Mr. and Mrs. McGoyle
1234 No Where Lane
Some Place, New Jersey 90909
Re: Estate Planning
Dear Mr. and Mrs. McGoyle :
I am writing to follow up on our recent meeting regarding your estate planning. I would like to follow up with you on one estate-planning tool that I think might be useful given your situation. That is the irrevocable “grantor” trust, which is a trust that contains certain provisions set forth in the Internal Revenue Code, which defines these types of trusts. With a carefully drafted irrevocable grantor trust, the income is imputed to you as the creator of the trust, but the trust assets are not included in your estate for estate tax purposes. In other words, as trust maker, you must pay the income tax on all trust income, but trust assets will not be subject to estate tax at your death. The effect of paying the income tax is to further leverage the transfer to your beneficiaries at no additional gift tax cost. These trusts are also referred to as income defective grantor trusts. However, the "defect" is entirely intentional. Grantor trusts are useful planning tools in several circumstances, particularly where you desire to sell appreciated assets to the trust without immediately incurring income tax.
I would like to explain why it might be beneficial for you to include you residential house in Clifton, New Jersey in a irrevocable grantor trust. This home is currently worth about $700,000 however, you bought the house in 1967 for $38,000. Under the Internal Revenue Code, when you sell an asset you must pay income tax on the amount above your “basis” in the property. In its most simplified sense, basis is the amount you paid for an asset when you purchased it, or if you received it by gift, it is the donor’s basis in the property. A typical sale of appreciated property causes imposition of income tax. However, a grantor trust is treated as you for income tax purposes. Since you cannot “sell” property to yourself, a sale to a grantor trust is ignored for income tax purposes. Therefore, the increase in the properties value will not be taxed upon you when placing it in this type of trust.
This is also true with your summer home in Myrtle Beach, South Carolina, that is now worth about $350,000 but you purchased in 2003 for $280,000. Furthermore, if you choose not to place this property into a trust that you create then probate laws of South Carolina will be applied to this home upon your death. Therefore, it is highly recommended that your home in South Carolina also be placed in this trust.
The area of the law, in regard to retirement assets like IRA, 401k, Roth IRA, that can be especially complicated. The reason for this complication is because we not only have to deal with the IRS and their complex and confusing regulations, but also with Treasury Department regulations. Some folks have retirement assets such as an Individual Retirement Account (IRA) or Roth IRA and other folks have their retirement assets in a company sponsored plan known as 401k (corporate employees), 403b (government workers) or Tax Sheltered Annuities (TSA). Note, a TSA has similar requirements as corporate and government plans but are held in the name of the participant employee like an IRA instead of the name of the plan. These corporate 401k, government 403b or TSA savings vehicles are termed "qualified" plans by the IRS. In either case, the goal is to put away as much pre-tax money as possible in order to take advantage of tax deferred accumulation of wealth. In some cases, 401k or 403b employer plans may even contribute a matching amount up to a certain percentage of the employee's income. Most inherited assets such as bank accounts, stocks, and real estate pass to your beneficiaries without income tax being due. However, that's not usually the case with 401(k) plans.
In regards to the 401(k) tax-deferred pension account owned by Argus, valued at $1,200,000 and the 403(b) tax-deferred pension account owned by Randi,