I read several estate plans every year. Unfortunately, many of those plans don’t even come close to expressing the grantor’s true wishes for their assets. If this happens for individuals with a net worth of $40 million, imagine how often this happens for estates in the $5 million to $20 million range.
I am not going to point fingers at property lawyers. They can only work with the facts that are given to them. The disconnect usually occurs with advisors who have been working with the grantor throughout the year. More specifically, the breakdown has to do with a lack of education about financial incentives and charitable planning.
After interviewing several thousand high-net-worth families, tea US Trust Study of Philanthropic Conversation It was found that one-third of respondents (31%) would go to a new advisor if that advisor could talk to them meaningfully about philanthropy. Think about that for a second. One-third of affluent families move to a new advisor if that person is more adept at helping them get their money than their current advisor. It has nothing to do with investment returns, asset allocation or finding hot alternative investments. It is concerned with understanding the values of the client and seeing the complete picture.
But consultants focus on solutions – and how they get paid to recommend or implement those solutions. Okay. I understand that we all have to make a living. I understand that charitable planning can be complicated and requires a lot of study. But many advisors don’t want to try anything new, and that mindset will only come back to haunt them in the long run.
Finally, there is the fear of property migration – the elephant in the room. If you believe that a charitable plan will result in lower fees under your AUM business model, you will find plenty of reasons not to recommend it to your customers. But if you do charitable planning properly, it will boost your business, not reduce it. You will have assets that can last for generations through a variety of trusts, foundations, and charitable funds. In addition, once clients promote how well you have integrated philanthropy into their overall financial plan, referrals are more likely to roll in.
The other day I had two separate calls with entrepreneurs who had just sold their businesses for close to the eight-figure mark. When I asked why he put $1 million or $2 million of proceeds into a donor-aided fund (DAF), he told me that his advisor said he could get a tax deduction. But that was the only thing they could do with the income. I’m sure the advisors had their clients’ interests in mind, but defaulting for DAF whenever clients mention philanthropy is like defaulting on high-risk tech stocks whenever a client asks for an investment. Is. It is a solution, but not the only solution.
I also think that advisors default to DAF as there is not much learning curve involved. DAFs are easy to set up, simple to administer and are available in most major financial institutions. Unfortunately, with DAF, you are only paying money. The family does not get any other benefit.
I asked two bosses: “Suppose there’s a solution that can get you the same tax deduction but at the same time benefit your family?” And they both were looking at me strangely. “No one ever told us we could do this!” they shouted. Again, I’m not cursing DAF, but there are many other ways to accomplish similar goals for your clients, often with better long-term results.
Take Pooled Income Fund (PIF) only. PIFs are essentially charitable trusts that “pool” irrevocable gifts together from one or more individuals, or a family. Like the more common charitable balance trust (CRT), a PIF is a type of split interest trust. A gift to a charitable trust. The income is returned to the donor. And at some point in the future there is one final gift to charity.
If you take a little time to learn about PIFs, you’ll find that they offer a much higher charitable income tax deduction than CRTs. Also, there is a lot of latitude in how the money can be invested. And the way PIFs are structured, you can drive income for several generations – something you can’t do with a CRT. Many of the PIFs we have set up are for two, three, even four generations of beneficiaries. For more information on PIF, see my recent article Definition of pooled income fund,
Study the matter
Let’s say you have a client, Larry Jones, who has received a $10 million offer for his property. Let’s say he has downgraded assets to zero over the past few years and is looking at a $10 million capital gain. As a California resident, Larry’s tax is going to be about $3.7 million (37%) when you factor in federal capital gains tax, as well as state income tax and probably net investment income tax. So, Larry would have $6.3 million left in his wealth. He should be able to live on the income, right?
I see three common scenarios:
1. The “no plan” plan. Here a good advisor told Larry that he could take 4% a year (about $250,000) for living expenses. Assuming that his estate is taxable, what’s left of the $6.3 million when Larry dies will be reduced by 40%. Not much planning, right?
2. Install a CRT. Larry can sell the assets inside the CRT, avoiding capital gains tax and receiving the full $10 million in proceeds. Since the “forced” payment of CRT is at least 5% per year, that’s $500,000 per year in income—twice what he would be earning with the no-cost plan.
However, Larry can only run the CRT for one generation, that is, during the lifetime of himself and his wife. If he dies the next day, or if he and his wife get into a fatal accident, he loses $10 million in property, and his children receive nothing. To avoid that dire ordeal, the conventional wisdom is to purchase second-to-die life insurance to convert the asset into an asset. Of course, the cost of such a policy could be as much as $100,000 a year at Larry’s advanced age. Now he is gifting to a trust and using his exemptions.
What most people don’t realize is that when money comes out of CRT, some part of it will be taxable at the capital gains rate. Essentially a CRT works like an installment sale.
3. Install a PIF. Suppose instead, Larry transferred the $10 million asset to a PIF. Here he can name his children and grandchildren as “Constant Income Beneficiaries.” When Larry and his wife die, their children will receive income from the PIF as long as they are alive and then their Children (grandchildren) will have income as long as they alive.
Even better, there is no forced payment like there is with CRT (see 5% above). Only earned income should come out. In addition, there is a special structure that my firm has in place for PIFs that can give Larry 4% tax-free income for the rest of his life, as well as for the lives of these children and grandchildren. So, Larry is now getting 4% of the $10 million ($400,000 per year). Since the income is tax-exempt, he’s essentially earning almost twice as much after including California state taxes.
So, what happens to the money after three generations have passed? The money only goes to the charity designated by the donor and is covered under DAF rules.
Who will benefit?
As the old saying goes, “There are three types of people to whom you can leave your money: your family, the IRS or a charity (choose two out of three).” You must have never heard that individuals choose the government. But he is your charitable beneficiary by default. I think you can do better, and so can your customers.
Randy A Fox, CFP, AEP is tea founder of Two Hawks Consulting LLC, He is a nationally known wealth strategist, philanthropic wealth planner, educator and speaker.