Perspectives in Estate Planning For many of us, estate planning is something we know we should do but somehow manage to postpone until some indefinite tomorrow; or, once having done a plan, put it away in a file for someone else to find. While both responses may be understandable, neither is very wise. There is simply too much at stake. Consider what estate planning is all about. In its essence, estate planning concerns the establishment or continuation of a tradition, one that involves the accumulation, conservation and distribution of assets. Your estate is both the real and personal property which you have a right, title or interest in, and which you intend to use to benefit yourself, your family and your community. In doing estate planning, we give an account of our assets, suggesting what they mean to us by what we use them for and whom we want to benefit from them. You need to give this account, rather than leave it for others to give; and you must retell it as often as the circumstances of your life change. It is your story, your tradition, which you should want to endure. Relate that story to your Morgan Stanley Smith Barney Financial Advisor. Together with Morgan Stanley Smith Barney s wealth planning professionals, he or she can translate that story into strategies designed to help you preserve, assign and endow your assets.
Estate Tax Estate Tax Many of us spend dozens or more hours each and every year working with tax advisors to help reduce our annual income tax. Yet, the federal estate tax does not get nearly that much attention, even though proper planning could result in significant estate tax savings. Today, it is more important than ever to protect your assets from significant loss due to estate taxes. The top federal estate tax rate is 45% (in 2009), and some states have their own independent estate tax. There are some very good reasons to develop an estate plan; among them are the following: Possibly reduce the amount of taxes your heirs will have to pay Be sure that your assets are distributed the way you want, to whom you want, when you want and in the amount you want Elementary Actions Establishing and Evaluating Your Objectives Your objectives determine everything. Even tax planning must take a back seat to carrying out your wishes and goals. Be sure you are clear about how you want your assets to be used, as well as who shall have the use of them. Estate and Gift Planning Objectives Maximizing the enjoyment of your assets during your lifetime Providing for you and your family in the appropriate manner Preserving asset values Controlling your family s future Reducing taxes and expenses Leveraging the use of tax exemptions Supporting the efforts of particular charities Taking an Inventory of Your Assets and Liabilities List completely all your property, real and personal, and determine a fair market value for it. Subtract any debts or expenses to determine your net worth. This remainder will be the basis by which you identify your objectives. Be sure to detail any health concerns or special needs of individual family members and then provide your estimate of the emotional maturity and financial needs of your children (or grandchildren). Preparing or Updating Your Will Your will is an essential part of your estate plan. It establishes who will receive your assets and in what manner and, where minors are concerned, who shall be guardians. Dying intestate, or without the benefit of a will, leaves the laws of your state to decide the division and distribution of your property. It can also create unwanted estate tax consequences. If you already have a will, review it periodically to ensure that it covers any changes in your circumstances, objectives or wishes or any alterations in tax law. Such changes might include a move to another state, the purchase of property in another state, marriages, divorces, births, beginning or completing college programs, health issues or special situations. 2 perspectives in estate planning / morganstanleysmithbarney.com
Key Tax Provisions Gifting to Family Lifetime gifts to family members or other individuals can reduce your estate while providing personal satisfaction. You are entitled to transfer up to $13,000* per person in 2009 without incurring any federal gift tax; and spouses together may donate up to $26,000.* These annual gifts may be in addition to any direct tuition or medical payments made on behalf of another person. You may also elect to use your Federal Gift Tax Exclusion during your lifetime, as a way to gift up to $1 million free of gift tax. This exclusion remains constant through 2009, unlike the Federal Estate Tax Exclusion, which increases as discussed below. Gifting assets during your lifetime reduces your estate in the amount of the value of the assets. Gifting assets also avoids estate tax on any subsequent appreciation and income earned on the property. Gifting to Charities Gifts to qualified charities are exempt from gift tax and remove these gifts from your estate. In addition, they may qualify for current charitable income tax deductions.