Estate Planning Case Study

Robert and Lisa Franklin Case

Personal and Financial Objectives:

1.) Robert plans to retire now and begin his retirement by traveling around the world with Lisa.

2.) Robert plans to sell his share of the securities business. He wants to sell half of his share of

the business to his key employee, Mark Newhart. He wants to sell the other half to his

daughter, Elise, who is the senior broker at the firm.

3.) After traveling around the world, Robert plans to return to the business as a self-employed

consultant on a fee basis, beginning January 2017.

4.) Robert Jr. will be starting at a private university in the fall of 2016.

5.) Robert’s grandchild, Greg, Pam’s youngest child, was born with a serious physical disability.

Robert plans to give Greg $2.5 million through a trust for his care and benefit.

Economic Information

- The couple expects inflation to average 4% annually. The expected stock market returns are

10% annually, as measured by the S&P 500 Index, with a standard deviation of 15%

- Tuition is currently $30,000 per year at the private university. The expected education

inflation rate is 5%.

- The 30-day T-bill is yielding 3.5%. The 30-year Treasury bond is yielding 7.5%.

- Current mortgage rates are 7.5% for 15 years and 8% for 30 years. In addition, closing costs

(3% of the mortgage) will be paid at closing and not financed.

Insurance Information

Life Insurance

Neither spouse has life insurance.

Health Insurance

Robert’s business provides health coverage for both Lisa and himself during employment

and during retirement.

- Major medical with an 80/20 coinsurance clause.

- $250 deductible per person.

- $2,000 family stop-loss provision.

Disability Insurance

Neither Robert nor Lisa has disability insurance.

Umbrella Liability Policy

They have $5 million of coverage.

Automobile Insurance

They have liability coverage, $250,000/$500,000/$100,000. They also carry

comprehensive and collision on their autos.

Homeowners Insurance

They have HO-3 policies on their primary residence and vacation homes. The vacation

homes are located on the US Gulf coast and in the mountains.

Residence Gulf Coast Home Mountain Home

Dwelling $975,000 $700,000 $600,000

Coinsurance requirement 80% 80% 80%

Deductible – all other covered losses $250 $250 $250

Deductible – hurricane n/a $10,500 n/a

Insurance Premiums

- Car insurance: $6,000 per year for all three of Robert and Lisa’s automobiles.

- Homeowners insurance: $8,500 per year (includes all homes).

- Boat insurance: $1,200 per year (covered under the umbrella policy).

- Umbrella policy: $1,000 per year.

Investment Information

- The Franklins have a required rate of return of 8%

- The couple can tolerate medium to high amounts of risk but have little need to take excessive

risks because of their net worth.

- Robert’s 401(k) plan investments are secure in a well-diversified but relatively volatile group

of small-cap value stocks. The 401(k) is still in the Smith Brothers’ Retirement Plan.

- Robert has a single premium deferred annuity that was purchase on July 1, 1981, for $60,000

and is current worth $233,047. The expected return over the next year and the 15 years of

fixed term of the annuity is 6%. The start date of the monthly annuity is January 1, 2016,

when the expected fair market value will be $247,030.

- Robert plans to sell 4,468 shares of Dollar Mart stock to his daughter, Vicki, who is

employed by Dollar Mart. Robert anticipates the stock will greatly appreciate in the

upcoming years. The stock was purchase in 2008 for $26.66 per share and is currently

trading for $11.25 per share.

Income Tax Information

- Robert and Lisa are currently in the highest federal income tax bracket, 39.6%.

- They also pay state taxes of 5%.

- For personal income tax reporting, Robert has a $700,000 salary.

- They do not reside in a community property state.

Retirement Information

- The 401(k) plan has a balance of $600,000 consisting of a portfolio of small-cap value

stocks. The portfolio is projected to average a return of 16% over the next 20 years with a

standard deviation of 8%.

- Robert’s anticipated Social Security retirement benefit is $24,000 per year in 2015 and will

increase at the expected consumer price index (CPI) of 4%.

- Robert has a profit-sharing type of Keogh plan. His company contributes $12,000 per year to

the profit-sharing plan. The contributions to this plan have been made out of the company’s

profits. The balance in his account is a result of annual contributions of $12,000, with a 7%

approximate average return.

- Robert and Lisa will continue to collect $200,000 per year in rental proceeds from

Commercial Property A.

- Robert will receive $50,000 per year from the charitable remainder annuity trust (CRAT) that

owns Commercial Property B for Robert’s lifetime.

Gifts, Estates, Trusts and Will Information

Gifts

The following are the Franklins’ only lifetime gifts.

- For the past several years, Robert has given cash gifts to each of his give children. Each gift

has been equal to the annual exclusion amount for the year of the gift, so no taxable gifts

have resulted.

