According to comprehensive reports from Worldway Group: Beyond investment returns, America's wealthy are most concerned with three things: asset protection, income tax savings, and how to properly transfer assets to the next generation.
Asset Protection
There is a saying that over 70% of the world's lawyers are in the United States, and 80% of legal lawsuits occur in the United States, with California and New York accounting for half of them. Litigation is common, making asset protection a vital discipline. When a person has no money, there is no need to worry about being sued because lawyers have no interest in you; once you have assets, especially significant assets—what is known in English as a "deep pocket"—you must be extra cautious.
In this regard, one must be particularly careful about asset protection at two specific times:
First, when facing legal litigation. In the United States, many things can make you a defendant, and the reasons for being sued are varied. For example, in personal matters, if you are at fault in a car accident, not only can the other party sue you, but even passengers in your own car can sue you; or, someone might trip at your doorstep, someone might get injured while you are hosting a party, your child might be in a car accident, your car might be involved in an accident while lent to someone else, a tenant might trip and fall in an investment property, or a construction worker might have an accident... all these can make you a defendant.
In business, if you own a company and an employee is involved in an incident, regardless of whether you were directly involved, you as the boss are very likely to be named as a defendant. For example: someone opened a restaurant where a manager harassed an employee, but the employee did not sue the manager because the manager had no money; she sued the restaurant owner, and the owner lost the lawsuit, paying one million US dollars in damages. If a company driver causes a car accident resulting in someone becoming permanently paralyzed, the owner is also within the scope of the lawsuit, and being ordered to pay millions of dollars in damages is common and not unusual. Such lawsuits are numerous and too many to list.
Second, when ending a marriage, whether it is your own or your children's marital relationship. In the United States, there are nine states (including California) that are community property states. According to state law, when a personal or child's marriage ends, assets are basically divided equally. Therefore, how to prepare in advance and design proper property ownership can have a significant impact on various situations that may be faced in the future.
Therefore, in terms of asset protection, the first line of defense is to utilize liability insurance: the coverage amount for personal and corporate liability insurance must be sufficient. In addition to general liability insurance, there is also a type of insurance called Umbrella Insurance, which must also be purchased in sufficient amounts. When investing in property, one should try to hold title through a Limited Liability Company (LLC) structure, which allows for a reasonable separation of legal liability. Different LLCs can also be used to hold different investment properties, as an LLC provides better protection against legal lawsuits than a general corporation. Additionally, try not to place assets, or place fewer assets, under children's names, as young people have a higher probability of being involved in car accidents and divorce property divisions.
Saving Income Tax
Regarding income tax, due to the United States pursuing global taxation based on FATCA, the demand for legal tax savings is increasing. The United States also faces a hidden concern for the future: the massive fiscal deficit and the fact that the Baby Boomer generation has begun to reach retirement age, making it highly likely that future income tax rates will rise again.
Additionally, there are state taxes. In California, net income exceeding $508,500 is subject to an additional 12.3% state tax. For high-income earners living in California, the annual income tax paid may exceed 50%. While utilizing tax-deductible items and certain company retirement plans can achieve partial tax savings, the amounts are limited, and taxes must still be paid upon future withdrawal. Of course, investing in plans with tax-free future income, such as state government bonds, is another method, but the disadvantage is lower returns. Therefore, America's wealthy have adopted the following method: using life insurance as a tool for tax savings and future tax-free income.
Many people still hold the traditional view of life insurance. In fact, the development and evolution of life insurance in the United States is like that of a smartphone; it has multiple functions, and the death benefit is just one of them. If designed properly, this product not only allows the policyholder to withdraw interest from the policy for their own use but also allows them to earn tax-free income for life. For example, a 40-year-old policyholder deposits $200,000 a year for a total of 5 years, then waits 5 years, and starting from age 51, can receive approximately $180,000 in tax-free income annually for 50 years, until age 100. If they live to 100, not only can they receive $9 million in tax-free income, but their family can also receive a death benefit of $5 to $10 million upon their passing.
Asset Transfer
In the United States, most people do not advocate transferring assets to the next generation too early, because young children having assets too early carries four major risks: they might spend the assets, squander them, lose them in a lawsuit, or lose them in a divorce. Even if one intends to give early, the following three factors must be considered:
First is the issue of gift tax. Generally, assets transferred while alive are called gifts; those given after death are called inheritance. Gifts have gift tax issues, and inheritance has estate tax issues. For the portion exceeding the gift tax exemption, a gift tax of up to 40% of the fair market value of the transferred net assets must be paid. The tax rates for gifts and inheritance are the same and are collectively referred to as transfer taxes.