** As with family gifting, gifts to charities during your lifetime can reduce your estate both by the value of the gift itself and by any subsequent appreciation. Key Tax Provisions The following critical tax provisions form the basis of many estate planning strategies: The Federal Estate Tax Exclusion The Federal Estate Tax Exclusion entitles each individual to transfer assets at death, free of estate tax. The exclusion amount is $3.5 million in 2009. Any portion of the Federal Gift Tax Exclusion you use during your lifetime will reduce the Federal Estate Tax Exclusion available at your death. The Unlimited Marital Deduction Federal estate and gift taxes may be deferred by taking advantage of the marital deduction this deduction allows one to pass an unlimited amount of property to a spouse, free of estate and gift taxes (assuming the spouse is a U.S. citizen). However, at the death of the surviving spouse, taxes will become due on the value of his or her estate, which may include assets received from the other spouse. The Generation-Skipping Transfer Tax Exemption If you wish to transfer any assets to grandchildren, or even great grandchildren, you face the potential imposition of yet another transfer tax the federal generation-skipping transfer (GST) tax. This tax is equal to the top federal estate tax rate, and it is imposed on the value of the transferred asset. There is, however, a GST tax exemption that allows you to transfer assets to skip persons (that is, people who are at least two generations below the person transferring wealth) without incurring any GST tax. This exemption is equal to the Federal Estate Tax Exclusion. The GST tax exemption is often used in connection with certain types of trusts, such as a life insurance trust, a dynasty trust or a charitable lead trust. (Information on these trusts begins on page 4.) Reducing the Estate and Gift Tax Burden There are effective methods for reducing your estate and gift tax liability. They vary in complexity and require advice from qualified legal and tax counsel, as well as support from a knowledgeable Financial Advisor and trust professional. Here are some options which may have relevance to your situation and concerns: For spouses, ensuring that each uses his/her Federal Estate Tax Exclusion Establishing a gifting program Donating assets to charities Placing life insurance policies in a trust Placing a residence in a trust Forming a family limited partnership to hold certain assets and use as a gifting vehicle Leveraging your generation-skipping transfer tax exemption *This amount may be increased for inflation. ** The threshold amount for 2009 is $166,800 for all individuals. The threshold amount for 2009 is $83,400 for married filing separate. For 2010, the reduction was to be completely eliminated. However, beginning in 2011, the full itemized deduction reduction of three percent of AGI exceeding the floor is scheduled to be reinstated. For 2009, the AGI floor is $166,800 ($83,400 if married filing separately). perspectives in estate planning 3
The Use and Advantage of Trusts THE HIGH COST OF SUCCESS: FEDERAL TRANSFER TAXES The chart below illustrates the federal estate tax and generation-skipping transfer tax exclusion amounts, and top tax rates. CALENDAR YEAR estate tax exclusion and gst tax exemption top estate, gift and gst tax exemption 2009 $3.5 million 45% 2010 repealed* 35% (gift tax only)* 2011 $1 million** 55% * Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (the Act), estate and generation-skipping transfer taxes will be repealed in 2010. While the Act repeals the estate and generation-skipping transfer taxes in 2010, the gift tax remains in effect. The top gift tax rate in 2010 will equal the top income tax rate for that year. Due to the sunset provisions of the Act, the 2001 estate and gift tax structure will be reinstated in 2011 unless Congress acts before then to extend the provisions of the Act. ** In 2011, the GST tax exemption will be indexed for inflation. In addition, the Estate Tax Exclusion is scheduled to be $1 million in 2011 under the 2001 estate tax structure. The Use and Advantage of Trusts Many methods and strategies used to reduce estate tax liability involve trusts. Trusts can be flexible devices designed to solve particular issues. They can provide for one s future care, support a surviving spouse and children, accommodate family members with special needs and reduce income, gift and estate taxes. A trust is a legal relationship in which an owner ( grantor ) transfers legal title to certain assets to another party ( trustee ), who in turn holds it for the benefit of the grantor and/or another individual or individuals ( beneficiary ). The terms and conditions under which the assets are held by the trustee are set forth in a written document. With revocable trusts, the grantor reserves the right to control the assets and change the terms of the trust at any time. If a trust is irrevocable, the grantor gives up rights to the trust assets and cannot amend the terms of the trust. 4 perspectives in estate planning / morganstanleysmithbarney.com