- Robert is planning to transfer $3 million of property to a grantor retained annuity trust

(GRAT) in 2015. Robert hopes to save on gift and estate taxes by transferring this portion of

his interest into a trust while retaining the right to a fixed ordinary annuity of $298,059 for a

term of 10 years. The Franklins’ give children will be the remainder beneficiaries of the

GRAT. Upon the death of a remainderman, the interest will pass to the remainderman’s

descendants. If a remainderman dies without heirs, then the remainderman’s interest will

pass to the other children pro rata. Based on recent Section 7520 rates, Robert expects the

taxable gift resulting from the transfer will be $1 million.

- Lisa has made no taxable gifts during her lifetime nor have any gifts been split.

- In 2014, Robert established a 5% CRAT by donating a piece of real estate (an apartment

building, Commercial Property B) inherited from his grandfather. The initial valuation of the

trust was $1 million with the initial income in the first year projected to be $50,000

beginning in 2015. Robert is the income beneficiary, and the charitable remainder

beneficiary is the Chicago Art Institute.

- Robert plans to donate $2.5 million to an irrevocable trust for his grandchild, Greg, the

youngest child of Pam.

Estates

The Franlins’ last illness and funeral expenses combined with estate administration

expenses are estimated at $450,000 each.

Wills

Robert and Lisa have simple wills. They have left all probate assets to each other. Each

will also include a six-month survivorship clause. Debts and taxes are to be paid from the

residue of the estate.

Will

Excerpts from Robert Franklin’s Last Will and Testament

I, ROBERT FRANKLIN SR., being of sound mind and wishing to make proper

disposition of my property in the event of my death, do declare this to be my Last Will and

Testament. I revoke all of my prior wills and codicils.

1.1 I have been married but once, and only to Lisa Franklin with whom I am presently living.

1.2 Out of my marriage to Lisa Franklin, five children were born namely Pam Franklin, Elise

Franklin, Jackie Franklin, Vicki Franklin and Robert Franklin Jr.

1.3 I have adopted no one nor has anyone adopted me.

3.1 I give my entire estate to Lisa Franklin, my wife.

3.2 In the event that Lisa Franklin predeceases me or fails to survive me for more than six

months from the date of my death, I give my entire estate to my children in equal shares.

3.3 In the event that any of the named heirs should predecease me, die within six months

from the date of my death, disclaim or otherwise fail to accept any property bequeath to

him and said legatee has no descendants, his share of all of my property of which I die

possessed shall be given to the surviving named legatees.

5.1 I name Lisa Franklin to serve as my executrix of my succession, with full seisin and

without bond.

5.2 I direct that the expenses of my last illness, funeral, and the administrations of my estate

shall be paid by my executrix as soon as practicable after my death.

5.3 all inheritance, estate succession, transfer and other taxes payable by reason of my death

shall be apportioned in accordance with the law.

CASH INFLOWS TOTALS

Salaries

Robert's Salary $700,000.00

Total Salaries $700,000.00

Passive Income

Rental Income $200,000.00

Total Passive $200,000.00

Investment Income

Interest Income $1,000.00

Dividend Income $6,500.00

Total Investment $7,500.00

TOTAL CASH INFLOWS $907,500.00

CASH OUTFLOWS

Ordinary Living Expenses

Credit Car Payments $2,400.00

Entertainment $50,000.00

Food $14,400.00

Clothes $30,000.00

Utlities $24,000.00

Charity $90,000.00

Total Ordinary Living Expenses $210,800.00

Debt Payments

Primary Residence $37,030.00

Vacation Home 1 $45,181.00

Vacation Home 2 $79,308.00

Total Debt Payments $161,519.00

Insurance Premiums

Homeowners $8,500.00

Auto $6,000.00

Boat $1,200.00

Umbrella $1,000.00

Total Insurance Premiums $16,700.00

Taxes

Property Tax $84,000.00

Income Tax $408,375.00

Total Taxes $492,375.00

TOTAL CASH OUTFLOWS $881,394.00

NET DISCRETIONARY CASH FLOW $26,106.00

Statement of Income and Expenses

Information Regarding Assets and Liabilities

Franklin Securities – Robert is a 50% Partner

- The fair market value of Robert’s interest is $5 million.

- The current adjusted taxable basis is $1 million.

- Details of the transfer of the business (sale) are as follows:

o 50% - a 10 year installment sale to Mark Newhart for a down payment of 20% on

January 1, 2015 and monthly payments beginning February 1, 2015 at 10% interest.

o 50% - self-cancelling installment note (SCIN) or private annuity to Elise.

Primary Residence

- Purchased 1998

- Jointly owner – Joint Tenants with Rights of Survivorship

- Market value $1.3 million.

- Original purchase price $300,000

- Current mortgage at 12% interest; payment of $3,085.84, (30 year) per month.

