Three-Dimensional Estate Planning

Three-Dimensional Estate Planning

Article posted in Practice on 8 March 2000| comments
audience: National Publication | last updated: 18 May 2011
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Summary

How does one integrate philanthropy into the wealth transfer planning process? In this edition of Gift Planner's Digest, Houston gift planner Paul L. Comstock answers this and many more questions in his thoughtful article, "Three-Dimensional Estate Planning."

by Paul L. Comstock

Estate planning is generally thought of as the act of accomplishing the thoughtful ownership transfer of one's assets during life and at death. In addition to planning the actual physical transfer of our wealth, most of us have desired outcomes beyond that physical transfer. These desired outcomes frequently include how to provide a lasting legacy or perpetuate a personal or family value. In reality, it is the transfer of these intangible values (who we are) together with our physical assets (what we own) that becomes the essence of estate planning.

When done properly, the estate planning process can help us develop a sense of immortality. Our immortality comes from seeing members of the rising generation embrace values that are important to us. It may also come from the professional work we do. Especially when such a contribution is utilized by other professionals and is deemed to be an important addition to a body of knowledge. Finally, the transfer of possessions we value and are identified with adds to our immortality. A good example would be the transfer of an art collection. How important is this sense of immortality? Ernest Becker wrote in his Pulitzer Prize winning book, The Denial of Death, that we are all immortality striving. That such an effort is a key motivation to what we do during this life.

Including what we would like to have done with our transferred assets as well as finding the formula that creates a slice of immortality is a two dimensional approach to a traditionally one dimensional experience. In addition, we need to add yet another dimension to this effort by including in our plan the goals and objectives of our beneficiaries. This makes estate planning a three dimensional effort.

Done properly, an estate plan promotes all of the qualities in our beneficiaries that we would espouse to them were we still alive. It maximizes the ability of our beneficiaries to fulfill their personal goals and objectives while doing so under an inherited value system. In order for this concept to be accepted by those to whom it is directed, there needs to be, on their part, identification with and a desire to have what is being transferred. It is most important, although not always achievable, that they agree with the structure and future management of the asset and values transfer elements of our plan. Unfortunately, most estate plans fall short of meeting all three dimensions of this process.

We, as professionals, often contribute to the short fall of achieving a three-dimensional estate plan. We may find it easier and less intrusive on our time to do so. Perhaps we even consider certain areas of inquiry outside of our expertise and scope of engagement. Such concerns are normally valid, realistic, and, most often, professionally correct. How then, do we guide and facilitate our clients into a more comprehensive three-dimensional estate planning process? How do we encourage a process that goes well beyond tax efficiency as the primary driver of the activity? This is particularly hard when tax planning is what most of our clients actually come to us to accomplish.

While we may all agree that the more difficult non-financial issues need to be addressed, again, how do we do it? For example, what is our process for understanding how the people involved behave with money? Do we know what level of responsibility they have exhibited in their personal behavior? How have they been trained to deal with money? Are relationships within the family system limiting the use of certain planning structures? These questions move most estate planning professionals into an area that may open up major problems. Such problems, once uncovered, will need to be solved. In most cases, the best way of doing so is by having a team of professionals representing different viewpoints on the same subject. It may be important to go outside of the general estate planning disciplines when considering members of the advisory team. For example, I bring in a psychologist who specializes in interfamily relationships. She provides an additional perception of what strategies make the most sense given the current family dynamics.

It is important that we are certain that the family goals and objectives are being met. A multi-disciplined advisory team helps keep the planning process truly on that course.

As professionals, we may need to rethink the way we assist our clients in developing their wealth transfer plan. Remember, while estate planning is entered into because of money and taxes, in the long run it is not about money and taxes, it is about people and the impact that money and taxes will have on their lives.