Basic Trusts Basic Trusts In addition to revocable and irrevocable, trusts can be inter vivos (established during your lifetime) or testamentary (established under your will). Here are some popular basic trusts: Revocable Living Trust To control the management and distribution of assets in the event of incapacity or death, You can: Maintain complete control of your assets as long as you are able Manage the investment of assets Receive income and/or principal from the trust Transfer property to your heirs Avoid probate for the trust assets Provide privacy for your family (in some states) Possibly reduce estate settlement expenses Credit Shelter Trust (CST) Typically funded at the death of the first spouse, the CST utilizes the Federal Estate Tax Exclusion and provides tax-sheltered assets for children. This trust: Allows the first spouse to die to use his or her Federal Estate Tax Exclusion to shelter trust assets from federal estate taxes Can provide income and principal to the surviving spouse and family Can provide for trust property to be transferred to heirs at the death of the surviving spouse free of estate taxes Keeps the trust assets out of the surviving spouse s estate Qualified Terminable Interest Property (QTIP) Trust You can also leave assets in excess of the Federal Estate Tax Exclusion to a Marital Trust/Qualified Terminable Interest Property (QTIP) Trust for the benefit of the surviving spouse. The surviving spouse receives all the net income and also may have rights to the principal. (The QTIP Trust arrangement might be used to assure that assets ultimately end up in the hands of the beneficiaries chosen by the first spouse, rather than to persons selected by the surviving spouse.) Irrevocable Life Insurance Trust (ILIT) In most instances, ILITs remove life insurance proceeds from your estate and hence from estate tax liability. You can: Provide income and/or principal to your heirs Prevent life insurance proceeds from being included in your estate Provide family with funds to pay estate taxes and other estate settlement expenses Properly Established Trusts Can Be Used to: Manage and protect assets during your lifetime Provide continuity in the management of your affairs after your death Control how and when your assets are distributed Avoid much of the costs and delays of probate Ensure privacy and confidentiality in the handling of your affairs Control income and principal distributions to children and grandchildren Reduce estate and gift taxes perspectives in estate planning 5
Advanced Trust Strategies Advanced Trust Strategies A number of trusts can be used to accomplish more sophisticated financial and estate planning objectives. These trusts usually are irrevocable and can be used by themselves or with other trusts. Some of the more popular are: Charitable Remainder Trust (CRT) CRTs can help investors diversify asset holdings, potentially defer capital gains tax and benefit charity. This trust provides a fixed payment stream to family members over a specified term and then distributes the remaining trust assets to charity at the end of the payment term. If the grantor creates the CRT during lifetime, the grantor will receive a federal charitable gift tax deduction and a potential federal charitable income tax deduction. If the grantor creates the CRT at death, the grantor s estate will receive a federal estate tax charitable deduction. The CRT is a tax-exempt entity, so it can sell appreciated assets and achieve diversification and perhaps a higher yield without incurring income/capital gains. The CRT may provide family with a higher after-tax payment stream than it otherwise would have received if appreciated assets were sold outside of the CRT and subject to income tax. Family members can defer the payment of capital gains tax on appreciated assets sold by the CRT at least until their receipt of annual payments from the CRT. Charitable Lead Trust (CLT) The CLT allows investors to transfer potential asset appreciation to younger family members at a reduced federal gift tax cost, while benefiting charity at the same time. The CLT provides a fixed payment stream to charity over a specified term and then distributes the remaining trust assets, generally free of federal estate taxes, to family members at the end of the charity s payment term. If the grantor creates the CLT during lifetime, he or she will receive a federal charitable gift tax deduction. Some (but not all) types of CLTs may