Even in 2001-2002, when President Bush, most of Congress and many wealthy Americans declared war on the “death tax,” estate planning did not stop. Affluent clients continued to worry about (1) wills, trusts and the distribution of assets during lifetime or at death; (2) family business successorship and continuity; (3) dealing with second spouses, multiple sets of stepchildren and disabled family members; (4) incapacity and longevity; and (5) asset protection issues. The demand for multidisciplinary estate planning is even greater now that it appears estate and inheritance taxes will not be eliminated.
Holistic estate planning places at least as much importance on family factors as on tax minimization. Three essential estate planning issues do not involve taxes at all: family system dynamics, asset protection and raising good kids.
Family system dynamics
Each family group is different in terms of culture and communication. There are varying degrees of independence and co-dependence, and typically a wide range of individual talents and shortcomings.
Certain trends and patterns are present in many families who share ownership of substantial business or investment assets. Perhaps the most important factor involves the concept of interrelationships. An estate planning review for any family unit should consider inherent repercussions for other family members or branches who share the family business legacy.
These same patterns may also be present where significant investment assets are involved. This may include real estate holdings. Issues such as control and management of investment assets within the broader family group are usually present.
Multiple family members, for example, may own interests in substantial rental properties. Their financial assets and income may vary. Over a period of years, there is natural growth in the number of family members who share direct or anticipatory financial benefits from the properties. Some family members will encourage reinvestment of cash flow to reduce mortgage indebtedness and to acquire additional properties. Others may emphasize payment of all available cash flow for current use. Who is in control of decision making?
Family system dynamics can also play a role when the significant business or investment asset has been sold and there is substantial liquidity. Family members have grown accustomed to centralized ownership and management of these assets, perhaps over several generations. Some are likely inexperienced in financial and investment matters. It is reasonable for them to seek continued direction in management of investment assets. Sometimes, there are feelings that ancestors would prefer and expect that the family keep the legacy intact, regardless of its new, liquid form.
These factors are often vague and subtle, but they are extremely important in the planning process. It is not necessary for each family unit to make the same choices in financial and estate matters, but it is important that family members and their advisers avoid conflicts or inconsistencies. Issues such as asset appraisal values, cash distribution policy and company growth expectations must be analyzed within the larger family group.
Asset protection
This is not a new topic precipitated by the recent economic crisis. Parents have always sought to protect assets that provide financial security for spouses and children. For affluent families, the preservation of assets and capital may be more important than superior growth, appreciation and financial performance. Consider these possibilities:
• Random lawsuits and crazy juries
• Rivalry between offspring or family branches
• Divorce and remarriage
• The next generation’s inabilities or lack of interest regarding financial and business responsibilities
• Mental or physical incapacity
• Risky business ventures and investments (or fraud)
• Drug, alcohol or gambling addiction
• Contingent liability associated with the fine print of commercial and financial transactions
• Changes in trust reformation and modification
• Multigenerational goals and objectives
• Greater flexibility, responsibility and capabilities required of trustees and other fiduciaries
• Risk of dramatic changes in government regulation
• Organization of interests to accommodate shared ownership (loss of control in partnerships, limited liability companies and corporations)
Prenuptial agreements are a necessary component of the asset protection process that must be handled with care and sensitivity. Perhaps nothing can be more unpleasant to discuss with a daughter or son in between the engagement announcement and the wedding. Too many parents and advisers quickly consider draconian forfeiture provisions in the event of death or divorce instead of allowing the young couple to reasonably deal with the financial risks and consequences associated with termination of marriage.
Raising good kids
The topic of trusts will inevitably arise in the context of estate planning for the next generation and beyond. It is often popular to discuss incentive trusts, which mete out financial benefits to beneficiaries as a reward for accomplishment, good behavior or avoidance of undesirable behavior. Too often, the goals and objections expressed by parents within these parameters reveal purely personal desires and aspirations. Articles in the mainstream press have overstated the success of these trusts.
Alternatively, parental optimism for the future can be expressed in the terms of a “supplemental income trust.” Regardless of the child’s career or life choice, he or she will appreciate an annual income supplement of $25,000 to $50,000, beginning at a specified age or graduation date. This is not enough money to create a lazy bum, but it certainly is enough to enable a child to enter a career that is well known for modest remuneration (e.g., teacher or social worker). It is much more effective to establish an income trust for this purpose than to offer well-intentioned promises of annual gifts consistent with gift tax planning techniques. Promises will not influence the kids’ long-term behavior or choices.
Too little consideration is given to the selection of trustees charged with the administration of trust funds for the benefit of children and grandchildren. This is much more important than merely filling in the blank of the attorney’s trust form. The expense associated with professional trusteeship is not nearly as important as the inherent tasks and responsibilities. Individual trustees’ future incapacity or lack of attention must also be taken into account if a trust will last for many years. Careful consideration must be given to appointment of successor trustees. Asset protection is important, but it is also important to encourage younger family members to learn their personal responsibilities for financial and business matters as trustees or direct owners.
New-age estate planning suggests the possibility of designating the child as co-trustee, and then sole trustee, of his or her own trust funds at appropriate ages. Many children embrace this concept. With careful planning, there are significant safeguards and protection in the event of unexpected lawsuits, divorce disasters or financial failures. There are many advantages over outright ownership of substantial assets. Although the arrangement is subject to possible abuse by a beneficiary serving as sole trustee, it also offers important speed bumps, which can act as asset protection safety nets in many cases.
Too many trusts are created for a term of too many years, or even for lifetime of a child as beneficiary, without regard for the possibility of a dramatic change in facts and circumstances. Good kids can become rotten kids; rotten kids can finally achieve a level of at least minimally acceptable responsibility. And handicapped or incapacitated children can benefit from future medical advances that could be dramatic in nature.
The estate planner may be well advised to focus more attention on the daughter-in-law or son-in-law. Trusts have the ability to provide flexibility, asset protection, tax advantages and peace of mind in the event of issues in a marriage. Remember, however, these in-laws are also parents of your grandchildren. It is not wise to treat them as strangers, or even adversaries, who cannot share direct or indirect financial benefits and financial security that will inure to the benefit of your grandchildren. There is always room to include the in-law as a contingent beneficiary under appropriate circumstances, regardless of strong fears concerning remarriage, relationship abandonment or an ancestor’s disapproval from the grave.
Keep your priorities in order
Do not be preoccupied with minimizing taxes. Family dynamics, asset protection and raising good kids are three examples of objectives that should be considered in the financial and estate plan for people of wealth. This is not the place to cut corners, minimize time or save a few thousand dollars. Charitable gifting should also be considered. There is a limit to how much wealth the kids can handle before it is obviously better to give it to charity, now or later.
Joe M. Goodman, based in Nashville, Tenn., is an attorney, a CPA with Personal Financial Specialist designation and a family business consultant with Adams and Reese LLP (joe.goodman@arlaw.com).