The Simsbury Bank -- Personal Banking, Business Banking and Investing, in Avon, Bloomfield, Canton, Granby, and Simsbury, CT

March 2008

In This Issue:

Do You Really Need a Trust?
Following Through on Your Estate Plan
Control Your Spending
Do You Really Need 70%?
Being Named a Guardian

Do You Really Need a Trust?

Trusts are often viewed as estate planning tools used to reduce estate taxes. With the changing estate tax situation, does that mean that trusts are no longer needed for estate planning purposes? The answer is probably not, for a couple of reasons. First, estate taxes are only scheduled to be repealed in 2010. They will be reinstated in 2011 based on 2001 tax laws. Second, trusts are established for many purposes, not just to reduce estate taxes. Some of the more commonly used trusts include:

Revocable living trust — This trust is established for reasons other than the reduction of estate taxes. With a revocable living trust, ownership of assets is transferred to the trust while you are alive. You can keep any or all of the income, act as trustee, change the trust’s provisions, or terminate the trust. A successor trustee can be named to take over if you become mentally or physically disabled. Assets in the trust are controlled by the trust agreement and are not subject to probate proceedings, which is considered one of its major advantages.

Bypass or credit shelter trust — Generally, this trust is used to ensure both spouses take advantage of the estate tax exclusion amount, without directly transferring assets to other beneficiaries until both spouses have died. Assets equal to the estate tax exclusion amount are placed in trust after your death. Your spouse may then use the income, and in certain circumstances, some of the trust’s principal, with the remaining assets transferred to your other beneficiaries after your spouse’s death. Make sure to review the amounts that will be placed in the trust. With the exclusion amount currently at $2,000,000 and scheduled to increase to $3,500,000 in 2009, these amounts may exceed the amount you want in the credit shelter trust.

Qualified terminable interest property (QTIP) trust — This trust is typically used when the spouse wants to control the use of any remaining assets that are not placed in the bypass or credit shelter trust. Assets that are not placed in the credit shelter trust are placed in the QTIP trust. Income from the trust is distributed to the surviving spouse during his/her lifetime. This qualifies for the unlimited marital deduction, so estate taxes will not be paid after the first spouse’s death. After the surviving spouse’s death, the principal is distributed to beneficiaries designated by the first spouse. This trust is often used to protect children from a previous marriage or to ensure that if a surviving spouse remarries, his/her new spouse does not inherit any of the assets.

Irrevocable life insurance trust (ILIT) — This trust is used to ensure that the proceeds from a life insurance policy are not subject to estate taxes. Often, the insurance policy is obtained to help pay estate taxes, with the policy held by the irrevocable trust. Annually, you can make gifts to the trust so the trustee can pay the policy premium. After your death, the trust receives the insurance proceeds, distributing them in accordance with the trust’s terms. With the uncertain future of estate taxes, you may wonder whether ILITs are still a valid estate planning strategy. You probably don’t want to undo any ILITs in place, since the estate tax won’t be fully repealed until 2010 and then will be reinstated in 2011. Even if the proceeds aren’t needed for estate tax purposes, you may find other uses for the proceeds, such as leaving larger bequests to beneficiaries or charitable organizations. Deciding whether to set up a new ILIT is a tougher decision. You should first analyze all relevant factors, including your views about the future of the estate tax.

Charitable remainder trust — Typically, this trust is used to provide a large charitable contribution while avoiding a large capital gains tax bill. You transfer an asset to the trust, typically one with a low basis that has appreciated significantly. Since the trust is a tax-exempt organization, it can then sell the asset without paying any capital gains taxes and reinvest the proceeds. You receive an immediate charitable contribution deduction equal to the present value of the property the charity will receive when the trust is terminated. You also receive the income from the trust, with the principal going to the charity after the trust terminates.

Qualified personal residence trust — With this trust, you place your home or vacation home in an irrevocable trust, retaining the right to live in the home for a specified number of years. When the trust terminates, ownership passes to your beneficiaries. The gift tax value is determined on the date the house is placed in trust by calculating the present value discounted over the trust’s term. If you die before the trust ends, the home is included in your estate at its fair market value. Since present value calculations are used to determine the gift’s value, this trust allows you to leverage the use of your $1,000,000 lifetime gift tax exclusion.

