Once wealth managers have uncovered a client family's wealth and legacy values and explored the psychology that goes along with those values, the next step is tactical: executing those wishes using the many tools available. Of course, the right tactics vary, depending upon whether clients wish for straightforward intergenerational wealth transfer, philanthropy or some combination of the two
Families and individuals seek the services of wealth managers for three main reasons: sudden wealth--such as exercised options or inheritance, dissatisfaction with their current investment manager or some sort of life-changing transition, according to Jennifer Ellison, a principal at Bingham, Osborn & Scarborough LLC in San Francisco, an affiliate of Boston Private Financial Holdings.
Ellison starts a client relationship by probing the family's background and focusing on their particular concerns, such as putting children through college, retirement, or taking care of aging parents. She wants to know their thinking about philanthropy and about family giving. Her firm can develop estate plans for the client, offer guidance on charitable giving and provide investment advice.
David Bakman, a wealth advisor at GenSpring Family Offices in Palm Beach, Fla., says he and his colleagues spend a lot of time on similar issues with client families, all within the context of revealing their personalities, their tolerance for risk, for complexity, and how to use their wealth productively to achieve the goals set out in their values analysis and the mission statement.
According to Roy Ballentine, president of Ballentine Finn and Co., Inc. in Waltham, Mass., traditional estate planning deals with the transfer of assets, and tax planning issues associated with asset transfers. "That turns out to be the easiest, least thoughtful part of the exercise," he says. "Questions about what sort of legacy the family is going to leave in terms of values around money and the use of money, governance structure and any sort of a mission related to family philanthropy are much harder to work out. For Ellison'sclientele, a major consideration in developing an estate plan is deciding how much money they want to put in their children's hands. Depending on their proclivities, donors can pass along assets over their lifetime or hold off until their death.
Beyond the more basic techniques of passing on wealth and reducing the size of the taxable estate, structures become more complicated. Take the Grantor Retained Annuity Trust, or GRAT, under which an irrevocable trust is created for a specified period of time. The individual establishing the trust pays a tax when the trust is created. After assets are placed in the trust, a taxable annuity is paid out to the grantor every year. When the trust expires, the beneficiary receives the assets tax free. The annuity payments come from interest earned on the assets underlying the trust or as a percentage of the total value of the assets. However, if the individual who establishes the trust dies before the trust expires, the assets become part of his or her taxable estate, and the beneficiary receives nothing.
This vehicle is popular with many wealthy families because it is sanctioned by the Internal Revenue Code; it is not an untested gimmick to reduce the size of the taxable estate. "It's totally vetted by the IRS," says Robert Benjamin, a New York-based partner in the law firm Wiggin and Dana LLP. "They tell you what the rules are, you follow the rules, it works. It's a nice option for clients."
Some families who want to start moving assets to the next generation, but avoid exceeding gift tax limits, structure family limited partnerships. FLPs are designed to centralize family business or investment accounts. They consolidate a family's assets into one single business partnership in which family members own shares. An FLP differs from a conventional trust in that family members actually own a share in a business. And an especially attractive feature of this structure is that shares can be gifted to family members over years, thus taking advantage of annual gift tax exemptions. (For more about FLPs please see "Keeping it in the Family.")
Benjamin cautions that this structure has elicited pushback from the IRS when people who don't own a closely-held business use their investment account assets to set up a family limited partnership and throw in the family home and possibly a second home. The IRS, he explains, has questioned whether discounts are appropriate where a legitimate business purpose is not evident.
Giving After Death
Many people prefer to wait until they die to pass on their wealth--out of fear they will run out of money or, worse yet, have to ask for money back from their children; a desire to retain control of their assets; or a concern about exacerbating the problems of a troubled child or grandchild who cannot manage money appropriately.
Benjamin encourages clients who intend to leave bequests to make annual gifts of at least $12,000 in one form or another every year to reduce the size of their taxable estates. One of his clients, a wealthy woman with 18 grandchildren, has been making such annual gifts for more than 20 years and, in addition has paid school tuitions--another way of making a gift if the tuition is paid directly to the provider, he says. "The money has been put to good use, and the children and grandchildren have had the benefit of those gifts over the years, and her taxable estate is far less as a result."
