What Is A Family Bank?
Family bank is a term used to refer to assets that have been pooled into a "bank" by some family members (typically the older, wealthy generation), and maintained for the use and benefit of other family members (typically the younger generation). Generally, a family bank works as a lender. The contributing family members agree to the terms (the rules) that must be followed by the beneficiary family members in order to borrow from the bank. Typically, the younger generation may borrow from the bank only for certain purposes, for example to purchase a new home, to pay for education expenses, or for emergencies, and then the funds must be paid back within a certain period of time, perhaps at a low rate of interest. The contributing members create the bank with the intent that it will last into the future so that each succeeding generation can benefit from it. The family bank can be structured in different ways, but generally a trust is used.
Example(s): Bob and his sister Liz have inherited a fortune from their ancestors. Bob and Liz decide to pool their excess funds and set up a family bank for the benefit of their descendants. Bob and Liz create a trust, fund the trust with investment assets, and name a bank as trustee. The terms of the trust provide that any of Bob's and Liz's direct lineal descendants may borrow from the trust to buy a home or vacation house, to purchase or start a business, or for any event deemed an emergency by the trustee. To receive the funds, the borrowers must promise to pay back the borrowed amount plus interest (unless the funds are used for emergency purposes) within a reasonable time as determined by the trustee.
What Are The Income Tax Consequences?
The income tax consequences depend on the vehicle that is used to create the family bank. If the funds are merely pooled into an account (e.g., bank, investment, etc.), the income generated by the pool is allocated to the contributing members in proportion to their contributions.
Example(s): Four brothers pool assets to create a family bank. The assets are deposited into an investment account. Vito contributes $500,000 (25 percent). Anthony contributes $500,000 (25 percent). Caesar contributes $300,000 (15 percent), and Francis contributes $700,000 (35 percent). Each year the account earns $160,000 in interest. Vito must report 25 percent of $160,000 or $40,000 of income on his annual income tax return. Anthony must report 25 percent of $160,00 or $40,000 of income on his annual income tax return. Caesar must report 15 percent of $160,000 or $24,000 of income on his annual income tax return, and Francis must report 35 percent of $160,000 or $56,000 on his return.
If the asset pool is placed in an irrevocable trust, the trust (which is a separate taxpayer) must report and pay taxes on any income generated by the assets. In general, trusts enjoy a smaller exemption and pay tax at a higher rate than individuals. If the asset pool is placed into a revocable trust, the grantor trust rules apply. The income tax return for the trust is merely informational, and the income and expenses are passed through to the contributing members in proportion to their contributions.
What Are The Estate Tax Consequences?
The estate tax consequences also depend on the vehicle that is used to create the family bank. If the funds are merely pooled into an account (e.g., bank, investment, etc.), the assets are not removed from the contributing members' estates and will be included in the members' estates (in proportion to their contributions) for estate tax purposes.
If the assets are placed in an irrevocable trust, the assets are removed from the contributing members' estates, and will not be included in their estates for estate tax purposes. Thus, a family bank using an irrevocable trust can be a successful estate freeze technique.
If the assets are placed in a revocable trust, the assets are not removed from the contributing members' estates, and will be included in the members' estates for estate tax purposes (in proportion to their contributions).
Caution: The contributing members must be careful not to retain any "incidents of ownership" over the property transferred in order to satisfy the IRS that the assets have actually been removed from the estate for tax purposes. Thus, contributing members must be prepared to totally release their control over the assets.
Technical Note: "Incidents of ownership" is a legal term which refers to the right of the transferor to receive or to control the economic benefits of the property transferred (e.g., the right to receive income distributions, to name the trustee, to name the beneficiaries, etc.).
This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.
The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.