New Risks to Wealth Management: To Gift or Not to Gift

Traditional risks related to the family’s wealth (including financial, intellectual and social assets) include the illness or death of the key family stakeholder, economic downturn and changes in the regulatory or legal environment. New risks are triggered by the dissipation of wealth due to generational mathematics—with each ensuing generation, the wealth is splintered—and the lack of creation of new wealth; this very turbulent economic time; the increased complexity of legal and tax matters; and the increased complexity of wealth management choices. These risks can be mitigated when the family coordinates its advisors and monitors the integration of all professional services.

The risks are further mitigated when the family embraces and encourages financial education and financial literacy across the generations. Mentoring, shadowing, exposure to the concepts and resources along the generation continuums reduces the chances for unintended consequences.

New Risk: The Bracket Game:  To Gift or Not to Gift…That Is The Question…..

On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the Act). The Act significantly changes the federal estate tax, which impacts estate planning for many and presents significant estate planning opportunities. The biggest surprise in the new law is the ability to give $5,000,000 of assets away now and remove those assets and any appreciation in their value from the donor’s taxable estate. In a marriage, this doubles the amount to $10,000,000. This law is in effect until December 31, 2012, and it is unclear what the state of the law will be from 2013 on.

This significant increase in the gift exemption adds to the donor’s ability to gift the annual exclusion of $13,000 each year and the donor’s ability to pay anyone’s tuition and medical expenses as long as payment is made to the provider.

The Act has prompted spirited discussions, “Well, now that I can really give that much, should I? What are the non tax risks to making those gifts?”

     Factors to consider when deciding whether to gift or not to gift:

1.     How much is enough?

This question is always worth discussing. Warren Buffet’s answer is, “Leave your children enough money so they can do anything, but not enough that they don’t have to do anything (although Buffet did not leave his children the bulk of his fortune, he did leave each of them a foundation of $1billion dollars to give to the charities of their choosing).  In my experience, the answer depends upon the individual, often changes over the lifetime of the donor and has to do with his/her children and the economic times.

2.     What strings do I want on the gift?

Whatever the amount, you must decide how much control there    is over the gift. Is it to be given outright? In trust? Who is the trustee? How long should the trust extend? What are the terms of distribution? Who are the permissible beneficiaries?

3.     Should I leverage the gift?

In addition to the strings that you want to impose on the gift, you should also address leverage. If you make a gift that is eligible for a minority or marketability discount, that increases the value of the gift by at least 20%. If you fund an irrevocable trust and anticipates that the trustee will use the funds to make annual life insurance premium payments, then significantly more may be added to the trust through leverage than if the gift were to be invested along more traditional methods.

4.     Am I willing to assume the risk that the gift, once given, is gone?

What if the donee becomes divorced or has creditor issues during the donor’s lifetime, and the gift is jeopardized? Can you live with that consequence? The cascading effects from a gift can have far reaching consequences. For example, if the donor parent gifts 20% of the stock in his closely held business to his children; and one of the children becomes divorced, it is not just that the child’s interest in the business may be vulnerable. Even if it is not vulnerable, the divorce court also has the right to order the valuation of the child’s interest in that business. To do that means valuing the business in its entirety;  and having that asset valued in a hostile environment—where the ex-in-law’s lawyer will try to value that as high as possible—will in all likelihood be in direct opposition to the donor parent’s valuation and appraisals for estate planning and transfer tax purposes. In addition, if the donee child is ordered to pay alimony or child support, then the income from the gifted asset will be taken into account when the court establishes the dollar amount. If the income is phantom income, which the child donee does not actually receive, that can present additional complications and litigation.

5.     Am I willing to give up the “fruit as well as the tree”?

In most cases, the fruit and the tree—meaning the income and the principal—go hand in hand. For example, are you ready to give away 20% of the underlying asset, knowing that the corresponding 20% of the income which is attributable to that asset will also no longer be available to you?

6.     Have I considered gift splitting?

Gift splitting—where one spouse makes the gift, and the other gives consents to that gift—is a very effective estate planning technique for the second marriage couple. Frequently, in that case, one spouse is wealthier than the other. If the less wealthy spouse does not have $5,000,000 of assets in his/her own right, then using the less wealthy spouse’s $5,000,000 exemption in full or gift splitting, with the wealthier spouse giving his/her assets to his/her own children can be a very creative technique. In effect, it doubles the amount that can be gifted. When considering this technique, especially if there is a prenuptial agreement or postnuptial agreement in place, care should be taken to protect the estate of the less wealthy spouse who consented to this gift or allowed the use of his/her $5,000,000 exemption.  The possibility that the exemption could decrease later, resulting in additional estate taxes in his/her estate to his/her beneficiaries, should be thought through and discussed.

7.     Should I gift more than the $5,000,000/$10,000,000 exemption and incur the 35% gift  tax?

For many very wealthy individuals, this is a question to consider seriously. The gift/estate tax rate has not been this low in eight decades. The difference between a tax exclusive gift and a tax inclusive bequest is significant at the higher dollar levels, and exploring this (especially if the underlying assets have significant growth potential or discount opportunities) should be an option.

 Solution: Creation of a Family Risk Management Policy Statement:

A solid family risk management policy contains the purpose, principle and procedure for implementation. The purpose of a family risk management policy may be to reduce the risk for family members, both individually and as a whole. Adherence to the policy would go far to protect the family’s human and financial assets and minimize potential liability. The principle of the policy may be to make clear that the responsibility is to identify the areas of high risk and to do whatever possible to mitigate that risk. The procedure of the policy may make it clear that each family member is expected to:

  • Achieve financial literacy with regard to his or her own wealth as well as the wealth of the family enterprise.
  • Draft and have both parties sign a pre-nuptial agreement.
  • Contact their insurance providers annually to review their insurance coverage to ensure that they are current and adequate.
  • Have in place basic estate planning documents: will, revocable trust, health care proxy, power of attorney for financial assets.
  • Participate in the development of an investment policy that is aligned with the family’s shared values.
  • Protect the family’s reputation by learning how each individual’s behavior, both positive and negative, can impact the family’s reputation.

A family risk management policy statement is dynamic. It should be reviewed and adjusted as the risks that families face evolve and change.

 

Patricia Annino is a sought after speaker and nationally recognized authority on women and estate planning.  She educates and empowers women to value themselves and their contributions in order to ACCOMPLISH GREAT THINGS in the world – and in so doing PROTECT THEMSELVES, those they love, and the organizations they care about.  Annino recently released an updated version of her successful book, Women and Money: A Practical Guide to Estate Planning to include recent changes in the laws that govern how we protect our assets during and beyond our lifetime.  To download Annino’s FREE eBook, Estate Planning 101 visit, http://www.patriciaannino.com.

Comments

  1. Great article may I post a link to it in my three blogs? I have many readers that will benefit from your insight and it may help both of us.

Speak Your Mind

*

css.php