 Qw . The owner could contribute the partnership interest to the insurance trust. Because the IRA will not be distributing an insurance contract to the IRA owner, but rather a limited partnership interest, the subsequent transfer of that partnership interest to the insurance trust should not trigger the three-year in-contemplation-of-death rule.
The FLP must have a demonstrable business purpose. The purpose of the FLP cannot be simply to acquire and hold life insurance. An FLP that has a demonstrable business purpose, however, may engage in many activities, such as acquiring life insurance policies and insuring the lives of individuals in which the FLP has an insurable interest. Congress and the U.S. Treasury have adequately demonstrated that the government's recognition of partnerships is not to be limited to only those partnerships that carry on a trade or business. IRC sections 721(b) and 731(c), along with Treasury Regulations sections 1. 704-3T(e)(3) and 1.761-2(a), contain provisions that are applicable to partnerships that merely hold passive investment assets.
The IRS has respected the intention of Congress with regard to partnerships in a number of published rulings. In two rulings, the IRS held that "passive investment clubs" may be conducted in partnership form and will be treated as partnerships for Federal tax purposes. (Revenue Rulings 75-523, 1975-I.C.B. 257 and 750525, 1975-I.C.B.). New York specifically recognizes passive investment partnerships as valid under state law.
Because the proposed transaction will provide certain collateral tax benefits to the owner of the IRA or her beneficiaries outside of the IRA, the transaction requires careful examination to evaluate whether 1) the transaction is for the exclusive benefit of the owner of the IRA and her beneficiaries or whether it involves an impermissible benefit to the owner of the IRA or her family members in their individual capacities, 2) the investment is prudent and appropriate for the IRA in light of the acquisition and other charges, and 3) the transaction will involve a prohibited transaction under the IRC. In addition, the presence of a life insurance policy requires consideration of whether the FLP transaction would be considered by the IRS to violate the prohibition against IRAs investing in life insurance contracts.
The prohibited transaction issues are the most serious area of concern in the implementation of this strategy. First, the economic consequences of having the IRA engage in a prohibited transaction are devastating. Second, the strategy outwardly appears to be an act of "self-dealing."
An IRA that engages in a prohibited transaction with its owner can lose its status as an IRA, resulting in an often devastating immediate income taxation to the owner on the total value of the account. Using separate IRAs could reduce this risk.
Although the proposed transaction appears be an act of self-dealing, it may in fact not result in a prohibited transaction. In Swanson v. Comm'r [106 T.C. 76 (1996)], a taxpayer's IRA became the sole shareholder of a newly formed sales corporation that exported goods for the taxpayer's operating corporation. The IRS attacked the transaction as prohibited and sought to collect tax on the recognition of the IRA's assets as taxable income. The Tax Court ruled that no prohibited transaction had occurred, and the IRS conceded its position by filing a notice of no objection. Based on the reasoning in Swanson, a contribution of assets by the IRA to a partnership in its formation with the IRA's owner should not result in a prohibited transaction.
IRAs are prohibited from investing in life insurance contracts [408(a)(3)]. However, in at least three private letter rulings (PLRs 8245075, 8338144, and 8327075), the IRS approved the purchase of life insurance indirectly funded by IRA accounts. In the proposed transaction, the IRA's interest in the FLP will be limited to a return of investment with a specified market rate of return that is guaranteed by all assets held by the FLP. The IRA's rate of return is not affected by the death of its owner and would not appear to constitute a life insurance contract.
Attorney Andrew J. Willms of Willms Anderson in Milwaukee, Wisc., is the creator of this concept. He had unsuccessfully requested rulings from the IRS. Another attorney has ruling requests pending with both the IRS and the DOL. He anticipates receiving favorable rulings in the near future.
The ability to invest IRA assets in an FLP may solve an untold number of estate planning problems. If the preceding strategy is properly implemented and its formalities followed, the following substantial benefits and cost savings may be realized:
* The IRA, using pretax dollars, will pay to the insurer the majority of the costs and expenses of acquiring and maintaining the life insurance policy, and the irrevocable trust, using favorable rates, will pay the amount of the premium equal to the costs of just the insurance protection afforded by the policy.
* The measure of the gift will be the
P.S. 58 amount, not the amount of premiums paid. This could provide significant
leverage for gift and generation skipping tax purposes.
* The death benefit paid to the irrevocable trust will be free of estate and income taxes at all times.
* The IRA can distribute to the participant the IRA's interest in the FLP, using appropriate valuation discounts for minority interests and lack of marketability. *
Milton Miller, CPA
William Bregman, CPA/PFS
Alan J. Straus, CPA
David R. Marcus, CPA
Paneth, Haber & Zimmerman LLP
The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.
©2009 The New York State Society of CPAs. Legal Notices
Visit the new cpajournal.com.