What are the latest developments in estate planning techniques? Here's a rundown. Plus, why your clients shouldn't get hung up on any thoughts of estate tax "repeal."
Working for the Silver Spoon
Many people who have struggled to amass wealth aren't willing to just hand it over to their kids. They are providing incentives for their children to "earn" the money.
"Clients are scared of negative impacts of inherited wealth on children," says John Scroggin, an estate planning attorney in Roswell, Ga. "They don't want to give them a Lamborghini lifestyle."
Enter the Family Incentive Trust. "It's a trust designed to put reasonable restraints on inherited wealth," Scroggin says. "It's designed to provide a safety net - incentives."
Lori Noffsinger, director of financial planning for First Union Securities in Richmond, Va., says heirs can be offered different incentives. For example, trust distributions can be limited to the amount the beneficiary has earned from a job or be made contingent on volunteer work. "Parents want to have some kind of control from the grave," Noffsinger says.
Understanding FLPs and LLCs
Family limited partnerships (FLPs) have been popular for awhile. But estate planning experts note that FLPs have now withstood several IRS challenges over the asset-value discounts they create for estate valuations purposes.
Ellen Simmons, vice president and head of estate planning at A.G. Edwards in St. Louis, explains an FLP's appeal like this: "You can give away assets while keeping full control." But the problem is that the partnership is supposed to be a business-like entity.
That's true, says Jim Barnash, field vice president with Lincoln Financial Advisors in Rosemont, Ill. "But people are getting away with putting a [securities] portfolio in," he says.
Charles Fox, estate planning attorney and partner with Schiff Hardin & Waite in Chicago, tells how FLPs work: "Suppose you put $5 million in marketable securities into a family limited partnership. You still have access to dividends and can make [investment] decisions. If you give away the limited partnership, you might get a discount of 30% to 50%" for estate tax purposes.
The discount helps in three ways, says Gary Spaid, a broker who runs Family Wealth Counseling, a Raymond James Financial Services firm in Edwards, Colo. "First, the client can give $16,666 worth of assets and, with a 40% discount, the gift is only counted as $10,000. Second, if there were any partnership units left in the estate, the estate tax would be on the discounted amount. Third, the growth in FLP assets that were gifted avoid estate tax."
Although FLPs work well with highly appreciated assets, such as real estate, they are more expensive to set up than other techniques, says George Guertin, an estate planning attorney in North Haven, Conn. "Appraisal costs can be high, and [FLPs] have to be reappraised every year," he says. "Legal fees are higher than others."
Fox says the FLP's counterpart, the limited liability company (LLC), has grown in popularity. "Each device allows you to get substantial discounts on the value of assets," he says.
David Handler, estate planning attorney and partner with Kirkland & Ellis in Chicago, agrees that LLCs are something of a trend. They're easier to set up because there's only one entity instead of a general partner and limited partners, he says. "Plus, there's no liability to anyone."
Giving it Away to Charity
Charitable giving, particularly with the rise in the stock market, has definitely increased," notes Terry Crow, general partner with St. Louis-based Edward Jones and president of its trust company.
Handler says altruism has always been popular among those with old money but it is now gaining favor in new money circles. "Things happen so much faster now than they used to," he says. "Someone 35 has $300 million in stock and $100 million is enough to get by on. We're seeing a lot of charitable intent, not just as a tax technique."
Charitable Remainder Trusts (CRTs) are fashionable. Spaid explains how they work: "The client places highly appreciated assets such as stock into a CRT. The trust sells the assets and reinvests the proceeds. The client gets a charitable deduction for the gift, avoids capital gains tax and gets income for his life and/or the life of his spouse. At the death of the second spouse, the charity gets what's left in the trust."
Some brokerage firms now offer charitable gift mutual funds. Nathan Crair, senior vice president and director of financial services for Prudential Securities in New York, says the firm offers such funds from Eaton Vance and Fidelity. "It's a technique for giving money to charity," he says. "They are donor-advised funds: The donor can advise the charity on when and where to give the dollars out."
Another trendy charitable vehicle is the family foundation. "It's for an individual who wants to pass the estate in a philanthropic manner," says Tom Shadden, who works with his son, John, at Morgan Stanley Dean Witter in Long Beach, Calif. "They can gift assets to a number of charities and develop it with a board of directors, which could be their children."
