Passing it on

Sep 5, 2017 - 7:00 PM

What will happen to your money and other assets after you’re gone? That’s the central question of estate planning.

Deciding how to apportion an estate is usually an easy choice for parents: most specify that assets should be split equally among their children after the second spouse dies. Exceptions might include a family business, in which one child receives a controlling stake while the others inherit different assets, or a situation where one child has special needs and requires extra care.

When thinking about how to divide up real estate, consider whether your heirs will likely agree on how to manage assets you’re leaving to them. Some may want to keep family properties like the home where they grew up, while others might prefer to sell and split the proceeds, says Kelly Gushue, who is CEO of Personal Finance Warrior, a financial coaching company.

Determining who gets what is only part of the process. Another challenge is structuring a plan to legally avoid estate and gift taxes to the extent possible. The goal is to skip what Joe McDonald, an attorney in Concord, New Hampshire, calls the “dying-with-your-boots-on scenario, which allows the IRS to tax the complete amount of your wealth.”

In addition to letting you save on estate taxes, trusts are a popular way to keep assets from going to creditors or ex-spouses (or the ex-spouses of your children), says Ramsay Slugg, a Fort Worth-based managing director and national wealth strategist for U.S. Trust.

For now, all Americans are entitled to a $5.49 million exemption for their estates, although President Trump and congressional leaders have said they want to repeal the federal estate tax entirely. Because the future of that tax is uncertain, some attorneys are advising clients not to make ironclad plans that involve getting around it, because it may be difficult to undo the mechanics if the tax is repealed or changed.

“Unless you’re suffering from a terminal condition or you’ve spent a lot of money in structuring or appraisals, it probably is best to wait and see,” McDonald says.

Setting up trusts is especially worthwhile if you have assets that are likely to appreciate, such as a privately held business. Before selling it at a premium, clients often put a noncontrolling slice of it into an irrevocable trust. The slice is valued at a discount, since it doesn’t exert control over the company, and the business itself is private. When it is sold, the value of that stake within the trust rises—but the difference in value isn’t taxable, a phenomenon called value freezing. “The spike in value between the time of the transfer and the time of the event escapes taxation completely,” McDonald says.

You can use various types of trusts to hold such a stake, including a GRAT, or grantor retained annuity trust. After making the gift that puts the stake into the trust, you need to file a gift tax return and send the IRS copies of the trust’s organizational documents, along with an independent appraisal of the stake. The IRS has three years to challenge the appraisal. Legal and appraisal fees to establish such a vehicle can run up to $30,000, McDonald says.

Decisions on how to leave money or assets to charity—or set up a foundation to give away funds during your lifetime and beyond—are among the “most neglected areas” of estate planning, McDonald says. Many clients choose these options because they don’t want to give all of their estate to their children, for fear of spoiling them; they also want their legacy to include helping the community.

McDonald recommends that clients with more than $3 million to donate start a private foundation, either an operating one (which conducts a charitable function, like running a health program) or a grant-making one (which donates to philanthropic causes). Foundations can be expensive to set up, staff, and administer, so many people with smaller amounts to contribute opt to give to a local umbrella organization like the Boston Foundation or the Philadelphia Foundation. These nonprofits manage donors’ assets collectively and direct the funds toward community needs, McDonald says.

Another popular option is a donor-advised fund, which mutual-fund companies like Vanguard and Fidelity offer. Fidelity’s donor-advised funds managed $15.5 billion at the end of fiscal 2016, making it the second-largest grantmaking organization in the U.S., after the Gates Foundation, according to Elaine Martyn, vice president of the Private Donor Group at Fidelity Charitable.

A Fidelity donor-advised fund requires a minimum donation of $5,000 in cash or securities. You can also sign over more complex assets that are often difficult to give away, such as shares in a closely held business, LLC, or private equity partnership, says Martyn. Once donated, these assets will be liquidated and the money invested in the Fidelity charitable pool or pools of your choice.

The value of what you’ve donated can continue to grow as Fidelity manages it, and whatever profits are generated are also available for you to direct into gifts to nonprofits. One client who donated $1 million last year saw her assets grow by $42,000 in the first six months, allowing her to increase her charitable gifts, Martyn says. Those gifts can be to any legal nonprofit; the most popular categories are faith-based groups, universities, healthcare and human-services organizations, and social-justice nonprofits, Martyn notes.

The money belongs to Fidelity Charitable once it’s donated, allowing you to take the full tax deduction right away. The fund charges donors less than 1 percent of assets annually to administer their accounts, with the exact fee depending on how much you have in the fund.

Once your estate plan is set, Slugg recommends, discuss it with your heirs, to avoid any unpleasant surprises, and to give them time to grow into their responsibilities running the family business or handling other assets.

“At some point you have to sit down with the children and the grandchildren,” he says. You may or may not want to get into all the details, but you should at least tell them that a plan exists.  


Pointing Your Kids in the Right Direction

Parents worry about what their kids will do with the family’s money once they inherit it. In a U.S. Trust survey of adults with $3 million or more to invest, only 42 percent said they were very confident their kids would spend their inheritance responsibly.

Part of the problem is poor communication between parents and their heirs. Many trust-fund heirs don’t learn they stand to inherit significant assets until they turn 18 or 21 and receive a bank statement in the mail.

“What people often do is not talk about anything with their kids until they’re older, and then it’s an awkward conversation,” says psychologist Dr. Jamie Traeger-Muney of Wealth Legacy Group. The best way to ensure your kids don’t squander their inheritance is to get them started understanding money from an early age—as young as five years old, she adds.

For more on this subject, see “Teaching Your Kids about Money,” available at bjtonline.com and in the August/September 2015 issue of BJT. —C.R.S.