Pros/Cons of Establishing a Private Annuity Funded by the Parents With the Parent’s After-Tax Assets |Weekly Wednesday Wisdom Webinars

Certified Elder Law Attorney and Financial Advisor Chris Berry of Castle Wealth Group answers retirement and estate planning questions every Wednesday at 1pm.

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Castle Wealth Group and Christopher Berry help families with estate planning, elder law, retirement planning, and tax planning from their offices in Brighton, Ann Arbor, Livonia, Bloomfield Hills, and Novi.



On this week’s webinar, attorney and advisor Chris Berry of answers the below questions.

  • Introduction / Positive Focus
  • Can you offer any information on the pros/cons of a parent establishing a Private Annuity funded by the parents with the parent’s after-tax assets(e.g., Roth IRA assets). The adult children would be the beneficiaries of this Private Annuity, and for income tax purposes the amount of the original annuity price/deposit would be reported by the parent as a gift (using a portion of the current $11.7 million gift tax exemption). Could this be a method that an elderly parent might consider in order to remove after-tax assets from a parent’s estate while still maintaining the tax-free character of continuing payments that would be made to the children?
  • Upon death, how can someone(Trustee/PR) access your house and stuff?
  • If you recently found out you have life insurance, how do I raise the value to the company?
  • Is Biden’s proposal increase on estate tax 3.5 per person or 7 million per couple?


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Episode Transcript

All right, we will go ahead and get started so my name is Chris Berry attorney and advisor with Castle Wealth group, and we do these Weekly Wisdom Webinars every week where it’s really driven by you whatever questions you have in the legal financial, and tax world or any news you want to talk about. Just put it into the Q & A or the chat section and we’ll go ahead and address it and someone put a question in already and we’ll go ahead and address it live on air. And then if you do have a more specific question feel free to go to this website and you can schedule some time on my calendar. If it’s more of a private question or something’s unclear and you want to see how it addresses your situation or if I’m going if something’s unclear just put it into the chat or the question and answer section I’ll make sure to address. So I just had one question come in plus we had one question ahead of time which is a doozy. But before I get into the question I was like start with a positive focus. Something positive that happens or is happening and something I’m really excited about is that my family my wife and kids. We’re going up north this weekend. So we’re going to Mackinaw Island we haven’t been to back island in a couple of years. So I’m pretty excited to go up there and we might do something called geocaching. I don’t know if you’ve ever if you know what that is. It’s basically an adult scavenger hunt or kid scavenger hunt too. 

Where people hide these little geocaches this is something we got into in the middle of the pandemic but there’s an app where you plugin it has your GPS and people have hidden things kind of throughout different cities and on different trails and stuff. So we’re pretty excited to go see check out what geocaches we can find up on Macna island. So that’s my positive focus I always like to start with something positive before we get going and with that, we’ll go ahead and get started. So this is a doozy this question that was submitted. I appreciate this one made me put on my thinking cap and I’ll go through it and there are some things that we have to address and always keep in mind. So well let’s go through the question first so can you offer any information on the pros and cons of appearance establishing a private annuity funded by the parent’s after-tax assets. The adult children would be the beneficiaries and for income tax purposes amounted original annuity price deposit et cetera would be reported to parent as a gift using a portion of the current 11 million dollar exemption. Could this be a method an elderly parent might consider in order to remove after-tax assets from a parent’s estate while still maintaining the estate tax-free character of the continuing annuity by understanding growth on the okay? So always and I get this and I appreciate the question but I always like to what they’re really talking about is a specific tool okay or maybe strategy and whenever I’m working with clients the first thing we always focus is on focus on is what is the goal. 

