Buck: Welcome back to the show everyone today my guest on Wealth Formula Podcast, well actually have two of them, but the primary guest that I have is Jerry Borrowman who’s a Director of Advanced Solutions at Cambridge Financial Advisors. He’s a chartered life underwriter, chartered financial consultant, is a charter to advisor philanthropy and life underwriter training counsel fellow, so in other words he knows his way around financial and insurance products pretty darn well, in fact there’s probably not a whole lot that he doesn’t know when it comes to charitable giving and strategies of enhancing estate planning. You know, this is a complicated topic and it was one that Christian Allen and Rod Zabriskie of Wealth Formula Banking, our partners over there suggested that might be good for for our audience, however I have to say that there is some levels of complexity here that I think that I asked Rod to join us. Rod Zabriskie’s on too. Rod if you would give us the sort of a little bit of a you know introduction to why you thought this would be a good conversation for our audience and the perspective that they should approach it.
Rod: Sure and maybe I can start out by giving a little more of an intro for Jerry. So the kind of all the titles and all those kinds of things maybe speak for themselves but for Christian and me, we worked with Jerry for a long time Christian maybe 13/14 years and for me it’s been about 10 years. And Jerry’s been a teacher and a mentor really a go-to for for advanced planning concepts and one of the things that that makes him what he is, is that I think of him like as a serial researcher, meaning that when when he wants to dive in and understand something he’s amazing at doing that and then just really getting in all the intricacies and he’s seen it from a lot of different angles not just as an adviser helping individuals with their own estates but he’s been in-house at the insurance companies including New York Life for years and so he’s seen it from many different angles and just so many different situations where it can apply. So really where this this all came together Buck was not too long ago we were talking about just the whole concept of estate planning and how charitable planning might fit into that and immediately you know Jerry’s name came to mind because he has been our go-to when it comes to to this type of planning and and really helping people, whether it’s primarily driven from a tax standpoint or whether they really are you know charitable oriented and they really wanted to build foundations or other things like that that will really perpetually help you know humanity. And so that’s kind of how this all evolved.
Buck: Well there’s obviously some profit and things like that as well that are you know financially beneficial from these things. But anyway Jerry I kind of left you out of this. So first of all welcome thanks for being on the show.
Jerry: Glad to be here.
Buck: So let’s start with this question. So why do families you know with considerable wealth use charitable giving tools to reduce their estate tax?
Jerry: So the estate tax applies to a very small segment of society now, about one out of every 1,000 estates will actually have to write a check, more would have to write the check if they did not use charitable giving tools. So one of the things that has been helpful to be in understanding charitable giving is the concept of social capital. And essentially what happens is the federal government has said people who achieve and accumulate great wealth have an obligation to contribute to society. I was admitting once where Bill Gates father Bill Gates senior spoke he’s an estate planning attorney in Seattle and he said we estimate that about thirty to forty percent of the value of Microsoft is directly attributable to the fact that it was founded here in the United States where we have effective infrastructure, where we have a community that’s supportive of that so we feel like we should give back. Well Congress has said there’s two ways you can do that. Number one is you can pay an estate tax money goes to the federal government it helps build all those infrastructure and other things that are helpful. The second is is you can give money to charities of your choice and for every dollar goes to charity we will reduce the estate tax by an equal dollar. So really the estate tax is a voluntary tax, something that you pay only if you choose to because there are other ways to direct your money. I suppose one of the big questions is what about the kids I think we’ll talk about that more later.
Buck: Well you know it’s funny you’re nice about it. I’ve heard other people call the estate tax the stupid tax too because it’s one of those things that if you can ahead you know it’s not that difficult to avoid you know. And some people are thinking to themselves well gosh you know this estate tax is really for the ultra ultra high-net-worth. So we’ve got some limitations and those are dropping can you just remind us what the estate tax would affect.
Jerry: Yeah sure so right now there’s an eleven and a half million dollar exemption per person. So you pay no estate tax unless your estate is greater than that at the time of your death, means that a husband and a wife can be at about twenty three million. That will hold until 2026 when the law that was passed by the Republicans two years ago sunsets and will drop to one half that amount for about eleven and a half million dollars for a couple. I think it is important to say too Buck that charitable giving impacts both the estate tax which follows on a small number of people, but it also affects income tax planning which falls on almost all people. And so these are tools that can be helpful regardless your net worth.