Vacation Home – Gulf Coast

- Jointly owned; purchased in 2011

- Market value $800,000

- Original purchase price $400,000

- Current mortgage at 7.75%; payment of $3,765.10, (15 year) per month

Vacation Home – Mountains

- Jointly owned; purchased in 2013

Current Assets: Current Liabilities:

JT - Cash $100,000.00 W - Credit card 1 $1,000.00

Total Current Assets $100,000.00 W - Credit card 2 $15,000.00

Total Curren Liabilities $16,000.00

Investment Assets:

JT - Franklin Securities $5,000,000.00

W - Lisa's portfolio $500,000.00

H - Deferred annuity $233,047.00

H - 401(k) plan $600,000.00

H - Keogh plan $526,382.00

H - Robert's portfolio $4,000,000.00 Long Term Liabilities:

JT - Commercial Property A $1,500,000.00 JT - Mortgage - primary $258,630.00

Total Investment Assets $12,359,429.00 JT - Mortgage - GC $369,428.00

JT - Mortgage - Mountains $687,444.00

Personal Use Assets: Total Long Term Liabilities $1,315,502.00

JT - Primary residence $1,300,000.00

JT - Vacation Home - Gulf Coast $800,000.00

JT - Vacation Home - Mountains $700,000.00

JT - Personal property/furniture $875,000.00

H - Auto 1 $80,000.00

H - Auto 2 $55,000.00

W - Auto 3 $40,000.00 Total Liabilities $1,331,502.00

W - Boat $110,000.00

Total Personal Use Assets $3,960,000.00 Total Net Worth $15,087,927.00

Total Assets $16,419,429.00 Total Liabilities & Net Worth $16,419,429.00

Statement of Financial Position

ASSETS LIABILITIES AND NET WORTH

- Market value $700,000

- Original purchase price $700,000

- Current mortgage at 7.8%; payment of $6,608.99, (15 year) per month

Commercial Property A

- Original site of the business

- Fair market value $1.5 million

- Adjusted basis $200,000

Single Premium Deferred Annuity

- Robert purchased this annuity on July 1, 1981 for $60,000. The current fair market value is

$233,047.

- An earnings rate of 6% compounded annually is expected in the near term.

- Annuity start date is January 1, 2016, at which time the fair market value is projected to be

$247,030 and will consist of 180 monthly payments (15 years).

- If Robert dies before the annuity start date, Lisa is named beneficiary (100% joint and

survivor annuity).

Summary of Indebtedness

Asset 1st

Payment

Mortgage

Amount

Term/

Years

Interest Monthly

Payments

Remaining

Payments

Remaining

Balance

Primary

Residence

4/1/98 $300,000 30 12% $3,085.85 183 $258,629.70

Vacation

Home GC

1/1/11 $400,000 15 7.75% $3,765.10 156 $369,427.86

Vacation

Home M

7/1/13 $700,000 15 7.80% $6,608.99 174 $687,443.56

Detailed Investment Portfolios

Robert’s Portfolio

Description Acquired Shares Adjusted Basis Beta Current FMV

Sears 8/05 16,325 $201,633 0.9 $830,214

Dollar Mart 1/08 4,468 $119,117 1.2 $50,265

Canon, Inc. 2/10 22,249 $400,188 1.4 $2,230,462

RC, Inc.* 9/10 3,742 $67,181 1.5 $222,600

WW Grainger 10/13 4,257 $221,435 1.2 $311,293

City Electronics 9/13 10,561 $304,062 1.2 $355,166

Total $4,000,000

 The RC, Inc. stock is Section 1244 Small Business Stock

Lisa’s Portfolio

Description Acquired Shares Adjusted

Basis

Beta Current FMV

Tenet Health

Care

1/05 2,542 $30,504 0.6 $50,209

Bay Bank,

Inc.

2/10 1,500 $120,000 0.5 $167,250

Microsoft 9/10 589 $53,010 0.7 $66,189

Zenith 10/11 22,190 $177,520 0.8 $216,352

Total $500,000

Questions

1. Assume Lisa dies on January 1, 2015.

a. What is the value of Lisa’s gross estate?

b. What amount qualifies for the marital deduction in Lisa’s estate assuming Robert

survives for 6 months following her death?

2. Which of the following transfers will not result in a taxable gift from Robert in 2015,

assuming he makes no other gifts?

a. Robert pays each grandchild’s private school tuition, $6,000 each.

b. Robert pays City Hospital for the hospital bill of a friend, $15,000.

c. Robert pays a university for a distant cousin’s law school tuition, $16,000.

d. Robert pays the tuition for Robert Jr. directly to a private university, $30,000.

3. What is impact of the survivorship clause in Robert’s will?

4. Robert and Lisa are considering the purchase of a joint and survivorship (second-to-die) life

insurance policy for the purpose of wealth replacement for the assets that were transferred to

the CRAT and to help to create estate liquidity. Discuss the most appropriate way to own the

joint and survivorship life insurance.

5. What estate planning recommendations would you make to the Franklins?

6. Explain the benefits of the grantor retained annuity trust (GRAT) Robert is planning to create

in 2015.

7. What are the advantages of using a charitable remainder trust (CRAT)?

8. Discuss private annuities and SCINs and how the sue of each would affect Robert Franklin

and his daughter Elise in the sale of half of his share of Franklin Securities to her instead of

in an installment sale.

9. If the Franklin set up an irrevocable trust for the rest of their grandchildren, what kind of tax

will the grandchildren pay on the income distributed to them from this trust?