The Dynamic Duo
These two powerful trusts are, in many ways, mirror opposites of one another. Properly designed, the Deferred Inheritance Trust pays its income to charity (usually a family foundation with our clients) for a term of years, or life then terminates, and the trust assets pass to your heirs, Gift/Estate Tax free. The Enhanced Income Trust, on the other hand, pays its annual income to you and your family. Upon termination, the trust assets pass to your family foundation.
Each of these tools, individually, produces considerable planning leverage, but when they are combined they can provide a very effective planning strategy. Consider the following scenario based on an actual case.
Meet Bob and Mary Ballard. They are 69 and 65 respectively. They have a net worth of about $10,000,000 and, unfortunately, are both in extremely poor health. With their current distribution plan, their five children would receive about $5 million of their Personal Capital at their death and the IRS would receive their Social Capital of about $5 million.
Even though the Ballards were very interested in supporting several worthy ministries, they could not see how it would be possible to do so without reducing their children’s inheritance which was already only half of their wealth. Consequently, like most other wealthy Christian families, they simply opted to do nothing for these ministries in their planning.
The Ballards completed the entire Family Wealth Counseling process and produced their Family Wealth Letter of Intent. In going through this process, they decided to stagger their children’s inheritance over a number of years instead of giving it all at their deaths. They also liked the idea of setting up a family foundation and allowing their children to retain the control of all their Social Capital and continue the family’s support of several important ministries.
The Ballards felt that $1 million to each of their five children was a reasonable inheritance. Because their extremely poor health had reduced our planning options and also their life expectancy, we asked them if they would be open to providing their children with the income stream from their inheritance for the first 10 years and then receiving the actual inheritance. They thought that would be completely acceptable, since the children would probably invest the money for income during that time period anyway.
This planning option opened the door for the Ballards to redirect their Social Capital from going to the IRS to going to their own family foundation and ultimately to the ministries their family cared about.
Here is what we did: In order to maximize the leverage in the Ballard’s comprehensive Master Life Plan, we suggested combining a testamentary Enhanced Income Trust with a testamentary Deferred Inheritance Trust. By establishing a Family Limited Partnership during their lifetime and funding it with the assets ultimately going into the Deferred Inheritance Trust, we were able to significantly increase the pay-out rate of the trust to their foundation and consequently shorten the trust’s term to 10 years. The trust would be set up to pay income to their Family Foundation for 10 years. At that time it would terminate and the $5 million in trust would pass to the children tax free.
The Enhanced Income trust was also set as a 10-year trust with the five children being equal income beneficiaries of the trust. Because the trust term was set for 10 years, the charitable Estate Tax deduction would be quite substantial. Using their combined lifetime gift exclusions (currently $1 million per person), we could actually eliminate all the Estate Tax liability due on the income stream to their children.
The following flowchart illustrates how this simple, yet powerful, technique works.
The net result of this creative planning strategy was profound. The Ballard children received essentially the same inheritance with the proposed plan as they would have with the current plan. But the real difference is that instead of the Ballards paying the IRS $5 million in Estate Taxes, they now will have $9 million in their own family foundation under the control of their children.
Consider the following results:
It is so exciting to see what can be done when you are willing to begin thinking outside the box.
© 2010 Stewardship Ministries, Inc.
The author, E. G. “Jay” Link, is the President of Stewardship Ministries, a teaching, training, and mentoring ministry for professional advisors and ministry leaders to equip them to effectively serve believers who have accumulated surplus, material possessions. He is the author of three books, “Spiritual Thoughts on Material Things: Thirty Days of Food for Thought,” “To Whom Much is Given: Navigating the Ten Life Dilemmas Affluent Christians Face” and “Family Wealth Counseling: Getting to the Heart of the Matter.” Mr. Link may be reached via email at jlink@StewardshipMinistries.org.