Three Dimensional Estate Planning

The estate planning process begins with defining goals and arranging the priority of completing them. Our goals may be illusionary or real. According to Victor Brown in his work, Human Intimacy, illusions are incomplete portrayals of reality. They deal with fragments of the individual, not the whole person. Illusionary planning denies the consequences of behavior and deals in indulgence rather than discipline. If we want our client's effort in planning to be successful, helping him or her establish real goals is essential.

In establishing real goals and objectives for the use and transfer of wealth, normally the priority of accomplishing these goals will fall into the following order: self, spouse, heirs, and community organizations. Developing a strategy to meet each objective in the order of priority is essential. Failure to do so will result in a stalled plan. Nothing will get done and we will wonder what happened. Thus, planning for gifts that are to be made to one or more charitable organizations comes into play only after the current wealth owners and their desired individual beneficiaries have been adequately provided.

When working with a client, we break down the process into four distinct areas: life style maintenance for wealth owners and heirs; the family endowment; the community endowment; and the family management organization necessary to maintain control and responsibility over the other three areas. Each of these areas of wealth transfer planning requires specific definition. All four areas are integrated, from a strategic planning standpoint, with each other.

Life Style Maintenance

Perhaps the most important planning objective of wealth owners is to maintain their current lifestyle. Once they are secure in that goal being achieved, making current gifts to beneficiaries, both individuals and community organizations, from excess wealth begins in a deliberate manner. We all know that when individual beneficiaries are the recipients of wealth transfers, challenges in behavior and personal productivity can occur. What we don't realize is that what is being done under most wealth transfer plans is the creation of a private entitlement program.

Creating private entitlement plans requires that all of the emotional as well as financial administration aspects need to be addressed. Various questions regarding each area should be answered. For example, what level of subsidy is desired? For what purpose is the subsidy being provided? What duration of subsidy is desired?

Does the term subsidy, entitlement, or private welfare sound harsh? We usually think of these terms in a negative way. Current wealth owners often find government subsidy programs undesirable in that they have historically provided the beneficiaries with unproductive and unfulfilled lives. On the other hand, such programs can and do offer opportunities to advance from one's current dependent status to one of self-sufficiency.

The debate on how to do the latter is a continuous one. The same difficult issues surrounding public entitlement programs are in place for private entitlement programs.

Many wealth owners take the approach of "what they (their beneficiaries) do with it is up to them." Others work at providing heirs with personal mentoring, required accountability, the development of competency, personal motivation, and a wealth transfer program that encourages positive personal development. Their goal is to allow their beneficiaries a sense of accomplishment not unlike those who go through life with much less assistance. Then there are degrees of both approaches that fall in between the two extremes.

As professionals, working with wealth owners on such planning, it is important that we think about what happens after the transfers occur. We need to contemplate the impact of unearned wealth on each beneficiary. Are we assisting in the development of responsible and productive adults or are we encouraging a long-term surrogate parent/child relationship. As you contemplate the work you do, keep in mind that the issues surrounding public assistance and entitlement programs are no different in scope of ultimate objectives and concerns of delivery than those that need to be addressed by private wealth owners when establishing such a program for their heirs. If you have been engaged in the wealth transfer business for very long, you have experienced both the positive and negative personal behavior outcomes that result from the receipt of entitlement wealth.

It is critical that we begin preparing heirs for the receipt of inherited wealth and their role in its future management. We should do so early in the process. The longer such efforts are postponed, the more difficult beginning the task becomes. And, the more likely that a private entitlement becomes a right and is depended upon.

When asked in the past what he was doing with his wealth at death, Warren Buffet has been quoted as saying, "I want to give them enough to do anything they want, but not so much that they will do nothing." How much is enough? A good way to approach this is the same way you would determine the amount of endowment a nonprofit organization should have.

You first determine the amount of annual income subsidy you would like to provide each beneficiary. Once determined, multiply the amount by 20. The answer becomes the amount of capital necessary for maintaining the annual subsidy after adjustment for inflation and taxes.

