Do you have any clients who want to:

• Supplement their income for retirement?
• Create a secondary income to pay for life insurance, long term care insurance, or critical illness insurance without using their pension benefits and Social Security income?
• Retire early and live on a “gap income” until other retirement benefits start?

If so, you may want to share the “Income Enhancement Trust” concept with those clients.

What is the Income Enhancement Trust?

The “Income Enhancement Trust” takes advantage of the tax-favored benefits of a tax-exempt trust to convert illiquid assets into retirement cash flow. This special form of trust allows your client to benefit from the full value of the assets transferred to the trust, not just the net assets after reduction for capital gains tax.

The most frequently used tax-exempt trust is the charitable remainder trust (or CRT). Although the client’s charity of choice eventually benefits from the trust remainder, it is the client who enjoys the

key benefit - the income stream - either for their lifetime, or for a number of years.

By using the CRT to avoid taxes at time of sale, the client ends up with more assets from which he can produce a retirement income. The capital gains tax on $500,000 is $60,000. At a 5% rate of return, this is another $3,000 per year that the client enjoys instead of the IRS.

Don’t forget – there is a current income tax deduction for the charity’s remainder that can reduce income tax in the year of the transfer, as well as five more years if the deduction exceeds the annual limit.

Which assets qualify?

Illiquid assets work well for this concept. An illiquid asset is one that does not produce interest or dividend income, and which the client cannot easily convert to cash. Some common examples of illiquid property include:

• Publicly traded stocks paying little or no income.
• Stock in a family business with no readily apparent market.
• Unproductive real estate or farmland.

 Although it may be a deciding factor for some clients, the size of the estate is not that important when considering this concept.

How does it work?

Assume that your long-time client Tom, age 60, has unimproved real estate in a developing area. It generates no income. He bought it for $100,000 and it now has a

fair market value of $1,000,000. The potential capital gain is $900,000. At 20% capital gains, Tom loses $180,000 of his profit to the taxman. Tom would like to sell and use the net profits to supplement his income, but he does not want to pay the capital gains tax.

By using the CRT, Tom will:

1. Remove $1,000,000 from his estate;

2. Avoid the loss of $180,000 for investment purposes;

3. Obtain a charitable income tax deduction; and

4. Create retirement income from an asset that did

not generate income before.

How is Tom taxed on his trust income?

Tom does not completely escape income and capital gains tax - but he does enjoy the special “four tier” tax system afforded to payments from a CRT. Under the four-tier rule, the annual payment consists of ordinary trust income first, then capital gains. Once these two sources are exhausted, the payment is made from tax-exempt income and then basis. Assuming no ordinary income in Year 1, Tom’s $65,000 will consist entirely of built-in capital gains, taxed at the 20% rate (which is still better than ordinary income tax rates) .

WIN-WIN-WIN

After paying his tax of 20%, Tom has $52,000 either for retirement, reinvestment or family gifting. If he wants to replace the $1,000,000 CRT gift for his heirs, he can purchase life insurance inside an irrevocable life insurance trust (ILIT) with part of the income stream. The Income Enhancement Trust can be a “WIN” for the client, his family and the ultimate charity.