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Misguided Estate Planning Goals

December 13, 2012

I have never met so many people that just wanted to give away millions of dollars in such a hurry as I did in the past couple of months.  Everyone I meet says they want to eliminate estate taxes for their heirs.  Actually, many of their reasons are senseless!


The goal should be to pass on to your heirs as much as possible.  Saving estate taxes is one method.  A fool-proof method that will completely eliminate estate taxes is to leave all of your money to charity.  Bingo!  No estate taxes!  That is not what they mean – but that is what they say and what they are trying to do, but the charity solution is ill-advised for people with families or others close to them.  So, now that we eliminated wiping out the taxes, let’s look at reality.


As I said earlier (October 9 and 11, 2012) the $5 million gifts do not save estate taxes on those amounts, but they will save estate taxes on the future income and appreciation and possibly the valuation discounted amount.  So, actually, estate taxes will be saved on wealth not yet received!


Let me relate some situations that have come up.


  1. A 70-year-old widow with substantial net worth in limited partnerships providing cash flow… She lives on with no liquid assets and wants to give away the source of her cash flow to save her children the taxes that might become due in 18 or more years (her life expectancy).  This makes no sense for her since the cash flow is providing her financial security.
  2. A husband and wife, both age 60 with 5 children… They have a business worth $30 million that throws off substantial cash flow which is completely used for living costs and houses worth of $10 million with very little marketable securities should not give away anything to save estate taxes that might be payable in 32 years (the life expectancy of at least one of them).  This is also so considering that the estate taxes might be $10 million (at today’s rates) so that each child would only get $6 million instead of $8 million.
  3. An 88-year-old that owns appreciated real estate could give away some of his real estate to have his estate save tax on the discount amount, but the children would not get a stepped-up basis in the real estate and would have to pay the capital gains tax when they sell the property.  The estate tax would be higher than the capital gains tax, but not a “slam dunk difference.”  The planning we did was to work out a way to fragment the property so that when he died, the estate can avail itself of valuation discounts.  He was planning to leave a substantial amount to charity.  We suggested making the charity gift now so the balance of the estate would be able to take a valuation discount on the remaining real estate.
  4. A very wealthy, charitable-minded client in his mid-60s has $4 million in an IRA Rollover account.  He made a decision to leave the IRA to a charity and is setting up a charitable foundation to be the ultimate recipient of the IRA funds.  This reduces the estate and eliminates the income tax an individual beneficiary would pay on receipt of any distributions.  When he reaches his minimum required distribution dates, he will receive distributions but the ultimate beneficiary will be the foundation.
  5. Another client, also with $4 million in an IRA rollover, but age 83, will rollover the entire IRA to a Roth IRA.  The tax payments will be paid out of other funds and will be removed from her estate saving estate taxes on that amount.  During the remainder of the IRA owner’s lifetime, distributions will no longer have to be made, income and appreciation will accumulate income tax-free and the designated beneficiaries will receive distributions income tax-free.  There will be an estate tax on the Roth IRA account, and that will be paid for with other funds leaving the Roth IRA account intact to pay tax-free income for generations to the beneficiaries that will include grandchildren and great grandchildren.  The client is also considering a life insurance      policy to cover the estate taxes on the Roth IRA which will be expensive, but will be made with money that will also leave her estate and the life      insurance proceeds will be received estate tax free.
  6. A client that is so obsessed with not having their assets diminished with estate taxes is buying an immediate annuity and using those annual proceeds to pay for life insurance to cover some of his estate taxes.  The payment for the immediate annuity will be removed from his estate and replaced with      life insurance proceeds that will be estate tax-free.  Some other footwork by the insurance agent has the client retaining 3% annually of the immediate annuity cost tax-free thereby almost replacing the cash flow that was lost by the immediate annuity funds being removed from their tax-free bond portfolio.
  7. A plain vanilla solution for people that are insurable is to buy life insurance through an irrevocable life insurance trust (ILIT) to cover the estate tax.  In this manner they are prepaying their eventual estate tax each year for pennies on the dollar.  Those that do this should pray that this ends being a bad financial maneuver [because they will live so long that it became an uneconomic action].
  8. Some clients want to make the maximum gift but don’t want to part with liquid assets. If they have a large enough valued house they could make the gift using a qualified personal residence trust (QPRT).  I suggested splitting the house into 4 parts – 2 for each parent.  Each parent then makes the      gift for 5 and 10 years, or 7 and 14 years, or whatever periods that are suitable for their situation, age and life expectancy.  The QPRT provides double discounts to reduce the value of the ultimate transfer of property to the children.  The first series of discounts is because fractional interests of the residence are being transferred. The second is because of the delayed transfer due to the terms of the QPRT.
  9. Many clients ask why can’t they just give their children the gift and skip using a trust.  They can, but the benefits of a trust are that it keeps the money in the “blood-line,” provides an element of asset protection, can have distributions sprinkled among family members without involving additional      taxable gifts, can decide who pays the income tax each year by the manner in which distributions are made and, if set up as a grantor trust, can  have the parent or grantor pay the income taxes on the amounts earned by the trust without that payment being considered a taxable gift.
  10. A client owns 60% of a building where the control was determined by the percentages owned.  By her making a gift of 11% of her interest, the valuation of the 11% was reduced by about a third and the mechanism was established for her estate to also be able to get a valuation discount of about a third since she no longer had control.  When she inquired about losing control, I reminded her about the “golden rule.”  “She who has the gold, makes the rules.”  With the many other assets she owned that were eventually to be distributed, her powers of “suggestion” would carry a lot of weight with her children that received the 11%.  Also, because she had 4 children, she only needed one of them to side with her.  Note: the 11% was given to a separate trust for each child.
  11. A 39-year-old client with very high net worth in businesses… He started wanted to begin giving away some of his wealth.  I suggested he consider a low-cost, 30-year fixed premium term life insurance in an ILIT which would actually cost less per year than legal, accounting and other fees so he could see how his family developed and grew before he started giving away assets.  I also suggested he consider putting any new businesses he starts in trusts for his children.
  12. A charitable minded client made a donation to a charity lead annuity trust (CLAT) where his favorite charities will receive $250,000 a year for 23 years and his children will receive $5 million at the end of that period with a 2012 taxable gift of $500,000.  Also, the client will receive a charity income tax deduction of $750,000 a year for six years starting this year.


These are some of the situations I’ve seen recently and should give you an idea of creative ways to handle the frenzy… or just side step it.  Please note that each of these methods have many technical details that are not covered here – the purpose of this article is to indicate some of the many ways estate tax planning can be handled.


A final word is: For an estate tax reduction plan to be effective, the owner needs to relinquish control over the assets, establish myriad partnerships and trusts all with bank and/or brokerage accounts, recapitalize entities, rewrite or renegotiate partnership, members’ or buy-sell agreements and adhere to strict requirements when managing the entities.


The variations described above are only a few of the ways estate taxes can be reduced or wealth can be managed.  My earlier blogs have other methods not repeated here.  As much as I do, I still learn new things because each client is unique and has their own wishes, desires, feelings and family dynamics.  Estate planning needs to be customized for each person and family.  Further, my steadfast advice to clients that fully applies to estate planning is that “if you do not completely understand what is suggested for you to do – don’t do it!”

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