give the grantor a potential federal charitable income tax deduction too. If the grantor creates the CLT at death, his or her estate will receive a federal estate tax charitable deduction. Grantor Retained Annuity Trust (GRAT) The objective of a GRAT is to transfer potential asset appreciation to younger family members at a reduced federal gift tax cost. The GRAT is an irrevocable trust to which an individual transfers assets and takes back a fixed annuity payment, made at least annually, for a specified term of years. If the grantor is still alive at the end of the annuity payment term, the remaining trust assets will pass to the beneficiaries (usually younger family members or a trust created for their benefit), free of federal estate and gift taxes. If the grantor dies before the end of the annuity payment term, some or all of the remaining trust property will be included in his or her estate and subject to federal estate tax. Qualified Personal Residence Trust (QPRT) The QPRT is a trust to which an individual (grantor) transfers his or her home but retains the exclusive use of such property for a specified term of years (the QPRT term). The grantor is treated as making a gift to the QPRT beneficiaries equal to the value of the home less the present value of his or her retained use of it. At the end of the QPRT term, the home will pass to the beneficiaries specified in the trust document (usually family members) free of federal estate and gift taxes. However, if the grantor dies before the end of the QPRT term, the home will be includible in his or her estate and subject to federal estate tax. Dynasty Trust The goal of a Dynasty Trust is to create a trust that can last in perpetuity for the benefit of multiple younger generations (children, grandchildren, great-grandchildren, etc.). Generally, the Dynasty Trust is an irrevocable trust that an individual creates during life for the benefit of younger family members in a state permitting trusts that last forever. In many cases, the trust is funded with that amount of assets equal to the grantor s remaining federal generation-skipping transfer tax exemption. A popular strategy often employed by the trustees is to invest trust assets in life insurance policies on the life or lives of the grantor and/or family members. Among other benefits, Dynasty Trust assets (including any appreciation) generally will not be includible in the grantor s estate and grow inside the trust free of federal estate, gift and generationskipping transfer taxes. In addition, trust distributions generally can be made to beneficiaries free of federal gift, estate and generation-skipping transfer taxes. 6 perspectives in estate planning / morganstanleysmithbarney.com
Professional Trust Services Professional Trust Services There are many advantages to appointing a professional trustee, to act alone or in conjunction with a relative or friend. A professional trustee can provide continuity, permanence and investment management, tax and administrative expertise. A professional trustee can also remain objective, avoiding conflicts of interest and biases that may arise if a family member or friend is selected. The Morgan Stanley Trust advantage is the unique combination of the strength of a professional trustee special expertise, objective consideration and lack of emotional bias and the personal knowledge, sensitivity and commitment of your own Morgan Stanley Smith Barney Financial Advisor. When you appoint a Morgan Stanley Trust affiliated trust company to act as your trustee or as your co-trustee, you access the vast investment management resources and enlist the services of experienced Trust Officers. These seasoned specialists will follow your trust instructions objectively and faithfully, balancing your wishes with the needs of your beneficiaries, generation after generation. The Four Ways to Pay Estate Taxes Life Insurance: The proceeds of a life insurance policy are payable immediately in cash and pass to beneficiaries income tax-free. By insuring your life for an amount equal to your estate tax liability, you can better ensure sufficient liquidity. Cash: Most estates do not include significant cash reserves, since the average investor is unwilling to sacrifice growth or income potential in order to maintain excessive liquidity. If there happens to be sufficient cash and all is used to cover the tax liability, your family will inherit only nonliquid assets. Loans: Your estate s legal representative may be able to borrow money. Since both loan principal and interest must be repaid, this may only postpone and multiply the issue. However, if this is an option you or your heirs wish to explore, talk to your Financial Advisor about securities-based loans, home equity lines of credit and other lending services offered through Morgan Stanley Smith Barney. Liquidation: Assets of the estate, including securities, real estate or business interests, can be liquidated; but the legal representative has no control over market timing. That is, a forced sale may result in financial loss if market conditions are not favorable. perspectives in estate planning 7
