Read Part 1: Asset Protection and Land Trusts
Read Part 2: Tenancy in Comman & Joint Tenancy: Pros & Cons
In Article I on protecting the family home we discussed strategies that don’t work on protecting the personal residence: the homestead exemption, tenants by the entirety, tenancy in common, and joint tenancy. In article II we discussed the Revocable Living Trust, the Qualified Personal Residence Trust (QPRT), Limited Liability Companies (LLC), Limited Partnerships, family Limited Partnerships (FLLP), and Corporations as additional methods that don’t work. The final segment, article III we will discuss the more practical approaches to protecting the personal residence: Equity Stripping, Equity Vesting, and Irrevocable Trusts.
Equity stripping
The words sound exotic, it means to simply take out large amount of debt on an important asset or to encumber the asset secured by the underlying asset. The theory is simple; if an asset is riddled with debt, then the creditor is unlikely to bother with trying to sue the owner for the asset, thus, asset protection.
Equity vesting
Equity vesting, is the repositioning of your vested equity in your home or other commercial real estate through equity mortgage refinancing. Your borrowed cash is then used to buy wealth building cash-value life insurance to fund your tax-free retirement. The benefit is tax-free growth within an insurance company guaranteed rate of return and tax-free withdrawal through insurance policy loans.
The concept isn’t difficult. Experts like Doug Andrews, author of Missed Fortune 101, and Roccy DeFrancesco, author of The Doctor’s Wealth Preservation Guide and The Home Equity Management Guidebook, (get a free copy of this book by Google+ this page) define Home Equity Harvesting as “removing equity” from a personal residence through refinancing (or a home equity loan) where the money borrowed is placed into cash value life insurance. I know it sounds weird. Who in their right mind would want to take a loan out on their home in order to purchase life insurance? Here’s your answer: Think of life insurance as a tax free savings account. A properly structured cash value life insurance policy can grow “tax-free” (no income taxes on capital gains, interest and dividends) and be removed tax-free via policy loans, and when properly structured will distribute tax-free to heirs at the time of death. To properly structure the policy, it must be over funded with cash using the minimum allowable death benefit that will allow the client to borrow from the policy tax-free. You can read more on how to monetize your real estate by using widely accepted leverage on real estate form a well known author Roccy DeFrancesco, J.D. by getting your free book.
An example: Mr. Smith is 45 years old, married and has a home with a fair market value (FMV) today of $400,000. He has 2 children and a spouse where their combined household income is $78,000 a year. Assume the Smith’s purchased the home for $185,000 seven years ago and that the current debt on the home is $125,000. Assume the current home loan is 6.5% with mortgage payment of $935 a month.
Mr. Smith will use a home equity line of credit (not a refinance) and will remove $76,500 of equity from the home over a five year period (which creates a 50% debt to value ratio on the property).
Equity Vesting is removing equity from a home to reposition it into cash value life insurance. Therefore, Mr. Smith will access his new line of credit in the amount of $15,300 every year for five years to fund an over funded/low expense cash value life insurance policy.
It is assumed that the life insurance policy used is and equity indexed life insurance policy that has a 1% guarantee rate of return on the cash value, has its growth pegged to the S&P 500 index and locks in the gains annually. It is also assumed that the policy will return 7.5% annually (which is conservative since the S&P 500 has averaged over 11% for the last 20+ years).
Mr. Smith will retire when he is 65 years old and will withdraw money tax-free through policy loans from his cash value policy from age 66-90 (25-years). Mr. Smith would be able to take $23,000 each year for 25 years for a total amount of $575,000.
If Mr. Smith had a home where they could harvest $200,000 of equity to reposition into a cash value life insurance policy. Using the same assumptions from the above example Mr. Smith could borrow tax-free from his life insurance policy starting at age 66? $61,000 each year for 25 years for a total amount of $1,520,000.
FULL DISCLOSURE: the above Equity Vesting examples have used optimum data as an optimum example. Your particular situation will be different based on your age, your health, borrowing capacity, level of interest rates, deductibility and limitations of your interest deduction on mortgage, and other factors. Please contact us to run your numbers based on your facts. We can be reached at 508-429-0011 or contact us through the contact form using the above link (click the link at the top of the page beside the telephone icon).
Irrevocable Trusts
While equity vesting is not for everyone, the personal residence is best suited for an irrevocable trust with an independent Trustee. A simple “revocable” trust, also sometimes referred to as a land trust, will not protect your home from potential lawsuits, divorce, Medicaid/Nursing home. You must “divorce” yourself from owning your personal residence or for any other valuable asset you wish to transfer to your irrevocable trust. As in a typical divorce decree spelling out the terms of settlement, so too your Trust Agreement must spell out the terms and conditions of the Grantor (the owner) relinquishing his ownership to the Trustee for the benefit of the Grantor and his heirs. The Trustee cannot be the Grantor, his spouse, his children, or any one related to the original owner by blood or marriage. The Trustee “must be independent” and must act independently in decisions and actions. The independent Trustee’s sole fiduciary duty is to protect the assets transferred at all costs and must grow the assets in order to fund future expectations of the Beneficiaries.
To learn more about repositioning assets for wealth building, implementation of precise asset protection systems, tax minimization strategies, elimination of the probate process, and elimination of the only voluntary estate tax system, and tax efficient transfers to your next generation email us.
Rocco Beatrice, CPA, MST, MBA, CWPP, CAPP, MMB – Managing Director, Estate Street Partners, LLC. Mr. Beatrice is an “AA” asset protection, Trust, and estate planning expert.