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Following Through on Your Estate Plan

Usually, a great deal of thought and effort goes into estate planning documents. You need to consider all your assets, decide who should receive those assets, and find the best strategies to accomplish your goals. However, your work isn’t over once you’ve signed those documents. You need to make sure your assets are properly positioned to go to your intended heirs. Some problems to watch for include:

Your assets aren’t titled properly to fund trusts. A common estate planning strategy used to preserve your estate tax exclusion is to set up a credit shelter or bypass trust. Assets up to the estate tax exclusion amount ($2,000,000 in 2008, scheduled to increase to $3,500,000 in 2009) are placed in trust. Your spouse can then use the income and even some of the principal, with the remaining assets distributed to your heirs after your spouse’s death. To fund the trust, however, you need sufficient assets titled only in your name. Assets jointly owned with your spouse will typically pass directly to your spouse and cannot be placed in the trust. However, you may want to split assets so each of you individually owns assets designated to go into the trust. Residents of community property states should review their state laws carefully, since they typically have more flexibility when using assets to fund trusts.
Beneficiary designations contradict your estate planning documents. Assets like life insurance, annuities, 401(k) plans, and individual retirement accounts pass directly to named beneficiaries. Provisions in your will and other estate planning documents cannot change those designations. Thus, review all your beneficiaries, ensuring those designations are compatible with your estate plan. Also review contingent beneficiaries, in case a beneficiary dies before you. After significant changes in your life, such as a divorce, remarriage, spouse’s death, or child’s or grandchild’s birth, review your designations to see if changes are warranted.
Owning assets jointly with just one child. Often, a widow or widower will add one child to bank accounts, brokerage accounts, deeds, and titles, so that child can help manage the assets if he/she becomes incapacitated. The widow or widower expects the child to share the assets with his/her siblings. However, the asset is considered a gift to the one child. For that child to split the asset with his/her siblings, he/she will have to make gifts to those siblings, possibly raising gift tax implications. Instead, consider using a power of attorney, so the one child can help with your financial affairs. Or, make a provision in your estate planning documents that adjusts distributions for any assets that pass to one heir through joint ownership.

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Control Your Spending

If you’re trying to increase savings, remember that savings are directly tied to spending — the less you spend, the more you have to save. Some tips to help you get your spending under control include:

Analyze your spending for a month. Are you surprised by how much you spend on dining out, groceries, entertainment, or clothing? Give serious thought to your purchasing patterns, looking for ways to reduce spending. Clean out your closet and really assess whether you need new clothes. Cut back on how often you eat out or at least dine at less expensive restaurants. Rent a movie instead of going to the theater. Make a list before grocery shopping and don’t deviate from it. Look for coupons and sales before shopping. You may scoff at these ideas for saving money, thinking they can’t possibly add much to your savings. After all, you’re just spending a few dollars here and there. But let’s take a look at just one example. Suppose you go to the deli every workday, spending $7 or $8 on lunch. If you brought a sandwich from home, it might cost $2 a day. That difference of $5 per day equals $25 per week or $1,300 per year. Save $1,300 per year for 25 years earning 8% compounded annually, and you could end up with $95,000. (This example is provided for illustrative purposes and is not intended to project the performance of a specific investment.)
Go over major expenditures also. When was the last time you comparison shopped your auto or homeowners insurance? Have you checked mortgage rates lately to see if you should refinance? Have you reviewed strategies to reduce your income taxes?
Make a spending plan and put it in writing. Budget for all major expenditures, and resolve not to purchase items that aren’t in your budget.
Throw out your credit cards (or at least hide them for a while). Most people find it more difficult to spend cash than to charge a purchase. So, for the next couple of months, only purchase items with cash.
Don’t purchase items over a fairly low dollar amount until your second shopping trip. How often have you purchased something on impulse, only to realize when you got home that you really didn’t need it? To control those impulses, compare price and value on your first shopping trip. Then go home, think about whether you really need the item, and purchase it on another trip.
Think carefully before making major purchases. Often, upkeep and maintenance will add to your costs. Do you really need a motorcycle, boat, recreational vehicle, or vacation home? Consider a less expensive car or a used car. Keep your car for four or five years instead of getting a new one every two or three years.
Figure out the maximum amount you can afford for a house and then buy one substantially less expensive than that. Not only will you save on your mortgage payment, other costs associated with owning a home will be lower. Living well within your means is one of the best ways to ensure you have money left over for saving.