Funding the High Cost of Success Funding the High Cost of Success Short of gifting the vast majority of your estate to charities, you may have some remaining estate tax liability even after applying sophisticated planning strategies and trust vehicles. In virtually all situations, that estate tax liability must be satisfied within nine months of the date of death. Under limited circumstances, some of the estate tax liability may be deferred for a period of time. However, interest will be imposed by the IRS in these situations. There are four sources from which funds can be obtained to pay estate expenses: cash reserves, loans, liquidation of assets or life insurance proceeds. While your legal representative can utilize any single source of funds, or a combination of several, some may be more efficient than others. Maximizing Benefits: The Leveraging Power of Life Insurance Of the several sources of funds previously outlined, life insurance is generally the most cost effective. For cents on the dollar, you can help ensure that sufficient cash is available when estate taxes are due, thus reducing or even eliminating estate shrinkage. A life insurance death benefit avoids income tax and can avoid estate tax in certain situations. Its benefit can far outweigh its cost. Example: Mr. & Mrs. Smith, both age 65, have a combined taxable estate worth approximately $5 million. The first to die will establish and fully fund a credit shelter trust with $2 million at his/her death so that the couple will be able to fully use both their Federal Estate Tax Exclusions (assume 8 perspectives in estate planning / morganstanleysmithbarney.com
Maximizing Benefits: The Leveraging Power of Life Insurance each spouse has one-half the assets in his/ her name). Assuming they both die in 2008, based on 2008 estate tax rates, the Smiths will have a federal estate tax liability of approximately $450,000. The Smiths plan to satisfy this estate tax liability with proceeds from a life insurance policy. Projected federal estate tax liability: $450,000 Life insurance policy face value: $450,000 Premiums: $5,806 x 4 years = $ 23,224* Total premiums as a percentage of estate value:.46% Total premiums per each dollar of federal estate tax liability: $0.05 Important Note Usually life insurance proceeds avoid probate and are exempt from income tax. However, they are subject to estate tax if you own the policy or have rights in the policy. To avoid increasing your estate tax liability with the very method you choose to pay it, implement one of the following plans: 1. Have your children purchase and own the policy. (They may pay premiums with gifts you have made to them which fall within the annual exclusion amount.) 2. Have a trustee of an irrevocable trust purchase the policy. (The trustee may pay premiums with amounts you have gifted out of your estate using your and your spouse s annual exclusions.) The latter choice, using an irrevocable life insurance trust, is among the most common estate planning strategies used today. As long as the trust is properly drafted and funded, gifts to the trust may qualify for the annual gift tax exclusion and the proceeds of the policy can be received without any estate tax liability. This liquidity can help ensure that many of your assets are preserved for distribution especially if your estate includes significant illiquid assets, such as a family-owned business or real estate. * For illustrative purposes only; premiums are not guaranteed until policy is issued. Based on a standard survivorship policy with two nonsmokers and a guaranteed death benefit to age 100. perspectives in estate planning 9
Estate Planning The particular policy selected by the Smiths is a Survivorship Life policy, possibly the most cost-effective method for married couples to fund estate tax liability. This type of plan insures two lives and pays a benefit after the second death when the bulk of the estate tax typically comes due. (At the first death, the combined use of the Federal Estate Tax Exclusion and the unlimited marital deduction may avoid any estate tax liability at that time.) It can be considerably less expensive than insuring each spouse independently. There are, however, a variety of new product designs for single life plans which offer improvements over traditional policies. With an array of choices, it is important to determine which plan is best for you and your situation. Your Morgan Stanley Smith Barney Financial Advisor can help in that determination. In fact, Morgan Stanley Smith Barney maintains relationships with a number of well-known, top-rated insurance companies that offer competitively