In the world of wealth planning for high income and high-net-worth clients, have things really changed? Here are my reflections of how the estate-planning and wealth planning industries have assisted wealthy families to accomplish their goals. I’ll address where we were yesterday, where we are today and predict where this endeavor is heading.
About 36 years ago, I was introduced to an article written by Professor George Cooper for the Columbia Law Review. The law review article, “A Voluntary Tax? New Perspective on Sophisticated Estate Tax Avoidance,”1 was subsequently reprinted in a 1979 book by The Brookings Institution and can still be purchased online today. Prof. Cooper and one of his students, Terence Kinsman, harkened back to 1917 and reviewed estate plans of some of the wealthiest families in the United States. Cooper shared the tools and techniques used in 1917, noticing that they still remained common viable options in 1977.2 These techniques included:
I. Estate freezing
A. Using preferred stock recapitalizations
B. Installment sales
C. Family partnerships and limited liability companies (LLCs)
D. Interfamily loans and fringe benefits inlcuding opportunity shifting
2. Creating tax-exempt wealth
A. Using life insurance
B. Qualified plans and annuities
C. Survivorship benefit plans
3. Disposing of wealth already accumulated
A. Using a generation-skipping transfer (GST) trust
B. Using philanthropy including charitable lead trusts (CLTs), charitable remainder trusts (CRTs) and private family foundations
Back in 1917, tax attorneys purposefully “hid” research about these planning tools in confidential documents of their wealthiest clients, who were sworn to secrecy. And, there weren’t many articles about these tools until Prof. Cooper wrote about them in his 1977 article. Prof. Cooper commented that almost all of the tools were in use some-60 years earlier by leading estate-planning attorneys for their highest-net-worth individual clients and high income family clients.3
Over the past 40 plus years, I’ve enjoyed the use of creative philanthropy in concert with asset-protected legacy trust planning and the advanced applications of permanent life insurance to help high-net-worth families accomplish all of the following:
- To provide long-term income security for spouses and their children
- To perpetuate family values and educate heirs of the importance of excellent values
- To protect family assets from the ravages of risks through asset protection planning
- To maximize income tax savings while also creating family and charitable legacies
- To help create organizations that specialized in creative philanthropy within the multi-disciplinary fields of law, accounting, wealth management, non-profit organizations and wealth planning. These organizations are growing as a bridge among the multi-disciplines designed to promote true collaboration among competing professions.
Fast-forward to 2013, 96 years after the focus of Prof. Cooper’s original research. What techniques are highly qualified estate-planning professionals employing today as their latest and greatest estate and wealth planning strategies? Let’s take a look:
1. Estate freezing
A. Non-voting preferred stock and preferred partnership freeze units
B. Installment sales to intentionally defective grantor trusts at the lowest current applicable federal rates (AFRs)
C. Family partnerships and LLCs
D. "Rolling" Walton grantor retained annuity trusts (GRATs), qualified personal residence trusts (QPRTs) and grantor and non-grantor inter vivos and testamentary CLTs
E. Low interest inter-family loans and fringe benefits including opportunity shifting
2. Creating tax-exempt wealth
A. Using life insurance owned inside irrevocable life insurance trusts (ILITs), GST trusts and LLCs
B. Qualified plans and annuities including employee stock ownership plans (ESOPs)
C. Survivorship benefit plans including family private split-dollar plans
3. Disposing of wealth already accumulated
A. Using GST trusts
B. Using philanthropy including CLTs, CRTs, private family foundations and donor advised funds
3. Using large discounted gifts including GRATs, QPRTs and charitable lead annuity trusts
Today’s complex field of wealth planning embodies many diverse disciplines: law, accounting, finance, insurance, asset protection, family wealth dynamics, family therapy, business succession, philanthropy, psychology, and of course, wealth management. And, while many advisors purport to be collaborative, true multi-disciplinary collaboration rarely exists. The question is, “Why?”
