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This article comes from local financial advisor Elliott Orsillo (www.seasoninvestments.com). Elliott's excellent analysis of the history and political realities of the debt ceiling debate is worth perusing. 
Hope this helps you!

The 95th Raising of the Debt Ceiling

Posted on January 15, 2013

“I can confirm we will reach the statutory debt limit today.” – US Treasury Official on December 31, 2012

debt_ceiling.jpgNow that all the political posturing surrounding the fiscal cliff is behind us, it is time for the newly elected Congress to wet their brinkmanship beaks over the debt limit placed on the US Treasury, affectionately known as the debt ceiling. As the opening quote indicates, the US Treasury reached its statutory debt limit at the end of last year. Using “extraordinary measures” and creative accounting, the Treasury thinks it can keep the US government afloat until late February or early March of this year before the debt limit will need to be raised for the 95th time in history to avoid default. 

The whole concept of a debt ceiling is a bit strange in that Congress has the power to set revenues (e.g. tax receipts) and spending, but chooses to outsource the process of issuing debt in order to fill the gap between these two (e.g. the deficit). A somewhat weak parallel can be made to a household which has a known income, the power to set spending, and credit to fill the gap between income and spending, which is extended to them by a bank. At some point, a “debt limit” is reached and banks will no longer extend credit to a household who has built up too much debt and is spending in excess of its income. This is where the analogy breaks down since our fictitious household has no control over raising its debt limit, whereas Congress has complete control over it.

The debt limit was first introduced in 1917 when Congress passed the Second Liberty Bond Act. Before this point, if Congress needed to borrow money to finance a specific plan or project, such as digging a giant canal in Panama, it would approve the sale of a lot of Treasury bonds. Each new lot of bonds was considered individually based on the merit of the need. But with the United States’ entry into the First World War, this process became much too time consuming, so Congress delegated bond issuance to the Treasury Department. The delegation did come with a major caveat which allowed Congress to cap the amount of debt the Treasury could issue by establishing a debt limit.    

Since that time, the debt limit has done very little to control the debt burden of the United States. The chart below plots the debt limit versus outstanding debt on a logarithmic scale. As a brief side note, plotting a logarithmic scale allows us to visualize percentage changes in the debt ceiling over time rather than just absolute dollar changes.


The points on the chart that have the steepest slope are the periods of time where the debt limit was increased the most as measured by the percentage change from the previous debt limit level. We see that the steepest increase was during the FDR administration in the early 40’s, which was followed by a long period of little to no increases. Then in the 1970’s with Nixon taking the US dollar off the gold standard and the embrace of Wimpy economics, the slope of the line turns up again. The slope has roughly remained the same ever since with the exception of the economic and technological boom of the late 1990’s.

It doesn’t take a genius to see that the debt limit is raised once the total outstanding debt either approaches or bumps up against the limit. The raising of the debt limit is a bipartisan practice as well. Since it was established in 1917, it has changed 104 times with 94 raises and 10 declines (although 3 of the declines only lasted for 1 day during political brinkmanship under the Carter administration). Of the 94 increases, 54 have been done under a Republican president and 40 under a Democratic president while the magnitude of the increase has been larger on average under Democrats.


The situation we find ourselves in today is similar to that of 1954 when Republican president Dwight D. Eisenhower butted heads with Democratic senator Harry F. Byrd who chaired the Senate Finance Committee. Eisenhower wanted to raise the debt limit in order to finance the build out of a national highway system. Byrd pushed back stating his concern over the apparent permanency of the national debt that had built up from the Great Depression and World War II. He demanded spending cuts be made in exchange for raising the debt limit. The Treasury had to take emergency measures to avoid default before both sides eventually came to a compromise and raised the limit while also cutting spending.

Not unlike the 1954 debate, the battle over the 95th raising of the debt ceiling has one side stating that it is for the good of the nation while the other believes it is the only tool left in the toolbox to try to reign in government spending. In reference to Congressional Republicans, President Obama stated, “They can act responsibly, and pay America's bills; or they can act irresponsibly, and put America through another economic crisis.” In response, Republican Senate Minority Leader Mitch McConnell fired back by stating that Democrats “need to get serious about spending, and the debt-limit debate is the perfect time for it.” There has even been talks of the Treasury printing a trillion dollar coin, a loophole which exploits the Treasury’s ability to mint commemorative platinum coins, to avoid the debt ceiling. Thankfully this idea has been put to bed, but it just goes to show the extremes our leaders are willing to consider due to the highly partisan and divisive atmosphere in D.C. today.

Needless to say, we are in for another drawn out debate which will be fought in the press and most likely end with a last minute fix. Our view is that this will be accompanied with short bouts of volatility over the upcoming weeks as investors and traders try to digest every tidbit of information they receive from the soon-to-be highly publicized debate. Although we don’t think the debt ceiling debate will be the catalyst that crashes the party, we do realize that there are real, unknown risks in the market that could pop up at any given moment. To quote BlackRock Investments, “the shell you can hear is not the one that hits you.”


elliott_headshot_bw.jpgAuthor Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.


