CategoryRetirement Planning Archives — Page 2 of 2 — C. Lynn Northrup, CPA, CPIM

Saving Money in Tough Times

Here are ten ideas that we’ve come up with realizing they are not all encompassing. You are welcome to comment and add to the list. We have more that we will share with you in a later post. This is an ongoing process!

1. Conserve energy by turning off the lights and keeping the heat down.

2. Scale down to one automobile. We did and several other couples in our neighborhood did and without any serious drawbacks. If you need an additional vehicle for a short time – go rent one.

3. Eat in and not out. If you do eat out, look for early bird specials and other deals.

4. Prepare a detailed budget and carefully review all line items for possible savings.

5. Maintain your car by changing the oil and rotating the tires.

6. Cut down on magazine subscriptions and use the internet more frequently, besides you’ll get more data faster and more currently.

7. Reduce your travel by taking day trips and enjoying what’s near you.

8. If you do take trips and stay in hotels, plan carefully and try to utilize your points for free nights.

9. When traveling by automobile take a cooler and pack food. Then ask your hotel for a room with a microwave and refrigerator to cut down on eating at restaurants.

10. Just plain do without and scale back.

My wife Jessica commented after editing this post – “pretty stark” – but you do what you have to do when times are tough. Maybe we should send this list to the Wall Street bankers taking big bonuses.

Rethinking Retirement

Everywhere you go the black cloud of the economy hangs over you like a constant drizzle telling you to crawl into a fox hole and don’t spend any money. Being of retirement age, this strikes home because we have worked hard all our lives. Now we’re working even harder and earning less.If we can’t retire, what are we going to do? My situation is a little different because I have consistently flunked retirement. I still relate to the issue since as a CPA advisor, I share everyone’s pain. People want answers and I’m frequently asked to provide them. These are tough answers because each situation is different.

One of the tough choices is with people who retired thinking their savings would carry them through their golden years. The first thing all retirees need to do is recalculate their budget and compare their current expenditure level to their retirement income. Most people took a hit on their investment portfolios and need assistance on how to invest the remainder. Most retirees should cut back on the fat and downsize where possible. There are a number of things that can be done to cut back on expenses. I’ll touch on some of these ideas in a future post. The key here is to match your retirement expenses to your retirement revenue as closely as possible.

Where can retirees get good unbiased advice? More CPAs will be shifting their focus to providing some level of financial advice. This is a good place to turn for people who have smaller portfolios. You should be looking for good practical advice on how to plan and budget for the future. It could be money well spent.

If you have a shortage of future revenue, you might want to explore getting a part-time job to narrow the difference. I realize this is neither why you retired nor what you had in mind when you retired. My advice is to deal with the world the way it is and not the way you wished it was. We all have to do what we have to do. One idea for part-time work is to link work with a hobby so it is more fun.

The person contemplating retirement also has tough choices. One of the main questions to ask is how long do I continue to work? I always try to have people develop a retirement strategy to gain a sense of what they want to do and where do they want to live during retirement. Based on personal experience, living in a retirement community can make it difficult for retirees to find acceptable work since there are a lot of people competing for a limited number of jobs. This is where developing a careful and thorough strategic plan for retirement really can make a difference.

When my wife and I considered moving to Montrose, Colorado as our last move, I developed a strategic plan similar to what I would do for a business client. We evaluated the pros and cons in addition to developing a SWOT (Strengths, Weaknesses, Opportunities, and Threats) analysis of how we were going to spend our retirement years. This removed the guess work from our decision process. We rented for a year until our house in North Carolina sold. I have seen a number of people saddled with two homes because they failed to think through all of the available options. Another mistake is buying a house prior to living in a community for a period of time. After they realized it wasn’t for them they were stuck with a house they couldn’t sell.

Retirement involves lots of choices and many difficult decisions. I will regularly include blog posts dealing with many of these issues. I welcome comments and questions. Since I have experienced many of these same challenges, I think I can help.

Recession – So What Do We Do Now?