Probably due to three reasons: the high added costs to the client; the strong need for the gatekeeper to control; and because there’s NO "I" in “team.” By far, the leaders of private banks, single family member offices, multi-family offices (MFOs) and high-end private client group attorneys often have difficulty in subordinating their roles. Private bankers, MFOs, registered investment advisors and wealth management firms typically are compensated primarily by receiving large fees for keeping large amounts of assets under management (AUM). Often, their objectivity is challenged when other advisors advocate liquidating assets into accounts to provide family legacies to charities, private foundations and dynastic trusts. Large purchases of life insurance are also challenged by these same money managers in favor of keeping these assets in traditional classes of AUM.
This view may be shortsighted when creative planners can multiply the size of philanthropic and multi-generation legacies using Prof. Cooper's thesis of eliminating estate and GST taxes through his "voluntary tax" approach.4
By far, the most "toxic" asset in many estates today are the large qualified plan/individual retirement account balances.5 While most tax practitioners advocate the use of "stretch" ROTH or traditional "stretch" IRA's, many advisors recommend that the ultimate beneficiary of this class of assets be a private foundation or a donor advised fund, thereby eliminating the double or triple taxes. However, through multidisciplinary creative insurance and philanthropic planning, it’s possible to increase the amounts going to heirs and favorite charities simultaneously five-fold.
In today’s very low interest environment, with many assets still undervalued since 2008, planners are using the intentionally defective grantor trust and creative freeze techniques including: GRATs, note sales, private annuities for unhealthy grantors and CRTs and CLTs for the philanthropic client. These strategies are further enhanced by simultaneously combining discounted family limited partnership or LLC units. By adding GST-owned privately financed or commercially financed private split dollar insurance on both Generation 1 and Generation 2, much of Cooper's voluntary tax6 is eliminated.
Further, by eliminating this large estate tax, more wealth will remain under the ultra-high-net-worth family's control for many generations. This phenomenon would certainly be advantageous for the “100-year family,” the focus of James "Jay" Hughes’ books Family Wealth, Keeping it in the Family (2204) and Family, the Compact Among Generations (2007).7 Eliminating the estate tax would allow Hughes’ 100-year family to focus on governance, family values perpetuation and aiding younger generations to become involved in making the world a better place through modern philanthropic activities.
So, what can we expect in the future?
The election of November 2012 and the need of members of Congress to work together have caused delays that might not be resolved until late 2013 or 2014. The huge budget deficit, the slow growth of the U.S. economy and the heavy weight of foreign debt in Europe will keep Congress from further directly raising taxes. Congress will have to eliminate many of the "tax expenditures" afforded the various groups of high income and high-net-worth U.S. citizens. Many of these tax expenditures have formed the thesis for Prof. Cooper's research.7
For the mega wealthy and very high-net-worth clients, I believe that the elimination of many of these tax expenditures will go a long way in reducing our deficits. Wealth planning will become simpler, less esoteric and less creative. Large charitable bequests exempt from estate taxes will probably still remain at the death of the second spouse, particularly when combined with death benefit-oriented dynasty trust-owned large amounts of wealth replacement trust owned permanent life insurance.
1. See George Cooper, "A Voluntary Tax? New Perspectives on Sophisticated Estate Tax Avoidance," 77 Columbia L. Rev. 2 (March 1977).
5. Qualified plan/individual retirement account assets are generally double or triple taxed at the second spouse's death. In states that have high income and estate or inheritance taxes, at death, there’s inclusion for federal and state estate or inheritance taxes. In addition, there’s also inclusion for federal and state income taxes. The income in respect of a decedent (IRD) is a deduction that reduces the double tax. See Internal Revenue Code Section 691(c). In several states that have high income and high estate and/or inheritance taxes, even with the IRD deduction, the double or triple tax can be as high as 80 percent on qualified plan/IRA assets.
6. Cooper, supra note 1.
7. James "Jay" Hughes is the author of two books on the 100-year family: Family Wealth, Keeping it in the Family (2004) and Family, the Compact Among Generations (2007).