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Finance Quarterly September 2011

The ultimate estate plan is not what you might think

The Ultimate Estate Plan Is Not What You Might Think

It’s said that seven out of 10 estate plans fall apart after the death of the parents who set up the plan. Legal documents like wills and declarations of trust aren’t designed to, and don’t, provide the information necessary for children to understand what their parents expect of them. As a result, the surviving children often have or develop different interpretations of their parents’ intentions. Imagine that your family is in a canoe. Mom and Dad have steered and directed the canoe throughout their lifetimes. Now imagine that Mom and Dad are gone. Their children don’t agree with each other and start paddling in different directions. Before you know it, they are arguing with each other and start hitting each other with the paddles to get their individual points across. In the real world, whacks with the paddles manifest themselves as lawsuits, and the assets that Mom and Dad have accumulated through their hard and diligent work are spent on legal and accounting fees. The worst part is that the children don’t speak to each other anymore. The ultimate estate plan is not just about trusts and wills and complicated planning ideas. To be successful, it must consider the “Family Equation.”

The Family Equation involves working with parents and family members during their lives and assisting them in navigating the complicated estate tax decisions they need to make and the consequences after their death. We believe this is best accomplished by advisors who are not selling products but instead are independently and objectively viewing alternatives.

Here are some items that need to be considered in this context:

Trustee Selection – Choosing a trustee is crucial. Our first choice is a trustee whom you know and who has a relationship with your children. We have found that family members who are well organized and able to interact with professionals can be excellent trustees. Compare it to daycare for your child. A hired babysitter can provide your child company, but can they be expected to instill your family values? Corporate and professional trustees also can do an excellent job and can provide multi-generational continuity, but their job is to adhere strictly to the documents appointing them—and, as we mentioned above, these documents are designed for legal effect, not family values.

Fairness versus equality – Many times parents provide equal shares in their gift and estate planning. As a parent, I can understand how much easier it is to create such a plan. However, after parents die these decisions can have unintended consequences and add tremendous stress to sibling relationships, especially where a business is involved. For example, suppose Child A is the executive director of a non-profit organization and Child B is the president of the family business. The parents, wanting to provide equality after their deaths, bequeath 50 percent ownership of that business to Child A and 50 percent to Child B. Child B, who is working 80 hours a week to manage that family business, wants to make major investment changes to the business but now has to contend with Child A who might want the business to stay the same. If the siblings disagree, no major decisions can be made, and the business and its employees suffer. As a result, the two halves produce far less than the whole, and in addition there is now a wedge driven between the two siblings. Possible solutions include providing Child A with non-voting shares and Child B with voting shares that allow Child B to override in these situations, or clauses allowing Child B to buy out Child A, if Child A needs cash and wants nothing to do with or be involved with the risks of owning a business.

Incentive Trusts – An incentive trust is a way for a parent to manage from the grave by special stipulations or milestones written in the trust document in order for the beneficiary to receive money.  The idea is to provide incentives to motivate children and not have them rely on their trust proceeds. Many times, however, we have seen how these provisions can actually have unintended negative consequences.

Suppose a trust provides that a child is to receive money only when he attains the age of 40. Then the child develops a serious illness at age 35 and needs money for medical treatment, but can’t get a dime out of the trust. Another popular option is the dollar for dollar incentive, where your children will receive a dollar for every dollar earned during their respective lives. On the surface it sounds good, but what if one child works at a non-profit organization that helps the poor, earning $45,000 a year, and the other works at an investment bank in New York making millions. Did the parents intend that almost all of the trust assets go to the investment banker? The takeaway is that incentives or stipulations to change a child’s behavior can have unintended consequences. A potential solution is to provide the trustee with the flexibility to govern situations down the road and reinforce behaviors you want your child to have as if you were still around. This is easier said than done, making the selection of the trustee crucial. When there is flexibility in your trust document, the trustee can decide when it is appropriate or how much should be distributed to your child.

Heartfelt Letter – This is a non-legal document or letter to your beneficiaries and trustees expressing your expectations, goals and ambitions for them. The letter is really a heart-to-heart talk of what your expectations are of your children in regards to how they live, treat others, and other lessons that you would like to impart to them. Likewise, it informs your trustee about how you would run the trust if you were still alive. In essence it is a transition document to hand over the reins of parenthood.

Family Involvement – Many wealthy parents are uncomfortable talking about money matters with their children. However, in my experience there is always a time that this information should be communicated to them; the question is when. This is an area where a parent should understand how this information will affect their child. Will this information allow your child to select a profession that they have a passion for rather than seeking a profession based upon compensation? For example, a child may have a passion for teaching, but recognizes that the income derived from teaching may not be sufficient for his or her needs. Therefore, communicating to them before they attend college may aid their decision to choose a profession. Or your child could be the total opposite and lose focus since they feel it is not necessary to have any educational goals. Every child is different, but what is important is teaching your child the responsibility of their potential inheritance and how you as a parent want this gift to be beneficial to them versus potentially ruining their lives.

Responsibility– This encompasses not only financial responsibility, but a responsibility to the greater community. We have many wealthy individuals who donate to, advocate for, or otherwise help – such as by volunteering or using contacts to create awareness about – great causes. When children see their parent’s involvement in these causes, we often see these wonderful traits passed on to the next generation. In contrast, we see parents who rarely make charitable contributions, treat vendors poorly, spend frivolously, are demanding, and then wonder why their children are like that.

Wealth is based upon many years of hard work and effort. Your legacy is not about the wealth you generated during your life but how that wealth is used to help others and, more importantly, the legacy you leave behind with the next generation. After you have spent a lifetime creating wealth, you can engage in complicated estate and gift tax planning, but that work, too, can be undone in a few years if the next generation dissipates it or drains it through infighting. Estate taxes are here to stay and most people need professional help to navigate the legal and tax complexities. But the ultimate estate plan must incorporate the Family Equation so that your estate plan has a better chance of succeeding, and to keep the canoe going in the right direction.

The contents of this article are informational only.  This article is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or any comparable state law, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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