Get your CE at Sea! What Counts and What Doesn't by Edwin P. Morrow ChFC, CLU, CFP, RFC Anyone living in the United States or any other jurisdiction with a heavy tax structure soon learns: "It is only the Net that counts !" However, most citizens become resigned to paying taxes - lots of taxes. Some even equate high tax payment with good citizenship and the price of success. But taxes can be legitimately reduced, or as Justice Holmes once said, "It is the right of every citizen to take any legitimate steps to reduce taxes."Incidentally, the good Justice has been so often quoted that no one knows exactly how he phrased it, but the concept counts. Perhaps Jack Benny said it better, "Taxes are the proud responsibility of every citizen, but I'd be just as proud for half the cost." Effective tax planning requires several steps: Understanding the basics of tax structure - where, when and how taxes are levied against income and assets. One does not have to be a CPA to absorb the fundamentals. However, enormous skill, experience and perseverance are required to prepare the complex tax returns of today. Recognizing the compound effect of all forms of tax over years to reduce the value of principal accumulation. Taxes matter during the working years, throughout retirement and thereafter as one wants to protect family survivors. Sometimes it is best to pay a bit more tax now to save a lot of taxes later. Taxflation. Inflation drives earned income, investment earnings and estates into higher tax brackets - and diminishes the value of future earnings as tax rates are increased. Present and Future Value. The impact of many planning techniques is not fully recognized in only a few years, but after the revised positioning has had an opportunity to benefit from earnings. Projections of hypothetical future values are essential. Uses of alternate ownership. To achieve maximum tax efficiency, it is necessary to use trusts. To be comfortable with these historic property titling, distribution and management tools, one must do a bit of study and insist on having critical questions adequately explained. Finally, it is important to be familiar with how securities, annuities and life insurance are taxed, and not taxed when each is properly arranged. If one truly desires to donate his or her earnings and accumulations to governments - to be spent at the whim of bureaucrats and regulators, then one needs do nothing. The default forms of ownership and investment maximize the tax.   Owned Rev. Living Trust Typical Irrevocable Trust Tax Effective Trust Form of Tax Securities Securities Insurance Securities Insurance Securities Insurance                 Sales Tax No No No No No No No Intangible Yes Yes No Yes No ? (1) No Capital Gains Yes Yes No Yes No ? (1) No Gift Tax No No No ? (2) ? (2) ? (2) ? (2) Estate Tax Yes Yes Yes No (3) No (3) No (4) No (4) Tax on Income Accumulation Yes Yes No Yes No No (5) No Tax on Income Withdrawals Yes Yes Yes (6) Yes Yes (6) Yes No(7) Available to Claims/Creditors Yes Yes Yes No (8) No (8) No (8) No (8) (1). Intangible property taxes would be levied based on the jurisdiction of the domicile (location) of the trust agreement. Some areas do not tax investments or their gains. (2). A federal Gift Tax may be payable if the annual transfer exceeds the eligible joint annual exclusion allowances, and the Unified Credit is not used. (3). Depending on trust agreement terms, there would be an estate tax exemption only in the first generation. (4). Depending on trust agreement terms, there may be a tax exemption in the second and even third generation. (5). Income is taxable within the Trust, based on the tax structure of the jurisdiction of the domicile (location) of the trust. An offshore Tax Effective Trust might not have to pay tax on non-distributed investment earnings. (6). Unless special trust language is present to authorize tax-free withdrawal transactions, income will be taxable whenever withdrawals are made. In most cases, income will always be taxable to second and third generations. (7). Special trust provisions enable the reinvestment of proceeds into investment- oriented insurance that contains tax-free withdrawal provisions. (8). Assets in these trusts are creditor and lawsuit proof unless they were created by a fraudulent conveyance or an act of tax evasion. Using Full Trust Power It is obvious from the above chart that for some families the use of a Tax Effective Trust can produce desirable results: Enhance wealth transfer effectiveness Provide liquidity available for emergencies Income tax-free cash available during lifetime for critical needs and for retirement income Income tax-free insurance proceeds at death Estate tax-free death proceeds Protection against creditors of the grantor and beneficiaries Protection against lawsuits subsequently filed against the grantor Potential generation-skipping transfer coverage Financial Advisor Caveats Many commission-based financial advisors are distracted by the immediacy of their personal reward. It takes time to have the right form of trust drafted, explained, executed and funded. So occasionally the wrong policy is sold to the wrong party. The Tax Effective Trust described should probably contain both Trust Protector and Trust Financial Advisor clauses to protect the family and the financial advisor. With irrevocable trusts, you only have one change to do it right! One veteran financial planner frequently uses term life insurance to bridge the period of time between when a decision is made to proceed and when all the legal documents have been properly executed. His close is remarkably effective: You must realize that all these benefits cannot be easily obtained. Very carefully drafted agreements must be prepared by an estate planning specialist attorney. What we always suggest is the following: Let's start the underwriting process for the types of insurance you might later decide to acquire. While an attorney is preparing a custom designed trust, and we are evaluating how much money you want to transfer and when it is most appropriate to do so, we will secure a standby insurance benefit using cheap term life insurance. Later, when everything is in place, your trustee can use that commitment to have the optimum funding placed into action. He takes an application and binder for a large term policy and puts it in force. When the desired Tax Effective Trust has been executed and funded, the company is requested to issue a new trust-owned policy, usually variable universal life, and discontinue the prior individually owned term policy. This type of planning can produce very powerful results:benefits for entire generations of a client family, a profitable long-term business relationship for the financial advisor, and a steady flow of referrals from extremely satisfied clients. Ed Morrow is the author of Computerizing your Financial Planning Practice, the Complete Millennium Preparation Guide for Advisors and Personal Coaching for Financial Advisors. He is also developer of the Text Library System used by 3,000 planning firms. He is a frequent speaker on practice management and technology to such organizations as the FPA (IAFP + ICFP), MDRT, NAIFA, IARFC and Society of Financial Service Professionals. For further information you may contact him at Financial Planning Consultants, Financial Planning Building, Box 42430, Middletown, OH 45042-0430, phone 800-666-1656 or email to: edm@financialsoftware.com Visit his website at www.financialsoftware.com