The most basic thing a married couple should do is take advantage of the federal estate tax exemption, says Benjamin. This year, an individual can leave $2 million and a husband and wife can leave $4 million to beneficiaries without incurring any estate tax, as long as their will is properly drafted. A common technique for doing this, he says, is to use a credit shelter trust, also called estate tax exemption trust, rather than give everything outright to the surviving spouse.
In this case, the donor sets up a trust in his will, using a formula whereby the maximum amount that can be passed along free of estate tax is put into the trust rather than given outright to the surviving spouse. The surviving spouse receives income from the trust during his or her lifetime and may be able to invade the principal; after death, assets remaining in the trust plus appreciation pass free of estate tax to the ultimate beneficiaries, say the children.
The donor can either give remaining assets outright to the surviving spouse or put them into a QTIP--or qualified terminable interest property trust. Although the QTIP carries no estate tax advantage for the surviving spouse, it is sometimes used in a second marriage situation when the donor wants to ensure that the second spouse receives the benefit and all the income from the assets during his or her remaining lifetime, but wants the accumulated assets to revert back eventually to his or her children rather than to those of the spouse.
When younger children are a consideration, clients will typically set up a trust for each surviving child. If the children are minors at the time of their parents' death, the income will be used to pay the expenses of maintaining them. Later, say at age 21, the children automatically start to receive money directly. Benjamin usually recommends implementing payouts at more than one age--say 21, 35 and 40. "The reason I recommend more than one payout is that if the child makes a mistake with the first payout, five years later they get a second one."
Charitable intent is a major consideration wealth managers must address with many of their clients. But John Roberts, a partner at Denver Investment Partners, says the first thing he wants to know is whether a client is charitably inclined. "Too often I've seen people put into charitable vehicles when the clients don't have much charitable intent. I've had many people say, 'Our children are our charity, our grandchildren are our charity.' They prefer to reduce the size of their estate by financing their grandchildren's college education."
On the other hand, many wealthy families are strongly charitably inclined and choose to establish a charitable remainder trust as an extension of their estate plan. Intended to reduce taxable income, this tax-exempt irrevocable structure allows the donor to put assets such as company stock into the trust, which then disperses income to beneficiaries--a spouse or children for example--over a stated period of time. After that time expires, the remaining assets are transferred to designated charities.
Ballentine does not favor this structure. "From an income tax planning perspective, they would be better off selling the stock, paying the taxes and reinvesting the after-tax proceeds. If they do that, the odds are very good they're going to have more income during their lifetimes, when you measure income after tax. They'll have control over the assets during their lifetime and the value that will build up will allow them to make a much larger charitable gift at death than they could have achieved with a charitable remainder trust. The donors could then set up a private foundation, contribute to a donor-advised fund or give the money directly to charities.
Patricia Angus, the head of Angus Advisory Group LLC in New York, says that as long as the family figures out what its objectives and priorities are, structure is not so important; it will follow from those objectives. One of her wealthy clients has chosen not to set up a foundation, but to make their gifts directly. "They have a process that is as formal as a private foundation without having all the tax filings and legal restrictions around it. They're getting the experience of working together, figuring out their common mission, their interest areas, and then grant-making and following through without having a structure."
In a donor-advised fund, a client opens an account with a private group or a community foundation and receives a tax deduction for the contribution in that tax year. DAFs created by some of the larger institutions such as Fidelity or Schwab can be funded with as little as $5,000 or $10,000, although Schwab has DAFs funded with as much as $250 million. The donor then recommends what part of the donation should be contributed in a given year and to which charities. Because of the upfront deduction, the IRS requires that the money is legally no longer under the donor's control. The fund or foundation that controls the money is not obliged to follow the donor's recommendation, but more than likely will do so.
