2014 Articles

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Succession planning for art and collectibles

Most people are collectors of some kind. Some own art that has been passed down through generations, and their collections may be worth millions of dollars. Others start collections based upon their special interests—as common as coins and stamps or as unusual as musical wind-up toys and fishing lures.
What all collections have in common is value, either in dollars or in the simple pleasure that having the objects brings. In either case, developing what is sometimes referred to as an art succession plan is an important element of a collector’s overall estate planning.
The goal of an art succession plan is to preserve and distribute the collection to heirs with the least possible turmoil and expense. Here are a few suggestions offered by collectors and art succession professionals.

Keep a comprehensive list of the items in the collection
A collector always should maintain a complete and up-to-date inventory of the items in his or her collection.
Along with the inventory, a collector should record all purchase and sale transactions. If available, authentication documents and the provenances (origins or sources of the collectibles and histories of subsequent owners) should be included. If the collection is small, a simple computer spreadsheet might suffice. Specially designed software is available for larger, more complex collections.

Know the collection’s value
The general rule for federal estate, gift and income taxes is that property is transferred at its “fair market value.” When dealing with publicly traded securities, that’s easy enough to determine. For collectibles of any significant worth, an appraisal or valuation of each item in the collection from a qualified professional, one who will meet the standards set by the IRS, may be needed.
When a collector or his or her estate seeks a tax deduction for the transfer to charity of items in the collection, the IRS requires a “qualified appraisal” for property valued at over $5,000, and when the value claimed is over $20,000, the appraisal must be submitted to IRS along with the proper tax form. An IRS Art Advisory Panel reviews appraisals reported on income, gift and estate tax returns to determine their accuracy when the collection or work of art is valued at over $50,000.
When looking for an appraiser, most professionals suggest choosing a member of either the American Society of Appraisers, the Appraisers Association of America or the International Society of Appraisers.

Plan now, not later
Michael Mendelsohn, a principal at Briddge Art Strategies, Ltd., an art succession planning firm, is the author of Life Is Short, Art Is Long—Maximizing Estate Planning Strategies for Collectors of Art, Antiques and Collectibles and recognized by Arts and Antiques magazine as one of the top 100 collectors in the U.S. He has seen at firsthand what can happen when a collector fails to plan adequately for a valuable collection. The following is a short summary of a situation that he related to Registered Rep., a publication for investment professionals:
Collector had amassed a substantial collection of sports cars. Although he had done some general estate planning, it did not include the collection. Succession planning did begin when Collector decided that the cars should be put on display. He met with Mendelsohn and his financial advisors. A plan was put in place hastily. A private museum would be set up to house and preserve the cars. Collector would purchase a life insurance policy on his and his wife’s lives. After they died, part of the proceeds would be used to fund the museum; museum profits would go to a charity for terminally ill children; and the balance would provide income for Collector’s children.
Unfortunately, a few months before the plan was completed, Collector died.
The collection passed to his wife and children. With no completed succession plan and a limited time to pay a hefty federal estate tax on the value of the cars, the wife and children began auctioning off the cars and arguing over who would get what. The unfortunate and unnecessary result was that a cherished collection was dismantled; a charity lost a significant gift; and Collector’s heirs were hit with a large tax bill.

Consider charitable gifts
When philanthropy is one of the goals of an art succession plan, a collector can reap a number of tax rewards. For one, the 28% long-term capital gain tax rate on the appreciation in value of a collectible is avoided when it is donated to charity rather than sold. The collector is entitled to an income tax deduction for the gift as well (subject to certain caps). And, because the collection is no longer part of the collector’s estate, there’s no tax bill looming in the future.
When a collector wants to make a charitable gift and still provide for his or her family, a charitable remainder trust may be a good solution. The collectibles transferred to the trust can be sold free of capital gains tax, and the income from the reinvested proceeds can be paid to the collector or designated beneficiaries for life. The collector receives a partial income tax deduction for the donation (the amount that represents the value of the gift to the charity).
If the collector still is concerned about smaller bequests to his or her heirs as a result of the charitable gift, another trust can be established. This trust purchases a life insurance policy on the collector’s life, often equal to the value of the collectibles that were transferred to the charitable remainder trust. After the collector’s death, heirs can receive the proceeds from the insurance free of both income tax and estate tax (as long as the collector lives at least three years after the trust was created). Of course, this approach comes at a price: the cost of insurance premiums on the policy.