priced products. The objective is to bring you the most discriminating strategies to help you meet your individual needs. Estate Planning Red Flags As you reflect on your objectives, please note that the presence of one or several of the following conditions may require you to review and make some critical arrangements, if you have not already done so. All or almost all assets are jointly held Property ownership in multiple states Substantial qualified plan benefits and individual retirement account assets Life insurance owned in your name or your spouse s Highly appreciated assets with low cost bases If any of these apply to you, call your Financial Advisor to help develop strategies for dealing with them. Estate Planning: The morgan stanley Smith Barney Advantage The efforts of a team of professionals, including your attorney, accountant, financial advisor and trust officer, can result in a sound estate planning strategy. Within this group, your Morgan Stanley Smith Barney Financial Advisor will function in the critical role of coordinator, in addition to offering investment guidance. He or she may also rely on the special resources of Morgan Stanley Smith Barney s Wealth Management group to help serve your estate planning needs. Morgan Stanley Smith Barney Wealth Management is a unique association of professionals, including Wealth Planning Directors, Wealth Planning Analysts, Insurance, Lending, Trust Specialists and Trust Officers who are located in or near the communities they serve. They will work with you, your Financial Advisor and your other advisors, such as attorneys and accountants, to provide accurate, up-to date and creative strategies in the area of estate and trust planning. 10 perspectives in estate planning / morganstanleysmithbarney.com
Insurance products are offered through SBHU Life Agency, Inc. Since life insurance and long-term care insurance are medically underwritten, you should not cancel your current policy until your new policy is in force. Your actual premiums may vary from any initial quotation you receive. A change to your current policy may incur charges, fees and costs. A new policy may require a medical exam. Surrender charges may be imposed and the period of time for which the surrender charges apply may increase with a new policy. You should consult with your own tax advisors regarding your potential tax liability on surrenders. Citi Trust is the business name for a wide range of personal trust and estate management and related services provided by various Citigroup entities to individuals, families and charitable entities throughout the world. For U.S. clients, trust services are provided by one of the following entities: Citibank, N.A.; Citicorp Trust, N.A.; Citicorp Trust South Dakota; Citigroup Trust - Delaware N.A.; or Citigroup Institutional Trust Company. The service providers are collectively referred to as Citi Trust and the entities as the affiliated trust companies. Morgan Stanley Smith Barney LLC and its affiliates do not provide tax or legal advice. To the extent that this material or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Any such taxpayer should seek advice based on the taxpayer s particular circumstances from an independent tax advisor. A Morgan Stanley Smith Barney relationship does not have to be established or maintained to obtain the products or pricing offered as part of the Morgan Stanley Smith Barney Home Loan Program at Citibank. Home equity programs not available in AK. A default (stopping monthly payments) on a mortgage could result in the loss of pledged real estate, securities or both. Our policy does not permit clients to use the proceeds of a home loan to invest in the securities or related markets. Your Financial Advisor may receive compensation in connection with this lending program. Affiliates of Morgan Stanley Smith Barney may earn fees in connection with the funding, origination, and sale of a loan. All home loans and lines are made by Citibank, N.A., or CitiMortgage, Inc., equal housing lenders, and are subject to Citibank s and CitiMortgage s mortgage qualifications. CitiMortgage does business as Citicorp Mortgage in NM. Citigroup Global Markets Inc., Citibank, N.A, and CitiMortgage, Inc., are subsidiaries of Citigroup Inc.
There is no guarantee that these strategies will succeed. This information is intended to illustrate products and services available. The strategies do not necessarily represent the experience of other clients, nor do they indicate future performance. Investment results may vary. The investment strategies presented are not appropriate for every investor. Individual clients should review with their Financial Advisors the terms and conditions and risks involved with specific products or services. Past performance is no guarantee of future results. 2009 Morgan Stanley Smith Barney LLC. Member SIPC. 526267 PS2015 7/09