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Optimize Municipal Bonds Up To 25% Annually

Overview

Do you have significant assets in municipal bonds to take advantage of their tax free nature? If so, you may want to reconsider because municipal bonds are not tax free. They are income tax free, but they are not estate tax free.

Yes, municipal bonds can save you the up to 40% tax assessed on the income they generate. But they will do nothing to avoid the up to 55% estate tax your assets will face at the time of your death.

Maybe you don't even need the 40% tax savings to afford your lifestyle and are using it to grow your estate for your heirs. But it will still be halved by estate taxes. Even more confusing, maybe you do need the extra income. Then what do you do to provide for yourself and provide for your heirs?

Client Profile

James (74) and Ellen (71) Weingart have an estate valued at $25 million, including $5 million currently invested in municipal bonds. The bonds generate a 5% tax-exempt return, which is $250,000. Because of the municipal bonds' tax free nature, you save $100,000 per year in taxes.

At the Weingarts' time of death, their bonds will be subject to estate taxes of $2.5 million. It would take 25 years of savings at the rate of $100,000 per year to equal the pending $2.5 million loss. But, to make up for the estate tax loss, it would take 50 years because those savings, as part of your estate, are also going to be halved by estate taxes. 

Solution

By converting the municipal bonds to a SPIA, Mr. and Mrs. Weingart would receive an annual income of approximately $350,000 AFTER TAX based on current assumptions. They elect to continue to receive the $250,000 income stream the municipal bonds were yielding, which left them with an additional $100,000 a year in income. Mr. and Mrs. Weingart used the $100,000 of additional income to purchase a last-to-die life insurance policy that will produce up to $6 million for their heirs. The $6 million will be income tax free and, as long as it is properly structured in an Irrevocable Trust, estate tax free as well.

The Weingart's retained the full income they were receiving from the municipal bonds and their heirs received $6 million instead of $2.5 million they would have gotten after the $5 million of municipal bonds was halved by estate taxes.
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  1. Assumes Joint Life Expectancy
  2. The current asset is assumed to be subject to estate tax at 55% if it remains in the estate
  3. Not all municipal bonds are exempt from federal and state income tax. Consult your tax advisors to determine taxation.
  4. A SPIA is a Single Premium Immediate Annuity that provides an income stream for a chosen number of years based on a single deposit made to purchase the annuity. The annuity income stream is calculated based on a Life-Only No Refund basis so that the income will last for your lifetime, or the joint lifetime of you and your spouse, if applicable, and no balance will remain in the taxable estate at death. The SPIA guarantee is based on the claims-paying ability of the insurer issuing the SPIA. Trusts should be drafted by an attorney familiar with such matters in order to take into account income and estate tax laws (including generation-skipping tax). Failure to do so could result in adverse tax treatment of trust proceeds. In order to qualify for income tax-free treatment, it is generally necessary to purchase the life insurance and the annuity from different carriers. 
    5. This example assumes an Irrevocable Life Insurance Trust (ILIT) is the owner of the life insurance policy so that the life insurance proceeds are estate and income tax free when paid to the beneficiaries trust.
This material does not constitute tax, legal, or accounting advice, and neither Newport Financial Group, Inc. nor any of its advisors, employees are in the business of offering such advice. It cannot be used by any taxpayer for purpose of avoiding any IRS penalty. Anyone interested in these transactions or topics should seek advice based on his or her particular circumstances from your appropriate advisor.