Now that we have a new President many people will think that his recovery program will have us back on track in a few months. I’m not so optimistic. My advice is to prepare for a longer term period of slow economic activity, maybe as long as two to three years. This isn’t what you want to hear, but it could well be reality. Assuming such a dismal projection, it is important for us to develop a survival strategy – perhaps strategies.Your strategy needs to include a thorough understanding your competition and markets. You will need to be aggressive and radically different to gain the necessary market penetration. Don’t think your sales volume will be like prior years. It’s probably going to be lower and with reduced profit margins. The world is different now. Keep reworking your strategy almost on a daily basis to make sure you’re on track. Agility is the key to survival.

Developing a budget is essential. The budget needs to include revenue projections together with generation of cash flow. This means managing how you invoice, manage accounts receivable, manage inventories, and manage accounts payable. Maintaining an effective and effective cash conversion cycle is the most critical measurement indicator that you can monitor. When projecting your expenses you need to reduce them to various levels to match the level of revenue projected. Your expenditure budget needs to include survival level outlays representing the minimum level of expenses possible. When you understand how low you can go then you can adjust to revenue levels appropriately.

A component of the budgeting exercise should draw you into analysis of your business processes to understand where there are opportunities to improve these processes. In the new business environment improvement of business process flow will be the key to attaining a competitive advantage. One of the best opportunities to improve business processes will be in reducing paper work and improving accounting efficiencies. We have forgotten the back office which represents huge opportunities.

Many CPAs are too focused on taxes and financial statements and fail to provide the business advice that clients need. This will change as businesses will seek out the advice they need to survive the recession. If businesses fail to receive what they need from their CPA then they should seek a professional who has the expertise to guide them through the tough times ahead and will be responsive to their needs and requirements.

My advice is to be flexible, disciplined, patient, and focused. This is a time to think different because life will be different. The old rules aren’t going to work so you need to find new guidelines and ways to do business. Lower your expectations and hope for the best while preparing for the worst. While things look pretty dismal, this is a good time to look for opportunities to improve your competitive position and profitability.

Application of Charitable Lead Annuity Trusts

Clients that wish to make contributions to charities can take advantage of low interest rates and depressed asset values to create and fund a charitable lead trust. This technique works much the same as a GRAT, but provides a stream of payments to a charity rather than back to the grantor during the initial term of the trust. A charitable lead annuity trust (CLAT) is an irrevocable trust that gives a designated charity (this can be a family foundation or a public charity) the “lead” interest consisting of a stream of payments for a term of years or for an individual’s life and thereafter passes the remainder interest to (can continue as a trust for the benefit of) remainder beneficiaries – usually the donor’s children.There are special rules on the use of CLAT’s for GST tax purposes which make this tool less attractive for estate planning on passing wealth to grandchildren. Because of this drawback it is best that donors designate their children (or trusts for their benefit) as the remainder beneficiaries of any CLAT.

The charitable beneficiary receives an annuity from the trust for the term of the CLAT, after which the remainder flows to the grantor’s children. Similar to a GRAT, the value of the gift to the remainder beneficiaries is established by referencing the 7520 rate. Any return in excess of this assumed interest factor results in a tax-free gift to the remainder beneficiaries.

Another variation and an alternative to a CLAT is establishing a GRAT and then making annual gifts to charity of the amounts received back from the GRAT in the form of an annuity payment. This allows the grantor to retain complete control over amounts given to charity as well as selecting the charitable recipients in each year. It also provides the grantor with an annual income tax deduction for the amount of the contributions.

The techniques we have been discussing is appropriate for people with estates large enough to incur an estate tax imposed at death. The current exemption from federal estate tax is $3.5 million. While this was scheduled to phase out in 2010, it is likely that the Obama administration will continue the exemption at this level. I don’t know how long interest rates will remain at these levels but it represents a great chance to pass on wealth to children at a significantly reduced cost of federal estate tax.

These are unique tools for high wealth individuals to preserve the value of their estates. I hope you enjoyed these series and can benefit from them.