Buck: Got it so when you think about this I guess the primitive financial perspective beyond the social capital and the things that you talked about that obviously you know people think about in terms of giving. But for the less charitable, don’t charitable gifts reduce the amount of money available to family beneficiaries?
Jerry: Yes of course they do because if you give money to a charity it’s less money to go to your kids except for this paradox. If by eliminating the estate tax or by substantially reducing your income tax you can, by giving money to a charity, you can use that to purchase life insurance that is also tax-free to the kids and in many cases you can get more money to your kids income tax free while giving money to charity instead of the government and for those people who think the 535 people in Congress are not as effective at directing Social Welfare as the charity of your choice, that’s a good solution to increase the inheritance to the kids while decreasing taxes paid to the government.
Buck: So this that you said something I think that kind of perked me up and probably perk some others out there up, the idea of basically you know using the life insurance is a way to create additional income. Rod maybe this is a question for you, is that one of the benefits of say banking? How would like Wealth Formula Banking or you know some the over funded insurance policies fit into that concept can you kind of fill in that gap a little bit.
Rod: Well as it relates to the fact that they are life insurance then then they can fit right. So when when Jerry refers to life life insurance planning inside of this larger charitable planning charitable giving concept, really can come in a lot of different forms and so depending on the situation in the individuals and what we’re ultimately trying to accomplish that will lead us toward what solution would make sense as far as the life insurance vehicle, how you how you fund it, and how it’s used over time whether it’s while they’re still living or what you ultimately referred to a minute ago when you said income tax free passing along and obviously if you do it right than the estate tax free passing along the wealth to the kids.
Buck: Which is any advantages here they actually have while you’re living?
Jerry: So that there’s advantages both while you’re alive and while your dead when question no chance person but to their family and today maybe there are. By the way we need to point out that the current estate tax law was passed primarily by a republican-controlled Senate in house. If the Democrats were over to take control of those again, you might see the estate tax limits drop. So as good estate tax planning should be done all along the way recognizing that there is change in Congress. Let’s talk about the income tax consequences of giving. So for example I graduated from the American College of Financial Services in Philadelphia a number of years ago, that’s where I got my master’s degree in financial services. I had dinner with the president of the college one night and I was talking about a presentation, I take him on the road that shows the effective ways his life insurance to maximize a charitable gift and I’m not a person who subject to the estate tax. And so as I’m talking this up he says well Jerry why don’t you do that for us and I said why. He says well if this is such a great idea why don’t you donate a policy on your life to the American College. So I looked at and here’s the way the math works out and it’s actually the opposite of the banking strategy because we wanted to create a policy that has virtually no cash, now you’ve got a high death benefit relative to premiums paid. For a one-time payment of $15,000 I was able to create and fully fund a $100,000 policy that is owned by the school that I went to. I was able to deduct the $15,000 so my after-tax cost was about 10,000. So for 10 cents on the dollar I was able to create a hundred thousand dollar endowment for a charity that means something to me, I believe in education and financial services. So that’s a way that I was able to use an income tax deduction to create a benefit for an institution.
Buck: You were also able to leverage that which is really interesting because I mean even though you aren’t able to take you know $100,000 deduction which would be ideal right, you were able to create $100,000 of giving, future giving, out of simply you know effectively the tax equivalent of $10,000.