Family Endowment

The family endowment is not unlike a charitable endowment. Principal is maintained permanently while the annual distribution is used for designated purposes. I prefer establishing a family endowment to provide restricted benefits. What is meant by restricted benefits? If you look back at your own childhood you will most likely find some event or asset related experiences that brought you closer to your parents and siblings. One such experience is that of participating in a family recreational property.

Those families who stay at a summer home year after year often cherish their memories from the experience. The property may be the symbol of consistency of quality family time together. I have found, both personally as well as professionally, that the loss of such a symbol within a family can be devastating to heirs. Unfortunately, maintaining such a facility on an undivided ownership basis can be just as difficult. It is not uncommon that a disparity in use of the property, as well as the financial ability to afford the maintenance required, exists among the heirs.

The family endowment provides a wonderful tool for perpetuating a family experience into future generations without imposing on sensitive personal financial interaction. The structure of the endowment is a trust that holds the property as well as sufficient financial assets to maintain the property. The family endowment can also provide for an education scholarship program, health care cost reimbursement, or family reunion travel and program expenses. Such a trust is often established in a jurisdiction that allows for perpetuities planning.

Community Endowment

The community endowment is an important aspect of the wealth transfer structure. It has been expressed in many ways that it is not what you own at death that matters, but what you have given away. Involvement in the family wealth on a non-personal consumption basis becomes the entry point for training the next generation. In addition, family philanthropic activity allows for a series of experiences ranging from understanding how to perform proper due diligence before investments are made, holding delegated authority responsible for performance, learning the difference between the governance and management functions of an organization, and feeling good about doing good for others.

Properly engaged heirs in the efforts of family philanthropy develop a sense of competency, responsibility, self worth, consensus building, and an appreciation for the talents and values of others. It, like no other activity, teaches the need to look beyond one's self for the securing of a satisfying and happy life. While family wealth facilitates the experience, it is a means, not the end. Family philanthropy places the role of wealth in a proper and healthy perspective. It encourages personal responsibility in the handling of wealth.

Determining the level of community support. There are two approaches to determining the level of funding for community support that should be considered. One is to first determine the amount of lifestyle subsidy desired as well as that which is to be included in the family endowment. A calculation of the amount of tax due on these transfers and a reserve established to meet that liability should then be made. The balance of the estate can then be given to the community support efforts of the family.

A second method, which often is the beginning point of this decision, is to determine the minimum community endowment amount by multiplying the normal annual gifts to public charities by 20. This is the same process mentioned under the lifestyle support area of planning. Multiplying the annual payments by 20 provides sufficient capital to continue that annual support.

How do we include philanthropy in estate planning? Much of the philanthropic planning done in the name of planned giving is tax driven once gift intent is expressed. Planned giving efforts may create the necessary motivation for wealth owners to proceed with making large philanthropic transfers. Wealth owners quite often find that planned giving techniques enable them to accomplish much more than they had anticipated with the resources at their disposal. This gift planning approach works well. So well that there is now a high level of competition among nonprofits for the same estate dollars. This competition often creates proposals that illustrate that there is no cost in giving. Many proposals give the impression that the economics of the gift swing totally in the favor of the wealth owner. While this may be true in some scenarios, such cases are rare and often expose the wealth owner to substantial audit and tax liability risk. Even if a strategy is adopted in such a way as to be perceived as providing economic favor to the donor, having such as the only motivation robs the donor of the joy of the gift. This can be a tragedy in the making if the planning technique fails to work as illustrated.

Nevertheless, such gift planning normally limits its focus to the two dimensions of the transaction-donor benefits and donor gift intent. It does not always take into account the impact that such a gift has on the heirs.