Freeze the Value of Your Estate

Low interest rates and assets values represent a perfect opportunity to freeze estate values and minimize inheritance taxes. The freeze technique utilizes a grantor trust which takes advantage of even lower interest rates than afforded by the 7520 and avoids revaluation of trust assets on an annual basis. This technique is more attractive than the GRAT application for use with assets that are difficult to value.A grantor creates and funds an irrevocable trust for the benefit of descendants. The initial funding of the trust is usually done with cash in an amount equal to 10 percent of the value of the property that will be included in the sale. This trust is a “grantor trust” making the grantor the owner of the entire trust for income tax purposes, even though the trust is a completed gift for gift and estate tax purposes.

Once the trust is funded, the trustees purchase the assets from the grantor in exchange for a promissory note. Since the trust is not a consideration for income tax purposes, the sale does not result in recognition of a capital gain. The trustees continue to pay down the note using the cash flow generated by the purchased assets, or by borrowing funds from a third-party lender, or by making payments in kind. The note can be structured as an interest-only note with a balloon payment of principal at the end of the term of the note.

The property sold to the trust is removed from the grantor’s estate immediately; with no risk of inclusion should they die during the term of the promissory note. If the grantor dies before the note is paid, any portion of the unpaid balance will be included in the grantor’s estate.

The interest rate used for the promissory note is lower than the 7520, meaning that less value is returned to the grantor via the sale technique than would be the case when using a GRAT. The promissory note is structured as a balloon note in contrast to GRAT annuity payments which must be paid with no more than a 20 percent annual increase. Accordingly, the sale technique has the advantage of allowing the subject property more time to appreciate outside of the grantor’s estate. One of the key advantages of this technique is that it is more appropriate for passing wealth to grandchildren than the GRAT technique.

One of the disadvantages of the sale technique is that it must be funded initially by a gift with sufficient assets to provide security for the promissory note. This strategy also requires some use of the lifetime gift tax exemption and cannot produce a $0 gift like the GRAT strategy. The value of the assets subject to the sale can change upon audit. The GRAT technique is based upon a specific tax statute whereas the sale to a grantor trust is a creative use of several different tax laws. However, if the technique is successful, there is an opportunity to pass on wealth to grandchildren with very minimal use of the life time gift tax exemption and GST tax.

We have one more neat estate freeze technique which we will share with you in the next blog post.

Estate Planning Strategies

Because values and security prices have dropped to all time lows combined with record low interest rates means it’s a good time to lock in the value of your estate for estate tax purposes. It could preserve future cash flow by reducing inheritance taxes on the transfer of estate assets to your beneficiaries.There are a number of strategies you can use to take advantage of depressed market values to remove future appreciation on assets in your taxable estate and pass that appreciation to beneficiaries with no gift tax. One of the best tools to accomplish this is utilization of Grantor Retained Annuity Trusts (GRAT). This strategy is accomplished by the donor placing property that is likely to appreciate over its current value into a trust combined with the grantor’s right to receive a fixed annuity with remaining trust assets passing to the grantor’s children or other beneficiaries. This can be an outright transfer or includable into a continuing trust.

The neat component of this strategy is that the grantor’s retained annuity is designed so that its present value determined by IRS rules is equal to the current value of the contributed assets. The effect of this action is that the present value of the remainder gift to beneficiaries is zero ($0).

The IRS assumes that assets contributed to a GRAT will appreciate at a fixed interest rate which is called the “7520 rate.” For GRATS funded in January 2009 the 7520 rate will be 2.4%. Accordingly, to the extent that appreciation of GRAT asset exceeds 2.4%, it will pass to the remainder beneficiaries with no transfer tax consequences. Therefore, the GRAT program effectively freezes the value of assets for estate tax purposes at current low prices and values.

There could be some drawbacks in that some portion of the annuity payments will have to be made in kind, thus requiring revaluation of the trust assets on an annual basis. Another drawback is that this strategy isn’t well suited for passing wealth to grandchildren and other more remote descendents.

There are other strategies we can utilize which will be discussed in future blog posts. The GRAT strategy is a no lose situation. All you need if for one GRAT trust to work and you’re ahead because if other GRAT trusts don’t work you still haven’t lost anything.

We’ll share other estate and gifting strategies in subsequent blog posts.