Jerry: Exactly right. And there’s other tools. Let me go a little deep here without one tool that’s kind of suppose it’s one of your listeners owns of business and it’s highly appreciated so they paid let’s imagine that it’s a car dealership and their basis in the car dealership is half a million dollars and it’s now worth 10 million dollars. So they’re going to sell this, they would owe tax on nine and a half million dollars of capital gains, potential tax is 20% federal here in Utah where I live, five percent state plus there’s a three and a half percent Obama care surtax so of the approximately nine and a half million dollars, they’re going to lose twenty-three twenty eight, one-third of that to taxes roughly three million dollars. If instead of that but they were to contribute the business first to a charitable remainder trust that they create. So they’re the grantor of a trust they contribute their business they sell the business inside the trust, they own zero capital gains because the ultimate beneficiary of the sale proceeds will be either a single charity or multiple charities may even be a foundation that they create in the name of their own family. So they just saved three million dollars in taxes during their lives while the money sits in that trust as long as the husband and wife are alive, they can take income from that trust for the rest of their lives. So instead of earning income on, and I know I’m doing a lot of math here and I without the benefit of a whiteboard, but we started out at ten million we would have had seven million if they had sold it and paid the tax, but instead of that we have ten million to invest we’ve increased their income for the rest of their life by 30%. We’ve eliminated the estate tax, now what do we do about the kids. Well it turns out that in addition to the sale of the asset without capital gains, they get an income tax deduction depending on the range of approximately $300,000. The income tax savings is going to come in at a hundred thousand with a hundred thousand dollars in income tax savings we could help them craft a life insurance policy and outside their taxable estate to provide a tax-free benefit to their beneficiaries. So if you follow all of that I have a business I’m going to sell it. Normally is thirty percent to taxes, I lose nothing to taxes, number two I’ll pay no estate tax on it, number three I’ll have income on ten million a principle instead of seven million for the rest of our lives and number four I’ll take care of my children using the income tax savings on that gift. You know I said that on the income tax savings would be deductions of approximately three million, so that would give us the money that we need to buy a life insurance policy. The kids that get ten the charity would get 10, the family would live off of an extra three million of capital we have saved income taxes and estate taxes and everybody comes out ahead except the federal government.
Buck: Can you repeat the one part I didn’t get there and and is is how the how the kids still end up with with money. The life insurance policy is it on this owner or you know how does that work exactly? How are they how are the kids still ending up with an inheritance at that point if the business was given away?
Jerry: I would be very glad to restate that. So if mom and dad sell the business anyway the kids are going to inherit cash right? Whatever mom and dad don’t spend between the time they sell the business and when they die. And we know that it’s down by 30% because of the taxes. Instead of that they’ve contributed to the trust they’ve sold that they paid zero capital gains and they get a deduction of anywhere between thirty to sixty percent of the ten million dollars to apply against their income taxes for the next six years. So let’s take a three million dollar tax deduction every year for the next six years they can write off right off up to sixty percent of their income and it’s that tax savings from those tax savings and we use to pay the premiums on a fix pay life insurance policy. So they’re just using income tax savings to buy a life insurance policy it ensures mom and dad is called a survivorship policy and that would give us savings of about a hundred and fifty thousand a year times six we could easily buy on most people an eight to ten million dollar policy that’s fully paid up at the end of six years. It’s owned by a trust for the benefit of the kids, it will mature at the death of the parents, income tax real estate tax free and that’s how they get the money that they would have gotten had they waited for their parents after the sale of the business.
Buck: Does the there’s a business have to sell first in order for all this to be triggered?
Jerry: No actually you don’t want to sell the business before it happens. There’s a very strict sequence of events and needs to be followed which is why I will say this, you started out by saying this is sort of a complicated area of planning, it really is and so you need to follow a very specific procedure to do it. The first is you create the trust. You can have no signed paperwork that you’re going to sell the business. The second is that you transfer ownership of the business to the trust. Now by the way this is in one place in the tax code where the creator of the tries called a grantor can also be the trustee to manage the money once it’s in the trust. So if I’m the guy who owns the business today I operated as Jerry Borrowman sole owner of the company after the gift I operate it as Jerry Borrowman trustee of the charity of and charitable remainder trust i then arrange for the sale after the trust has been created well we don’t want to push it off too far in the future because you really don’t want to be operating a business the intent is to sell it without cap I negotiate the sale as trustee I’m acting on behalf of myself and the future charitable beneficiaries could be a university could be a church could be a health care system any 501C3 charity is eligible and I sell the business file a tax return I pay zero capital gains. So that’s the sequence of events.
Buck: Got it. You mentioned a couple times charitable remainder trust. Can you define what that is for everyone just for clarity?