These foundations are for people with substantial wealth. Because of high administration costs, foundations for estates of $1 million are not economically feasible, says John Shadden. "Most are $10 million to $20 million and more."
Creating a Real Life "Dynasty"
Nothing lasts forever? Think again. "The concept of a dynasty trust has proliferated," Handler says. "You create a trust in a state that has abolished the rule against perpetuities." Delaware and Illinois are examples. "The trust can go to a child, grandchild and great grandchild."
A dynasty trust is a generation-skipping trust. Currently, a person can put $1,030,000 in a generation-skipping trust and skip the estate-tax bill.
Fox says dynasty trusts compare favorably to other trusts that tax assets to each generation. He explains: "You put $1 million into a trust, invest at 7% and don't make withdrawals. If you pay tax at 55% each time a generation dies off, at the end of 100 years you might have $80 million to $100 million.
"On the other hand, if you did the same thing with no generation tax [via a dynasty trust], in 80 to 100 years your great grandkids would have $500 million to $700 million in trust."
Choosing Offshore Trusts
Offshore trusts for creditor protection are a hot topic in estate planning, but they are also met with skepticism.
"We're seeing a fair amount of interest in offshore trusts in places like the Turks and Caicos Islands or Belize," Fox says. However, the volatility of those and other foreign governments is a concern, he says.
Spaid reminds clients that while these trusts protect assets legally, they are also tax neutral. "If you don't pay income tax on assets, whether they are in the United States or not, you may end up in jail," he says.
But Guertin calls offshore trusts schemes. "I'm skeptical until they're approved in court," he says. "No case has gone up high enough in the courts. There's political danger. Their laws may change. ... I don't want to put clients in risky things."
A less risky option is an onshore trust in Alaska or Delaware. These trusts, too, are supposed to offer creditor protection. "But I haven't seen proof that they work," Guertin says.
Fox warns that onshore trusts used for asset protection are irrevocable. And the donor cannot compel a trustee to give the donor a payout. "Be careful in picking the trustee," Fox says.
Further, Barnash dislikes the limited flexibility to choose a trustee. "The challenge is that you must have a trustee who's a resident of that state - a bank or a trust company in Alaska or Delaware."
Even for clients who face major liability issues, onshore trusts may prove unappealing, according to John Shadden. "We've talked about Alaska trusts," he says. "We've found they're complex and costly. And it's questionable whether they're guaranteed to work. We don't see a huge amount of interest."
Estate Tax Repeal or Not, Clients Need Help
The need for estate planning isn't going anywhere, despite what might happen with estate tax "repeal."
Keep in mind that the word repeal - as used by politicians - has its own meaning.
The so-called estate tax repeal approved this past summer by Congress and later vetoed by President Clinton had a 10-year phase-in period and would have eliminated the step-up in basis.
"My feeling is that they will not repeal the estate tax," says Ellen Simmons, vice president and head of estate planning at A.G. Edwards in St. Louis. Instead, she predicts some mitigation. "The $675,000 exemption increases to $1 million by 2006. It might happen quicker or you might get a larger exemption."
Gary Spaid, who runs Family Wealth Counseling, a Raymond James Financial Services firm in Edwards, Colo., agrees. "Since dead men don't vote, I give the [repeal] little chance of passing in the future," he says. "Even if it did pass, two different administrations would have plenty of time to add some sort of transfer tax back to the tax code."
Nevertheless, because of the uncertainty, clients are procrastinating more than ever.
There are ways to deal with uncertainty, according to Lori Noffsinger, director of financial planning for First Union Securities in Richmond, Va. "I've been seeing advisers recommend that clients make more prevalent use of disclaimers."
That is, allow the surviving spouse to disclaim assets and thereby pass them directly to the kids or to a trust using the deceased's exemption equivalent to avoid estate taxes. But if estate taxes disappear, the spouse can accept the entire estate and still pass assets to the children without estate taxes.
Regardless of the tax rules, clients still want the same result. "Clients really appreciate protective measures - making sure wealth goes where they want it to, and making sure the client, children and grandchildren are protected," concludes John Shadden, a broker at Morgan Stanley Dean Witter in Long Beach, Calif.