Then we focus on the strategy and then we pick the right tool too often people kind of do their own research and they’re focusing well this tool sounds pretty cool. Should I figure should I apply it to my situation well let’s first figure out what are we really trying to accomplish at the end of the day and then develop the strategy and then pick the right tool because that’s gonna really we’re not gonna spin our wheels necessarily if we focus on starting with what the goal is. So always start with what is the goal and then let’s develop the strategy and then let’s pick the best tool. So this is kind of going back a little bit and looking at a private annuity and there are different ways to structure this this could be handled almost through like a contract between parents and kids. But there are a couple of issues that we have to kind of flesh out before we even get to whether that’s the right tool. Because the annuity what basically looking at annuity in its strict sense what it is is a straight income stream like social security is an annuity if you look at it annuity just as a pure and simple it’s not a fixed index annuity. It’s just income for a period of time or for life but really what I think the goal that we’re trying to accomplish is is a state tax plan and also may be providing for the kids now while alive versus just adult kids. Now while alive so the kids can kind of see the value or the parents can see the value while they’re alive versus when they pass away. so I’m guessing that’s kind of what the goals are and so we need to understand just kind of how taxable buckets work. So we have these different taxable buckets and I’ll call this post-tax. I used to call this taxable but let’s call this post-tax to let’s call this tax-deferred or tax-deferred and let’s call this tax-free income tax-free. And then we have this fourth bucket that becomes more important as we see the estate tax potentially drop I call this tax-free plus and this is income and estate tax-free. I really do appreciate this question this is like a SELA exam or CFP exam. The question there’s a lot to it so first post-tax accounts are like checking savings brokerage accounts here. Typically what you’re going to be taxed on potentially is the gains might be taxed on any gains okay tax-deferred you have things like your pre-tax IRAs. Your 401ks here are your tax ordinary income tax rates. So if you pull any money out it stacks income tax rates then we have our tax-free bucket. This is like the common answer is the Roth also we have cash value life insurance 529’s health savings accounts and then so this is income tax-free but these are not estate tax-free so these still count towards your estate tax and then in the tax-free bucket. We can always move IUL into an irrevocable life insurance trust so we can move cash value life insurance into something that’s state tax-free. We can’t do that with Roth. So this question is asking okay after-tax assets so it’s lumping a Roth in an after-tax asset understand that Roth is not after-tax or post-tax a Roth is inside of this bucket and what’s important about the Roth is that it’s a qualified account. What that means is if you wanted to gift you can’t gift a Roth. You don’t have the ability to gift a Roth what you would have to do is you could gift cash value life insurance. 

If you wanted to keep it tax-free or you’d have to pull it out of the Roth to make a gift from this post-tax bucket. So understand that right off the bat we cannot gift Roths okay ross can pass to the next generation upon death but you cannot gift a Roth we could gift cash value life insurance. So that might be the tool that we want to look at using because it’s something that is tax-free. So we’ve kind of checked this and it can provide a benefit for the kids and again we’ve been talking a lot about cash value life insurance. It’s really become an important tool because it gets us around a lot of these income tax and estate tax issues as we see income taxes going up and estate taxes or the state tax exemption coming down. There that’s where cash value life insurance really can play a role. And so let me talk about estate taxes okay so right now estate taxes and I’ll just keep it at a single individual and this person’s obviously done their research because it’s 11 million dollar exemption adjusted for inflation and that’s going to put us right now at about 11.7 million dollars. Meaning if you die with less than 11.7 million dollars in kind of these types of accounts here then you owe zero estate tax. If you die as an individual with more than that then this is going to get taxed at 40 percent, okay and we know according to current tax laws when the tax cuts and jobs act expires. So the tax cuts and jobs act which runs from 2018 to 2025 then this is dropping down to a 5 million dollar exemption. And again if you die with more than five million dollars of life insurance or Roth money or real estate or checking your savings or IRA it’s going to be taxed it again potentially forty percent. So one of the strategies and we’ve talked about this before is understanding that the estate tax exemption is going to drop one thing we can do is we can gift maybe we gift a portion of this now because if we gift it now we’re still going to have that 5 million estate tax exemption when it does drop. So we’ve got this portion of the money out of the estate and there are different ways that we could do it. We could a lot of times we would gift it to trust to maintain control but this is where we could gift this money out it can’t come from the Roth though again it cannot come from the Roth. If you wanted it Roth you’d have to gift it or if you wanted to use the money that’s sitting in a Roth you would have to put it into the taxable bucket and then there you could set up an annuity if you wanted to or you could move it to cash value life insurance depending on the situation. So we could gift the money it just can’t come directly it can’t be Roth to Roth. We have to take it out of the Roth and we could gift post-tax money or we could gift cash value life insurance really depending on again what the goal is and figuring out the best strategy. So let me see if there’s anything else I wanted to mention on this after-tax from parents’ estate. Well so the only way that we could maintain the tax-free character again so if we want this tax-free really our only option would be to pull the money from the Roth again that would not be taxable put it into a post-tax account okay. And then from there and there are different ways we would structure it purchase index universal life insurance that could provide income based on the cash value to the beneficiaries. And we could even remove it from the estate entirely if we wanted to put in an island but that would be more upon death. 