Second is what assets should be given. Properties or stock assets that have appreciated significantly should not be gifted, because gift tax is calculated based on market value, and the recipient must assume the original cost basis of the asset.
For example, a property purchased for one million that has appreciated to ten million, if gifted to children, the gift tax is calculated based on the ten million market value, but the children inherit the one million cost basis. If the children later sell this property for ten million, they will have to pay income tax (capital gains tax) on nine million, creating the possibility of double taxation. However, if parents retain highly appreciated assets until death as an inheritance, children only need to pay estate tax, and the cost basis of the inherited property will be calculated based on the market value at the time of the parents' death. In the same example, if the property is worth ten million at the time of the parents' death, there is only the issue of estate tax; if the children sell the property after inheriting it, and the sale price is ten million, the children's inherited cost basis is also ten million, so the 9 million in capital gains tax can be saved. From this, it can be understood that highly appreciated assets are not suitable for lifetime gifting; if gifting is necessary, one might choose cash or assets that have not appreciated.
Third is how parents can retain control after gifting. Transfer the assets to an LLC. Parents gift LLC shares to their children while remaining the manager. The biggest advantage of this method is that even if the parents acting as managers only own one or two percent of the shares, they still have full control, and it is also more favorable in terms of legal litigation protection.
Fourth is living trust planning, which is very important. In addition to avoiding the time-consuming and costly trouble of probate, living trust planning can also solve the risks of parents passing away early and children inheriting property too early. One of the most famous examples is the singer Elvis Presley. He passed away at a young age, but he stipulated in his living trust that his daughter could only withdraw interest from the trust before her twenties and could not touch the principal. This was to prevent and protect against potential legal lawsuits that might arise from his daughter marrying and divorcing too early. As it turned out, his daughter did indeed divorce twice before the age of thirty.
Estate tax is another issue that needs attention. In the United States, assets exceeding the current estate tax exemption (currently $5.34 million) are subject to an estate tax of up to 40%.
A major problem here is that estate tax must be paid in cash within nine months after a person's death. If the assets are worth $30 million, the estate tax could exceed $10 million. There are generally four solutions for paying estate tax:
Cash payment: But it is impossible for most people to keep that much cash on hand;
Selling assets: If the assets are mainly properties, stocks, securities, and company shares, one must not "die at the wrong time," otherwise, if the market is unfavorable at the time of death, the heirs may be forced to sell assets in a hurry due to the pressure of paying estate tax, resulting in significant losses;
Borrowing from a bank: If the children or heirs do not have sufficient income or credit, they may not be able to borrow;
Negotiating installment payments with the IRS: The annual interest rate can be higher than 20%, and the penalties for late payment are also very high.
The above four options are all less than ideal. In the United States, a commonly used method is to use an Irrevocable Life Insurance Trust (ILIT) to resolve these dilemmas, but the most important thing is to choose the right trust manager and owner, followed by choosing the right life insurance plan. If designed correctly, the insurance death benefit can be completely exempt from income tax and estate tax. Currently, high-end clients in the United States use Irrevocable Life Insurance Trusts to purchase high-leverage life insurance—that is, for people around 50-60 years old, the insurance leverage can be as high as 1:8 to 1:10—using the tax-free death benefit to settle estate taxes and smoothly transfer assets to the next generation. For non-US persons, insurance death benefits are completely tax-free and there is no need to set up an Irrevocable Life Insurance Trust.
In summary, do not transfer assets to the next generation too early, so as not to lose the principal while trying to save on taxes. Even if you want to gift, you must choose the right structure to gift the right assets to enjoy tax benefits while minimizing legal litigation and potential risks to your children. Do not gift highly appreciated assets too early; it is best to leave them until after you pass away, which allows you to retain control and save on capital gains tax. At the same time, use small amounts of money to create high leverage and use an Irrevocable Life Insurance Trust to solve future estate tax problems. One additional point: the cost of life insurance in the United States is one-fifth to one-sixth of that in mainland China, and one-third to one-half of that in Hong Kong.
Worldway Group Editor