Ellison of Bingham, Osborn & Scarborough says that her firm has set up a donor-advised fund for its clients called the BOS Foundation, which is under the auspices of the Marin Community Foundation, which gives each client account charitable status. The beauty of the DAF structure, says Ellison, is that clients can make very efficient donations to their charities rather than scramble on Dec. 15 to donate appreciated securities to 20 different places. Theysimply go online and make a recommendation as to where the donations should go, and how much to give, and appropriate checks are sent out by the fund. Moreover, clients whose yearly income varies can put a large amount of money into the donor-advised fund in a year when income is very high and get a big tax deduction. In doing this, they have the option of funding their gifting for the next five or 10 years.
Alternatively, clients can put a sum of money into their accounts every year. Assets that haven't been granted out stay in the account and grow, adding to the corpus that can be used for giving. Cash and appreciated securities make up a large part of DAF funding, but real estate, art, livestock or other, more exotic types of assets can be used to fund a DAF account. (For more on DAFs please go to "Give, Wisely" from the Dec. 2007 issue of Investment Advisor, at www.investmentadvisor.com). At many of the large fund companies, investment advisors can continue to manage DAF assets.
On the question of how large a family's assets should be before they consider setting up a private foundation, opinions vary. Ellison says that for clients in the $5 million to $10 million range, a foundation is probably far too much work to accomplish what they're after. Other wealth managers, such as Lisa Whitcomb of Glenmede Trust, put the threshold as low as $2 million. GenSpring's Bakman says that generally a foundation makes sense only to the extent that it either gets assets upfront or will receive assets from other structures set up by the donor so it can justify the administrative, accounting, legal and other costs.
However, more than costs must be taken into consideration in deciding whether to set up a foundation, says Ballentine. "You don't make that decision based solely on cost; you make it on the totality of theissues to which the decision relates. The important factor is: What is the family's commitment to working together oncharitable activities?"
Whitcomb agrees. "You're achieving a number of objectives with a family foundation that you might not have another way to accomplish; one of those is how a family foundation can bring a family together."
Benjamin adds that "If you like the idea of having family members or friends carry on a specific charitable purpose that you back, then a charitable foundation you create may make sense." He likes to see his clients set up their foundations during their lifetimes. This allows everybody involved in the project to know what the mission of the foundation is, avoiding complications later. "[A client] can set this up as part of [his or her] will, but quite often the trustees or the directors of the foundation will go off in their own directions."
Ballentine likes the idea of giving away money in chunks during the donor's lifetime. "Many of the families we work with become very engaged in that; they have a lot of fun doing it." He says one client couple was talking about giving away money through their estates. "Finally, I said, 'You know, it's a lot more fun to give money away while you're alive than when you're dead.' They looked at me and blinked, then looked at one another and said, 'You know, he's got a point.'"
This couple--who had already taken care of their children financially--had not focused on the pleasure they could derive from giving away assets they knew they didn't need "They decided to get going now," Ballentine adds, "and most of it will be given away while they are able to do it themselves."
Thanks to new ways to outsource administrative burdens, philanthropists can start a foundation at a much lower level of assets. There are now about $450 billion in 70,000 private foundations, according to Foundation Source President Christopher Infurchia. Of those, he adds, "60% are under $1 million, and 87% are under $5 million" in assets. The Fairfield, Conn.-based firm handles the back office tasks for 800 foundationclients with $3.4 billion in total assets under administration, but doesn't manage those assets. Because of the efficiencies of outsourcing, Infurchia asserts, foundations can save about 20% of overhead costs through outsourcing to Foundation Source as compared with traditional foundations that do it all in-house. That savings brings the threshold for starting a foundation way down to about $250,000.
A foundation can be a wonderful way to "get the family together," notes Page Eberstadt Snow, chief philanthropic officer at Foundation Source. A foundation gives the wealth manager and the client family a "way of teaching the kids skills in investment management, reading the financials of the non-profits, and presenting ideas in a group," and the older generation gets to "watch the kids in action." Working with family in a private foundation is a "way of getting disconnected kids involved and aware."--Kathleen M. McBride
Michael S. Fischer is a New York-based financial writer and editor. He can be reached at firstname.lastname@example.org.