While the wealth owner may feel that what the beneficiaries get is what they get and they should be happy with whatever it is, it is not uncommon for charitable gifts to be disputed by disgruntled heirs. In addition, heirs may have expectations of what they are entitled to that are not met. There may be ill feelings that are improper and unfair towards the wealth owner. It is better that those impacted by the estate planning effort understand the desires and motivations of the wealth owner. It is also important for the wealth owner to understand the desires and motivations of their beneficiaries. Failure to do so leaves out the third dimension of this effort. Leaving out this third dimension in the process may cause the full realization of the transfer potential to not be reached.

If the current wealth owner does not wish to participate in such disclosure and communication, so be it. However, it is essential that proper documentation and confirmation of gift intent be established and maintained. Doing so will help insure that future disputes are dealt with in a manner that produces results consistent with the intent of the wealth owner. It may also prove to be very important to each beneficiary.

What happens to charitable gifts if the estate tax laws are repealed? Whether or not a change in the estate and gift tax law will actually occur is not nearly as important as anticipating and assuming that it will. It is interesting that most charitable giving experts are quick to agree that giving is not about tax savings. On the other hand, it will be a test of faith to those harbingers of altruism in gift motivation if the estate and gift tax is repealed or current charitable gifts do not receive an income tax deduction. How then will we recommend considering gifts to the community if there is no tax liability when wealth transfers to personal heirs?

The answer may vary from wealth owner to wealth owner but will focus on real public involvement motivations. These may include their need to express love and appreciation, show support to favored organizations and the people remaining with them, fulfill a desire for immortality, successfully influence others to engage in activities and behavior deemed to be of value to society, or to give back to others something that was given to them. Whatever the personal motivation developed by a current wealth owner, it is the estate planners charge to incorporate these motivations in such a way that the tax benefits achieved currently are an added benefit, not the primary benefit. Then, should the tax benefits disappear, the primary motivations will remain.

Family Management Organization

Establishing beneficiary skill sets for successfully managing the various planning entities created is a challenge we must face in the planning process. Much of our planning incorporated in the wealth transfer process includes forming family investment partnerships, limited liability corporations, operating businesses, and trusts. These entities all require management responsibility. They must file tax returns, hold annual meetings, and provide reports to shareholders or trust beneficiaries. Roles such as managing partner and fiduciary are created and carry high levels of responsibility and accountability.

It is very difficult for most wealth owners to choose which or how many beneficiaries will participate in such management functions. Those left out may be hurt and/or angry. Current wealth owners may wonder how the delegated responsibility will be handled. They want to know that the results will be consistent with the intent that formulated the plan.

Many wealth owners would like to have individuals they trust and have confidence in be the successor management of these entities. If such is not available to them, the dilemma of selecting an institution to provide such services comes to bear. While there are many such institutions to chose from, it is very difficult to do so. Even when an institution is selected, there are normally provisions that allow the beneficiaries to change from one institution to another.

How then are wealth owners to be assured that the decisions made by their governing beneficiaries will be consistent with what they would have done? There is none. Nor can there be put in place assurances that good judgment will always prevail in the decisions that are imposed on their wealth. What can be done, however, is to establish the vehicles important to properly train heirs in both personal and group leadership and the responsible use of unearned wealth.

The venue for such leadership and personal wealth management training is the current wealth owner's organization. It should focus on governance versus management since most of the heirs will not take an active management role in the entity that holds their inherited wealth. They are generally best suited to overseeing what is done with their assets than actually performing the management function. Certainly, this is not always the case. There may be one or two members of a group of heirs that will possess such skill sets. More than likely, however, those individuals will need assistance in running an organization for the financial benefit of their fellow heirs.

Establishing a financial parenting program centered on the management of the family philanthropic activities is the best beginning spot for such an effort. All the characteristics of proper governance and management, related to the entities that will become their responsibility in the future, can be learned through this effort. The best entry-level position for this is the junior board of a family grant making entity. That entity may range from a special family checking account to a private family foundation.

Regardless of which entity format is utilized for this effort, the key element is engagement. The participating heirs must feel that what they are doing has meaning. That it is not a token experience to satisfy the ego or control of the current wealth owner. They must feel that they are a solution and not a problem.