Communicate
Finally, experts recommend strongly that a collector take into consideration what family members have to say. Are they interested in keeping the collection intact? Do any of them want specific pieces in the collection for themselves, or do they prefer to receive the proceeds from sale of the collection? The answers may have a major bearing on the ultimate shape that a succession plan takes.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.

 

 

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Investment aspects of life insurance

Almost everyone believes that he or she needs life insurance to provide cash for his or her family, business partners and charitable endeavors that he or she values. But what people don’t always consider is the utility of life insurance as an investment vehicle during one’s lifetime.

Overview: cash value policies
In general, there are two types of insurance. Term life insurance is pure insurance and provides only protection—in the form of a cash payment to a beneficiary upon your death. Cash value life insurance (sometimes referred to as permanent life insurance) has the added bonus of the tax-free buildup of accessible wealth. With these policies the premiums that you pay cover the insurance company’s overhead and the cost of insuring the lives of the company’s customers, with the balance going into the policy’s cash value.
Because of initial selling costs, cash values build up very slowly at first but accelerate in later years to provide competitive long-term yields. There are various types of policies, differing in how the death benefit is fixed, how the cash value is invested and how the policy owner can utilize the cash value.

General account policies
In whole life insurance the premium is fixed and calculated to be paid until a given age. (When cash value is equal to the death benefit, the policy is paid up, and no further premiums are required.) Your cash value is placed in the insurance company’s general account, which, by regulation, is invested quite conservatively.
The insurance company guarantees a minimum rate of return and pays dividends in addition. You can take dividends in cash, add them to your tax-deferred investment and use them to reduce your premium or to buy small “paid-up” additions to your policy, boosting the total death benefit. The cash value is available through tax-free loans, which, as long as not repaid, reduce the death benefit. Dividends generally may be withdrawn tax free.
Universal life insurance involves a general account investment in which interest is credited at prevailing rates with a guaranteed minimum. You choose, within limits, how much in premiums to pay, and the death benefit varies with your results.
Paying the target premium proposed by an insurance agent guarantees that coverage at the desired level will last for life. Paying more than the amount proposed builds up additional tax-sheltered value. Paying much less, however, may require you to increase premiums in later years to keep the cash value from being exhausted by policy expenses and, as a result, the policy lapsing.
With a universal policy you choose how your cash benefit is applied. In Option A (also referred to as Option 1), cash value is applied to the death benefit, reducing the insurance component over time. With Option B (or Option 2), the insurance amount remains fixed, and the cash value increases the death benefit, providing a substantial inflation hedge. You can withdraw money from the cash value tax free up to the cost basis, but you should be careful to leave enough to prevent the policy’s collapse.
The risk with both types of this insurance is that interest rates may decline, and the insurance company may not produce sufficient returns in its general account. Companies’ failure to meet legal capitalization standards will bring in regulators to slash the cash values of policy holders.

Variable policies
Variable universal life insurance offers all the premium and death benefit flexibility of universal life while cash value builds up in investment accounts managed by the policy holder.
You are typically given a choice from a universe of accounts, similar to mutual funds, that invest in stocks, bonds, and money market and other funds. You may vary your premium within limits, but it’s important not to exceed a government-mandated “seven-pay” test during the policy’s first seven years so that the policy will not be classified as a “Modified Endowment Contract.” Such a designation would prevent tax-free loans and withdrawals.
Because the cash value of a variable policy is subject to market conditions, it is possible for it to fail. To “bullet proof” a policy, consider keeping three years’ worth of policy expenses in the company’s guaranteed interest account.
The risks in variable policies are market risks. History tells us that the markets, over time, tend to outperform the guaranteed returns achieved by insurance company general accounts. This is especially true with the added power of tax-deferred compounding. Equally important, variable policy cash values are not subject to the fortunes of the insurance company.
As you can see from this very brief overview, determining the type of insurance policy that best fits your needs requires serious consideration. In addition, there are issues of how to structure the ownership of your policy. We recommend, therefore, that before making decisions, you consult your advisors.

© 2014 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2014, are not reflected in this article.