Jerry: Sure so it turns out that the tax code does have a lot of definition around charitable giving because there’s a potential for abuse. So there are a limited set of tools that are available and most are called split interest gifts. So think about splitting something into two parts. In the case of a direct contribution to a charity, if I write a check to my church this year I write the check I get an immediate deduction, the charity has control of the money from that point forward, I have no retained interest in an immediate gift. In a split interest gift the IRS says we’re going to have two beneficiaries, one is a charity and one is the person who created the gap. So in the case of a charitable remainder trust I’ve given the business away I’ve sold it I retain a life income from that business either for myself or for my wife and myself, that’s the split. I own the income from the trust for as long as I live, the charity gets the remainder. There’s an exact opposite that called a charitable lead trust, and by the way the charitable lead trust is the nuclear option of estate planning this is how you can eliminate the estate tax, you could have a hundred billion dollar estate and with the charitable lead trust eliminate the estate tax completely. In that case I create a trust and I provide income to the charity that’s the split for a period of time typically 10 to 15 years. At the end of that time, the remainder goes to my children but free of estate tax. So this is a way suppose I wanted to pass the business on to the kids instead of cash, I would use a charitable lead trust to accomplish that while eliminating the estate tax.
Buck: Interesting yeah okay got it and then yeah that makes a lot of sense actually. So well you talked about a direct gift that’s the alternative right. Let’s talk about the risks in terms of you know I mean all this as we’ve talked about is fairly complex and I’m sure the government the IRS they probably don’t like the fact that even though there’s these laws and estate taxes that there are ways to fairly fairly easily circumvent them. So what are the risks and when it comes to this kind of stuff?
Jerry: So my belief is if you have very capable legal advice that’s familiar with these tools if you create a charitable lead trust a charitable remainder trust a donor-advised fund things that are very well defined in the code, the risk is very small. There’s not going to be a tax court case named after you. What we do see in the in the planning community that I personally am opposed to is that people will try to come up with step transactions where I’m giving the money away and yet through tax free loans from the charity I’m able to get the money back that I gift and so I’m really tax laundering the money. I saw one recently there were four steps I give money to a charity the charity creates an investment company and puts all of the money that I donate into that investment company, the investment company then loans me money tax-free so if I gave a million dollars I get a million dollars back as a loan, the investment grows over the years, when I die we use life insurance to pay it off but I really never parted with the property. And so the IRS would go after something like that pretty aggressively. So it’s if you think within the guidelines there’s very little risk if you want to wander out and try to do some different than there is substantial risk.
Buck: I want to focus a little bit on the idea you know you said that there you know that the family but beneficiaries can really come out ahead. Going back to the idea that if you’re giving something away how can you know your family be better off. Can you give us some actual you know elaborate on that and maybe give us some examples.
Jerry: Yeah sure. So the one that we’ve already talked about is a terrible remainder trust I’ve given my business away I’ve sold it the money is going to go to a charity when I die. I use tag savings to buy a life insurance policy. Typically you’ll use a second to die policy where you’re paying the least possible premium for the most death benefit because it’s an inheritance replacement policy. But that’s not the only way you can do it. In the case of a charitable lead trust where I’m trying to transfer an appreciated asset to my kids at a discount, the problem is, is that if I die during the term of the lead while money’s going to the charity the full asset comes back into my estate. So in my life insurance to pay the estate tax during that ten-year period of time were exposed to taxes. A third way that people can do it is you can use it to fund the trust once you created it. And then I gave you an example of an amplified gift to a charity someone that I care about using a one-time payment you could do that with ongoing payments. And so these are some of the ways you can can use that. The whole ideas I’ve been in the life insurance business coming up on 42 years and if if you show people how a life insurance policy works and ask if they’d like that they almost always say yes, when you ask people generally do you like life insurance they say no, and the reason of course is it’s paying for the life insurance policy so we like what it does but we don’t like paying for it. What the charitable strategies do is help us find tax dollars to help buy the life insurance that is going to either help us during our life with cash values or help our family after we die.
Buck: So in a nutshell what is this sort of all mean?
Jerry: So think about this. My uncle was a professor at University of Wisconsin Madison and then it became Dean of the School of Education at Berkeley. When he died a group of his former students put up money to create the Morell Borrowman Center at the University of Wisconsin because they admired him. So this gave him some kind of immortality. Using the tools that we’ve talked about including life insurance allows family to expand their reach in the community. So for example one way you can do that Buck is suppose that that we are giving a large gift on my death to a University of Utah, million dollars we’re going to put that on what’s called a donor advise on the University of Utah will receive the funds but they’ll allow me to give my children to give advice on how to correct the money that’s created every year on that and they can give some to the University but they can also give to the United Way of Salt Lake City they can give to cams that help children with blindness all sorts of things well in each of those cases the money’s coming from our family to those charities. My children are going to sit on their boards because I’ll be invited to that because of this substantial gift. And so the way of family builds influence in the community is by using these tools to amplify their personal connections as well as do something that’s very satisfying. So a lot of families will assign a grandchild or a child and say this year the income from our trust is going to distribute twenty-five thousand dollars. You get to be responsible for choosing a charity for five thousand of that. Now you’ve got a child who is is going out and searching out the charities and trying to figure out which ones matter, this becomes a great way to transfer values and ideals from one generation to the next. How much you’re getting out of this is this, charitable giving is good for charities, it’s good for families and it’s not particularly good for the government but they’ve said it’s okay, they like charities too, and most importantly it’s a way to create values to become important to a family.
