The Real Issue in Estate Planning: Family Dynamics

For years, too much emphasis has been placed on taxation in estate planning.

For years, too much emphasis has been placed on taxation in estate planning. 

Not that tax savings isn’t important, but it’s become the issue, rather than keeping the focus on the REAL issue, which is family dynamics. Even clients will get this wrong. 

When I ask a client, “What is your primary goal?” they will sometimes respond, “To pay as little tax as possible.” To which I respond, “No problem, I can eliminate your tax burden completely. We will just leave everything to charity.” 

After a brief silence followed by the client laughing, we see the truth. The primary issue is how and to whom they want to leave their assets, followed by doing it in a tax efficient manner.

What I appreciate about the estate tax exemption increase is that most people, over 98%, will have no estate tax issues and it has had two effects. One, unfortunately, is that many people who have always focused on taxation don’t think they need estate planning at all, and the other is that we must now focus on family dynamics and the real concerns of clients in leaving assets to their heirs. As one study concluded, we have for decades prepared the assets for the heirs. Now we need to focus on preparing the heirs for the assets.

Changing the Conversation

This becomes a more difficult conversation, both for the advisor as well as for the client. We are no longer just running numbers, we are talking about soft issues: people and society, personal feelings and in some cases, failings. 

Sometimes clients feel like the pursuit of their financial successes has led to strained, distant relationships with their children. In the movie “The Bucket List,” we see this with Jack Nicholson’s character who, while wildly financially successful, has lost touch with his daughter and, as a result, his grandchild. This is not something that writing a check will change. As one well-known estate planning attorney asked, “Why do you think I can write 4 paragraphs in your will that will make up for 40 years of bad parenting?” Ouch.

So, where does this leave us? There are three key issues to address: One is the client’s desired use of the funds by the heirs, the second is the heirs’ ability to handle the funds responsibly, and the third is the protection from third-party dysfunction like lawsuits, creditors, taxation, and divorce.

Client Sentiment

First, does the client have the confidence in their heirs to handle the money responsibly, or do they even care if they do? I find most clients perfectly comfortable with their children, whom they feel they raised well and gave a good education and life lessons. Even with confidence in the children, issue three related to third-party protections should be considered, which we’ll discuss later. 

When the client is not confident the children will behave in the manner that they desire, so-called “incentive trust” language can be devised. As long as it does not violate public policy and stays within the bounds of being legal and possible, incentive trusts can provide guidance to heirs by creating a variety of incentives to perform certain behaviors or avoid certain behaviors desired by the client. Examples include: not smoking, not using drugs, age attainment, achieving education objectives, marrying within one’s faith, having a prenuptial agreement prior to marriage, and other behaviors. 

An experienced estate planning lawyer can help the client word these issues properly so as to not violate public policy, rendering the clause unenforceable, or state it in an overly generalized way (such as “$250,000 when he marries,” which led to over a dozen marriages in one famous case). This can be a fascinating conversation with clients that helps you to discover their most important concerns.

Capacity of the Heirs

Second, do the heirs have the capability to handle the assets properly? This consideration includes special needs trusts for disabled beneficiaries, trusts for minors too young to make their own decisions about money, and beneficiaries with a history of drugs, prison, gambling, or uncontrolled spending and debt. 

Parents naturally want to protect those children who cannot protect themselves, and trusts with discretionary language in the hands of a trustee, sometimes aided by a “letter of wishes” giving insight to the client’s concerns, is often the right way to structure an inheritance.

Protection from Third Parties

Third, is the client concerned about protecting the beneficiaries and funds from third party issues like lawsuits, creditors, taxation, and divorce? If so, trusts often make sense. Not because the children can’t handle the money; just the opposite, because they are likely to be so successful on their own that they may have careers in medicine or architecture for example, where lawsuits are common. 

In addition, while your client may not have a taxable estate, the children may have one, so why pile money they would pass through to their children on top of an already taxable estate? Using an irrevocable trust, you can have the best of both worlds – the assets are available to them if they need them, but not part of their estate nor accessible to their creditors if they don’t. 

This is to say nothing of the fact that we don’t know what estate tax will be a generation into the future. With a divorce rate often cited as near 50%, it is understandable that many clients might be concerned about the potential erosion of inheritance to divorcing spouses, sometimes going so far as to require prenuptial agreements with certain provisions to protect the trust funds. 

Philanthropy is a type of inheritance unto itself, giving the beneficiary the gift of giving, rather than the funds for personal use. This can allow successful children to continue the family legacy and pass it on to their children, can protect those who can’t handle money from losing those funds while enabling them to improve the world around them, and maintains those assets outside the threats of taxation and creditors. 

Knowing how these issues affect your clients and their estate plans brings you closer than ever to them and their families, securing your position as a trusted advisor both now and for future generations. The ability to discuss the details of the client’s desires should always remain central to planning, regardless of the effects of estate taxation.

Trucendent’s network of estate planning attorneys can not only help you and your clients understand the impact of their decisions on estate taxation, but can also help guide more difficult conversations around family dynamics. To learn more about Trucendent’s solutions for advisors, click here.

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