So yeah so that would be the only way that we could kind of check all the boxes of tax-free gifting the money out of the estate and kind of creating an income stream if we didn’t want all of those what we could do is we could gift the money out again take the money from if it is raw take the money from the raw put it into just a checking savings account and then from there we utilize that as a gift gifted into maybe. So another option would be gifting it to a single premium immediate annuity that could provide lifetime income to the children if that if the annuity portion is one of the goals. So again really to fully answer this question I need to as a fiduciary attorney need to see the whole picture and we’d start with really what is the underlining goals and then let’s develop the best strategies to help achieve the goals and then and only then would we pick the tools. So as this question was originally laid out it’s just not going to work you can’t take Roth money and gift Roth money it’s just it just won’t work so we need to figure out kind of some other tools to use depending on what the goals are but that said this was a great question. I had to put on my thinking cap so that’s always fun and that’s why I love doing these weekly wisdom webinars our questions we get aren’t always this complicated. This was quite complicated but I’d recommend for the person that kind of submitted this let’s talk longer about it and probably it’s not going to be just a 15-minute conversation. 

I really need to wrap my head around and arms around the whole situation so schedule some time more than happy to dive deeper into that question so hopefully, that was helpful. All right so another question was just submitted so this question what are your thoughts on the best way to allow someone okay to access your house keys safely and remote private things. So I’m assuming this is upon death. So upon death how can someone and I’m assuming we’re talking about by someone we mean like your trustee or a personal representative trustee under a trust a personal representative under a will how can they access a house and stuff right. So different ways this can be done but really the person that has access to this. Typically is going to be whoever you named as a trustee or personal representative. It’s their job to wrap up your final affairs take care of everything not to sound morbid but I guess it’s going to depend on kind of how we know that someone passes away. Like if you pass away alone in your home then someone’s going to realize kind of you’re missing the contact the authorities and authorities would gain access. And then from there, they would notify either next to kin or whoever the personal representative or trustee is and then they would gain access to it. I guess a way that a lot of people do it now is while living a let the person know who the trustee is. Let them know that they are the personal representative and then maybe just kind of make a copy of the key for the house you could add them to the safety deposit box because obviously if you’ve appointed them it’s someone you trust. So that’s probably what I would recommend and then also the important thing is to make sure that person knows where the estate plan is or make sure they have a copy of it. And when I’m what I’m talking about is the trust the will financial power of attorney and medical power of attorney and probably right away while you’re still alive they should have copies of these at least at the very least there’s nothing confidential or anything in those documents and so god forbid you to have a stroke you get in a car accident. You want to make sure they have access to those right away versus having to try to track them down in your house or something like that. So hopefully that was helpful all right so that was the two questions I had submitted or that had been submitted. 

So if you do have any questions in the legal financial tax world please submit them now and we’ll give everyone a minute to do that but yeah and then just continuing the thought on this and where we see things are going again estate taxes are really a big issue these days. So we know that the state tax exemption is dropping from 11 to five and then we have president Biden’s proposal. That’s talking about dropping this even further to 3.5 million with again anything taxed anything greater than that is going to get taxed at about 40 percent and then the other thing that we see with president Biden’s proposal is that anything that’s in this bucket. If you have more than a million dollars here and we’ll count real estate in here too you’re going to lose potentially step up in basis. Where now the kids that inherit this are going to have to pay the tax on all the capital gains they inherit. So again one of the biggest risks and biggest opportunities we’re seeing is just the idea if we want to make money out of here. So this is the first bucket that we’re pulling money from this is the second bucket and then this is the third and then if we know we’re not going to spend all our money then we want to put money into this estate tax-free book. Here’s another question that just came in if you recently found out you have life insurance how do I raise the value through the company. Well if you have life insurance and you want more life insurance. So the question is so let’s say you have existing life insurance already but you want to raise the value I guess it depends on the type of policy but typically once you went through underwriting. You got that initial life insurance policy you can’t add more normally what you would have to do is you’d have to go through underwriting again. 