Understanding Charitable Remainder Trusts

Posted on: October 18th, 2012

Understanding Charitable Remainder Trusts

How to Secure a Lifetime Income, Save Taxes & Benefit a Charity

Since 1969, countless families have used charitable remainder trusts (CRTs) to increase their incomes, save taxes and benefit charities.

What does a CRT do?
A CRT lets you convert a highly appreciated asset like stock or real estate into lifetime income. It reduces your
income taxes now and estate taxes when you die. You pay no capital gains tax when the asset is sold. And it lets you help one or more charities that have special meaning to you.

How does a CRT work?
You transfer an appreciated asset into an irrevocable trust. This removes the asset from your estate, so no estate taxes will be due on it when you die. You also receive an immediate charitable income tax deduction.

The trustee then sells the asset at full market value, paying no capital gains tax, and re-invests the proceeds in income-producing assets. For the rest of your life, the trust pays you an income. When you die, the remaining trust assets go to the charity(ies) you have chosen. That’s why it’s called a charitable remainder trust.

Charitable Remainder Trust

Why not sell the asset myself and re-invest?
You could, but you would pay more in taxes and there would be less income for you. Let’s look at an example.

Years ago, Max and Jane Brody (ages 65 and 63) purchased some stock for $100,000. It is now worth $500,000. They would like to sell it and generate some retirement income.

If they sell the stock, they would have a gain of $400,000 (current value less cost) and would have to pay $60,000 in federal capital gains tax (15% of $400,000). That would leave them with $440,000. (See chart at right.)

If they re-invest and earn a 5% return, that would provide them with $22,000 in annual income. Multiplied by their life expectancy of 26 years, this would give them a total lifetime income (before taxes) of $572,000. Because they still own the assets, there is no protection from creditors and no charitable income tax deduction is available.

What happens if they use a CRT?
If they transfer the stock to a CRT instead, the Brodys can take an immediate charitable income tax deduction of $90,357. Because they are in a 35% tax bracket, this will reduce their current federal income taxes by $31,625.

The trustee will sell the stock for the same amount (see chart at right), but because the trust is exempt from capital gains tax, the full $500,000 is available to re-invest. The same 5% return will produce $25,000 in annual income which, before taxes, will total $650,000 over their lifetimes. That’s $78,000 more in income than if the Brodys had sold the stock themselves. And because the assets are in an irrevocable trust, they are protected from creditors.

What are my income choices?
You can receive a fixed percentage of the trust assets (like the Brodys), in which case your trust would be called a charitable remainder unitrust. With this option, the amount of your annual income will fluctuate, depending on investment performance and the annual value of the trust.

The trust will be re-valued at the beginning of each year to determine the dollar amount of income you will receive. If the trust is well managed, it can grow quickly because the trust assets grow tax-free. The amount of your income will increase as the value of the trust grows.

Sometimes the assets contributed to the trust, like real estate or stock in a closely-held corporation, are not readily market-
able, so income is difficult to pay. In that case, the trust can be designed to pay the lesser of the fixed percentage of the trust’s assets or the actual income earned by the trust. A provision is usually included so that if the trust has an off year, it can make up any loss of income in a better year.

Comparison of Income After Sale
  Without CRT With CRT
Current Value of Stock $ 500,000 $ 500,000
Capital Gains Tax* - 60,000 0
Balance To Re-Invest $ 440,000 $ 500,000
5% Annual Income $ 22,000 $ 25,000
Total Lifetime Income $ 572,000 $ 650,000
Tax Deduction Benefit** $ 0 $ 31,625
*15% federal capital gains tax only.
(State capital gains tax may also apply.)
**$90,357 charitable income tax deduction times 35% income tax rate.

Can I receive a fixed income instead?
Yes. You can elect instead to receive a fixed income, in which case the trust would be called a charitable remainder annuity trust. This means that, regardless of the trust’s performance, your income will not change.

This option is usually a good choice at older ages. It doesn’t provide protection against inflation like the unitrust does, but some people like the security of being able to count on a definite amount of income each year. It’s best to use cash or readily marketable assets to fund an annuity trust.

In either (unitrust or annuity trust), the IRS requires that the payout rate stated in the trust cannot be less than 5% or more than 50% of the initial fair market value of the trust’s assets.

Who can receive income from the trust?
Trust income, which is generally taxable in the year it is received, can be paid to you for your lifetime. If you are married, it can be paid for as long as either of you lives.

The income can also be paid to your children for their lifetimes or to any other person or entity you wish, providing the trust meets certain requirements. In addition, there are gift and estate tax considerations if someone other than you receives it. Instead of lasting for someone’s lifetime, the trust can also exist for a set number of years (up to 20).

