I had two clients call that morning asking about the advertisement and what it entailed. One client already had a variation of the planning vehicle in effect. With the other, we had discussed the idea a while back and it was not adopted, but in both cases, the advertisement caught their attention even though they were unsure what exactly was being proposed.
I thought this advertisement was a brilliant piece of marketing by the financial institution and the related investment advisor. The headline sensationalized the term "tax-free" and hit upon a sore spot for many high net worth people, the after tax cost of their children's private schooling, for which a family trust can be an effective vehicle to reduce such costs. However, the issue with the advertised trust or any trust that I propose to one of my clients is: how much money do you need to establish the trust? I would suggest that in this low interest rate environment, you would require at minimum $500,000 in free cash, but more likely $1,000,000 for this plan to be cost effective.
If you have been a loyal Blunt Bean Counter reader, you already know about family trusts. I have discussed the use of family trusts on several occasions and even looked at how they would be beneficial in the payment of university costs.
The key to the advertised family trust is that capital gains generated inside the trust can be distributed tax-free or nearly tax-free to children or grandchildren who have little or no other income. Depending upon the manner in which the trust is established, dividend and interest income that is allocated to a child under 18, may or may not be distributed tax-free and may or may not create income attribution issues that negate the value of the trust (see my blog post tomorrow).
For the purpose of today's blog post, I will just concentrate on capital gains and ignore interest and dividend income for now.
If a trust is settled with or loaned $500,000, it would need to realize around 5% yearly capital gains appreciation to earn $25,000 in capital gains, an amount that could be distributed essentially tax-free ($250 or so of tax) to a child to pay for their private school if they have no other income.
prescribed rate loan to lock in the 1% prescribed rate, however, I would still question the tax and cost effectiveness of such a move. I'll discuss these details tomorrow.
I have not reviewed the details of how a family trust works here; you can read the links above if you would like to get up to speed. Tomorrow, however, I am going to post a blog on using a prescribed rate loan to fund a family trust that can be used to help pay for private school, university or any other costs your child has, which is probably very similar to what that financial institution's trust does. See you tomorrow.
The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.