So you’d have to either if you really like that policy go through underwriting maybe they’ll let you add more depending on how the policy is set up or what you do is just go through get a new policy and go through underwriting again. And especially if you’re looking at life insurance more as an asset class then hey it’s something I need then as you get older or if your health deteriorates a little bit. The fact that you’re not as healthy as you were when you’re 20 isn’t that big of a deal a lot of people say no life insurance is too expensive. Well, it depends on what your goals are but I would say if you’re looking at life insurance, not as a replacement of income or to cover a mortgage or cover young kids but more as an asset class then I wouldn’t really worry about kind of your health assuming that you’re insurable. Here’s another question that just came in so hopefully, that helps. Is Biden’s proposal to increase the state tax by 3.5 per person or is it seven million per couple? So all of these numbers here are per person so with a married couple you can double that so if Biden’s proposal goes through it’s 7 million for a couple. When the tax cuts and jobs act expires it’s 11 million in change for a married couple and right now the as the person said with inflation this is about 23 million dollars. So again I don’t have any clients that are at the 23 million spots but I do have clients here and obviously here so that’s why we’re spending a lot more time talking about estate taxes because we know it’s kind of interesting. I had what I’ve found with this estate tax question it’s kind of interesting I’ve had this conversation a lot of times last couple of days. 

So what we’ve found is that people’s assets with them the smart assets with this market run we’ve had the last 12 years assets have been going up pretty strong and then on the flip side of it now we see estate taxes. The state tax exemption is going down and so I have plenty of clients who worked hard they’ve accumulated a lot of wealth and their assets are going like this while at the same time the estate tax exemption is going kind of head down. And so either we can look at the like kind of some of these planning ideas that we’ve talked about or a lot of times the thing that I said what’s the first thing that you should be doing if you’re in a situation like this to spend your darn money. You know I just got done with a client meeting today with a wonderful woman and she has more money than she says. She’s flying down to Florida and like kind of regular seats, I’m like go first class you know like you have more money than you’re going to end up than you need. So rather than engaging in kind of fancy estate tax planning techniques sometimes the best thing is just starting to spend some money that’s why you work so hard for it. That’s what I always say is the best state plan is going the last check bounces but that said if even if you don’t spend the money then second I’d rather leave more money to your kid’s charity versus leaving it to the IRS. And so that’s where all right first kind of spend more money but then if you look at it spending more money we’re still going to have money left over then and only then let’s start thinking about what other ways that we can kind of maximize legacy. 

So that we can put more money in your kid’s or your favorite charity’s name or unless to the IRS unless you want to leave money to the government IRS. That’s perfectly fine I’m not saying you have to do any of that but I just see with the market kind of going out the last 12 years and then with the state tax exemption going down either now or in the future. A lot of people could be having these estate tax issues and so there are some things that we should be looking at now like gifting before the estate tax exemption drops but yeah. And then also I’ve had clients just recently conversations with okay the market’s been going up and up and up what’s going to happen it’s probably going to drop. So maybe we should move some money kind of off the table into investments that are geared towards growth and safety to lock in some of the gains that we’ve had. So if that’s the conversation you want to have just reached out to us but in those areas, we’re having a lot of review meetings with our clients those are some of the things that we’re seeing. So with that any other questions that you have all right let me see okay all right. So looks like there’s nothing else coming in. So with that, I want to thank everyone for joining me really appreciate the questions like the ones that make me think a little bit. Really this is not for me it’s for you so I want to make sure you get value out of it so join us next week invite friends. You are very welcome really appreciate it makes it a great week take care bye. 

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