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Do You Really Need 70%?

A general retirement planning rule of thumb indicates that you’ll need 70% to 80% of your preretirement income. Many estimates now indicate that may be too little for those who want to live an active retirement lifestyle. But when you realize how much you need to save to ensure your retirement income last for what could be decades, it’s tempting to question whether you really need even 70% of your preretirement income.

First, you should prepare a detailed analysis of your expected expenses after retirement. Sure, some expenses will decrease, typically commuting, work-related expenses, savings amounts, and possibly taxes. But other expenses are likely to go up, including travel, entertainment, and health care. How much you will need depends in large part on how you plan to spend your retirement years. Thus, it’s important to really take a hard look at how you plan to spend your retirement years, so you can make reasonable estimates of how much it will cost.

Keep in mind, however, that things seldom go as planned. A recent survey of retirees found that 18% expected their retirement expenses to be higher than their preretirement expenses, but 39% actually had higher expenses (Source: The Wall Street Journal, May 12, 2007).

How can you help ensure that your expenses will be lower? Consider these tips:

Pay off your mortgage. Mortgage payments often consume 30% or more of an individual’s gross income. Eliminating this expense can drastically reduce income needed for retirement. If you can’t pay off your mortgage, consider selling your home and purchasing a smaller one for cash. Not only will you eliminate the mortgage payment, but a smaller home often results in lower ongoing expenses, including lower utility bills, property taxes, and maintenance costs.
Get rid of other debts. It’s not unusual for consumer debt payments to equal 10% to 20% of an individual’s after-tax take home pay. Try to enter retirement debt free.
Keep your automobile. Instead of purchasing a new car every couple of years, keep your current car for as long as it’s in good working order. That will eliminate car payments from your retirement budget.
Look for ways to reduce travel and leisure expenses. Look for and use senior discounts. Plan activities for nonpeak times, when rates may be lower.
Consider relocating. The cost of living varies significantly from city to city and state to state. You may be able to reduce your living expenses substantially by moving to another locale. However, this is more than a financial decision. You also need to decide whether you want to move away from family, friends, and familiar surroundings.
Work at least part-time. If you still don’t have sufficient funds to support yourself during retirement, consider working at least part-time. Even a small amount of annual earnings can help significantly in funding your retirement.

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Being Named a Guardian

When asked to serve as the guardian of someone’s minor children in the event of his/her death, it is usually meant as a compliment. However, don’t accept this role without giving it serious thought. Consider the following:

Are your lifestyles compatible? Go over all details involved in raising the children. Will the children have to relocate far from their current home? It is difficult to lose parents, but it becomes even more traumatic when the children must relocate away from friends and school. What are the parents’ preferences regarding education, religion, lifestyle, and other factors? How well does your family get along with their children? Consider the impact on your children, including the fact that you will probably have less time available for them.
How much financial support will be available? This involves more than making sure money is available for college and other expenses directly attributable to the children, such as clothing, medical expenses, and entertainment. Additional children in your house will increase many of your bills, including food, utilities, transportation costs, etc. Your house may now be too small, requiring an addition or moving to a larger home.
Are you comfortable taking on responsibility for the children’s finances? Just because you agree to take physical custody of the children does not mean you have to handle their finances. You may feel more comfortable with another person involved to review how money is spent.
Has a contingent guardian been named? Find out if a contingent guardian has been named in case you cannot serve. However, don’t use this as an excuse to say yes when you really want to decline. It is better to indicate that you do not want to take on this responsibility now, so another guardian can be chosen. Also, if your situation changes in the future, inform the parents immediately.

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Copyright © 2008. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.