Buck: Got it. Rod wif anything what would you like to add or you know point out specific maybe to your experience with the kind of kind of people we have as listeners?
Rod: Yeah so maybe one thing I’ll hit on first is a few examples of ways that we can fund these highly appreciated assets of all sorts can be used right Jerry. So you used an example of a business what if it was a piece of real estate or stock or other things like that?
Jerry: Yeah so so all kinds of things can be used to create these charitable gifts. The one caveat that I would say because it just feel like I need to you should never give a gift that is indebted because I create something called unrelated business taxable income and it could make everything in the charity taxable. So the nature of the gifts have to be carefully considered but you can give appreciated real estate, you can give and appreciated business, you can give an appreciated stock. Let’s talk for a minute for the people who don’t really want to create an ongoing legacy people want to give a gift today, one strategy that can save people a great deal of income taxes right off the bat is this. Suppose that I want to give $20,000 to a charity this year and I will get a deduction for that amount because it’s under 60%, if I have some stock in my brokerage account that is appreciated in value, I can sign over 20,000 dollars worth of the stock and get my same twenty thousand dollar deduction, but if I have a little basis in that stock say two thousand dollars, I escape paying capital gains tax on the appreciation. So these strategies work for everybody, it’s just understand what’s available and how to use them in a specific situation.
Buck: Got it. Anything else from your side Rod?
Rod: Maybe the last thing I’d say is just that the you know based on the people that we’ve talked to and work with us are we have a lot of people that I think are maybe not necessarily in that in that boat of you know especially at this point being above that 23 million dollar mark, but are on the fast track to building wealth and certainly by 2026 or like you said maybe sooner if democrats take control and maybe some of those exclusions change then they will be very quickly I think in camp said that it could matter and so I think maybe some of the sequencing that Jerry talked about today it isn’t a priority or at least a fit to start taking action immediately at least understanding some of the pieces and needing to get into place in the right sequence is critical because if you’re at the point where you want to sell your practice and you already have a buyer then it’s it’s going to be too late to use some of those tools that the Jerry’s referring to. But if you know you want to sell and you’re at the very front end of that and you get engaged in the process before you find a buyer that alone can make all the difference in the in terms of the types of tools you can use.
Buck: Guys I really do appreciate the time here. Obviously most people or listening already know Rod probably through Wealth Formula Banking and you can get in touch through to rod you know by going to wealthformulabanking.com and see all the stuff we’ve done there it’s also [email protected] but also Jerry if people want to talk to you in more detail about these strategies you know and I will say this that I think when I think about when that estate tax splits and knowing where a lot of our listeners are especially in our investor group you know if they’re at already at or five million and they’re in their you know 40s and 50s you’re gonna get there pretty quick especially with some of the things that we’re doing on the investment side and if they want to talk to you Jerry how did they get ahold of you?
Jerry: So the way that I prefer is to go through Rod and Christian. I’m going to act as their backstop in this. So initiate the conversation with them. I’m happy to talk to people directly I just like it to come by referral from them.
Buck: Yeah also makes sense honestly just from the from the standpoint of understanding kind of, I like to have an interpreter sometimes in these types of things that in fact that’s why I brought Rod on because you know you’re you’re trying to connect you know where our current situation is, you know with our people with you know with some of the higher level stuff that you’re doing. So that sounds great. So if you’re interested in anything Jerry talked about we’re obviously you know the standard stuff with Rod and Christian and Wealth Formula Banking reach out to rod and Christian or shoot me an email [email protected] and I will connect you. Jerry, Rod thanks again for being on Wealth Formula Podcast today.
Jerry: Enjoyed it. Thanks Buck.
Buck: We’ll be right back.