Do I have to take the income now?
No. You can set up the trust and take the income tax deduction now, but postpone taking the income until later. By then, with good management, the trust assets will have appreciated considerably in value, resulting in more income for you.

How is the income tax deduction determined?

The deduction is based on the amount of income received, the type and value of the asset, the ages of the people receiving the income, and the Section 7520 rate, which fluctuates. (Our example is based on a 3.0% Section 7520 rate.) Generally, the higher the payout rate, the lower the deduction.

It is usually limited to 30% of adjusted gross income, but can vary from 20% to 50%, depending on how the IRS defines the charity and the type of asset. If you can’t use the full deduction the first year, you can carry it forward for up to five additional years. Depending on your tax bracket, type of asset and type of charity, the charitable deduction can reduce your income taxes by 10%, 20%, 30% or even more.

What kinds of assets are suitable?
The best assets are those that have greatly appreciated in value since you purchased them, specifically publicly traded securities, real estate and stock in some closely-held corporations. (S-corp stock does not qualify. Mortgaged real estate usually won’t qualify, either, but you might consider paying off the loan.) Cash can also be used.

Who should be the trustee?
You can be your own trustee. But you must be sure the trust is administered properly—otherwise, you could lose the tax advantages and/or be penalized. Most people who name themselves as trustee have the paperwork handled by a qualified third party administrator.

However, because of the experience required with investments, accounting and government reporting, some people select a corporate trustee (a bank or trust company that specializes in managing trust assets) as trustee. Some charities are also willing to be trustees.

Before naming a trustee, it’s a good idea to interview several and consider their investment performance, services and experience with these trusts. Remember, you are depending on the trustee to manage your trust properly and to provide you with income.

Do I still have some control?
Yes. For as long as you live, the trustee you select—not the charity—controls the assets. Your trustee must follow the instructions you put in your trust. You can retain the right to change the trustee if you become dissatisfied. You can also change the charity (to another qualified charity) without losing the tax advantages.

Can I make any other changes?
Generally, once an irrevocable trust is signed, you cannot make any other changes. Be sure you understand the entire document and it is exactly what you want before you sign.

Sounds great for me. But if I give away the asset, what about my children?
If you have a sizeable estate, the asset you place in a CRT may only be a small percentage of your assets, so your children may be well taken care of. However, if you are concerned about replacing the value of this asset for your children, there is an easy way to do so.

As the illustration below shows, you can take the income tax savings, and part of the income you receive from the charitable remainder trust, and fund an irrevocable life insurance trust. The trustee of the insurance trust can then purchase enough life insurance to replace the full value of the asset for your children or other beneficiaries.

Replace Asset with Insurance

Why use a life insurance trust?
With a trust, the insurance proceeds will not be included in your estate, so you avoid estate taxes. You can keep the proceeds in the trust for years, making periodic distributions to your children and grandchildren. And any proceeds that remain in the trust are protected from irresponsible spending and creditors (even spouses).

Life insurance can be an inexpensive way to replace the asset for your children. (Every dollar you spend in premium buys several dollars of insurance.) Insurance proceeds are available immediately, even if you and your spouse both die tomorrow. And, in addition to avoiding estate taxes, the proceeds will be free from probate and income taxes.

So what’s the catch?
There really isn’t one. Combining a charitable remainder trust with an irrevocable life insurance trust is a winning formula for everyone—you, your children and the charity.

You convert an appreciated asset into lifetime income, and because you pay no capital gains tax when the asset is sold, you receive more income than if you had sold it yourself and invested the sales proceeds. You receive an immediate charitable income tax deduction, reducing your current income taxes. And by removing the asset from your estate, you reduce estate taxes that may be due when you die.

With the life insurance trust replacing the full value of the asset, your children receive much more than if you had sold the asset yourself, and paid capital gains and estate taxes. Plus the proceeds are free of income and estate taxes, and probate.

Finally, you will make a substantial gift to a favorite charity. And because the charity knows it will receive the gift at some point in the future, it can plan projects and programs now—benefiting even before receiving the gift.

Should I seek professional assistance?
Yes. If you think a charitable remainder trust would be of value to you and your family, speak with a tax-planning attorney, insurance professional, corporate trustee, investment adviser, CPA, and/or favorite charity. Be sure an attorney experienced in CRTs prepares the documents.

Benefits of a Charitable Remainder Trust
  • Convert an appreciated asset into lifetime income.
  • Reduce your current income taxes with charitable income tax deduction.
  • Pay no capital gains tax when the asset is sold.
  • Reduce or eliminate your estate taxes.
  • Gain protection from creditors for gifted asset.
  • Benefit one or more charities.
  • Receive more income over your lifetime than if you had sold the asset yourself.
  • Leave more to your children or others by using life insurance trust to replace the gifted asset.

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