Developing within the heirs the ability to reach consensus on difficult issues, learn management delegation, hold others accountable for that which they have been asked to do, and instilling a sense of responsibility in the use of wealth are key elements in three dimensional estate planning. These are big goals but are generally at the forefront of the concerns of current wealth owners. When such an effort is underway, this whole three-dimensional approach begins to take shape. Not only does it identify what we are really trying to do with our wealth transfer plan, but also now incorporates how the beneficiaries will be involved.

Integrating Philanthropy In The Wealth Transfer Process

Once real goals have been established, it is essential that they be written in an easy to reference way. Doing so allows all professionals, as well as the wealth owner, to keep on track. With so many options for wealth transfer strategies that can be successfully adopted, keeping on an agreed upon course keeps the plan focused and moving forward. Too often, initial objectives are forgotten and new ones established based on current planning fads or schemes.

One way of staying focused on the community or social capital transfer objectives is to have as a goal the desire to maintain all current financial support to all beneficiaries. It is important for the wealth owner to keep in mind that a "luxury enjoyed twice is a necessity," and those who have developed a sense of entitlement will miss that present subsidy. This applies to family members and nonprofit organizations that receive regular and continuous financial support.

Making philanthropy part of the family culture encourages maintaining community support values. It creates a sense of being connected in a positive contribution way. It also allows the message to be sent early on that part of our family wealth will be devoted to this important tradition. When estate plans include capital set-asides for the community benefit, would be family beneficiaries should learn to embrace and understand the motivation behind such actions.

While there are several approaches that have proven to work, following a strategy that allows for errors and provides a high level of probability that such will occur is critical. Why? Maintaining one's lifestyle during life is of prime importance to most individuals and should be relatively certain. In addition, having flexibility with the amount of capital set aside to do so is critical in the event of unforeseen expenses or changes in asset values. In reviewing the amount of capital necessary to maintain one's lifestyle, future investment and spending assumptions are required. It is important to explore how these assumptions impact the ability to maintain one's lifestyle over the individual's life expectancy. In the case of husband and wife, use their joint life expectancy or the life expectancy that is the longest.

In determining the amount of community support, it is important to keep in mind the amount necessary to fund the desired program, as well as allow for investment growth of principal to meet the impact of inflation. Under the Prudent Investor Act adopted by most states, the trustee is required to consider the impact of inflation on the value of the assets that will pass to the trust beneficiaries. Such an imposition causes the value of the assets to grow along with the amount of the annual distribution.

Reality is, however, that most individuals do not grow their spending in their latter years by the annual rate of inflation as reported by CPI. Even if such is the case, growing the value of the corpus by that same inflation only creates a larger estate tax liability.

A more efficient method of determining the necessary capital required for lifestyle maintenance of the current wealth owners is to establish the capital account with only that amount that will maintain its current value based on reasonable investment assumptions. The assets in excess of this amount are then available for current transfer purposes. Since the gift tax rate is applied on the value of the transferred assets versus estate taxes that are imposed on the total value of the assets, giving during one's lifetime is generally more tax efficient.

In addition to making transfers to heirs to provide for both their lifestyle enhancement and a values capital pool, inter vivos gifts to charity allow for both a current income tax, as well as future estate tax savings. If current charitable gifts are being made out of capital, having that capital housed in a tax exempt entity reduces the amount of capital necessary to meet both current and future desired community support goals.

Three dimensional estate planning will always include the community. It will focus on people more than taxes and money. In the end, the results of such planning should be happier and more productive lives. It should provide a slice of immortality to those who incorporate it into their wealth transfer efforts. As professionals in this area, you have a wonderful opportunity to step out of the safety zone of this process and encourage wealth owners to do the same. Become engaged and encourage engagement of all involved, either as a wealth owner or a beneficiary. There will be added benefits to all.

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