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Leaving a Legacy
You'll have to go sometime, but the right planning can ensure your estate will live on
Found in: Inside Business Magazine
12-15-2003
By: Peter Strozniak, Inside Business writer
You're going to die someday. Your first thought: "Gulp." Your second thought: “What’s going to happen to my estate?" While the affluent and mortal must face these issues in one way or another, there's no guarantee they'll deal with them. Trouble dealing with the end may partially explain why some fail to prepare an estate plan. But estate-planning experts say there may be deeper reasons why they never draft such a plan.
In addition to facing their own death, people have complex -- and sometimes conflicting thoughts about how to equitably share their wealth with their children, their grandchildren and their community so that their lifetime worth will leave a positive legacy. What's more, they haven't determined how much money they need to be financially independent for the rest of their lives. So what happens?
Nothing. And when there's no estate plan, the survivors may have to go through a painful court process, which publicly determines how your estate is divided. What's worse, about half of what you worked so hard for will be taken by the federal government's estate tax law.
So what's the solution?
The good news is there are hundreds of ways you can make sure everything you've worked for in your lifetime will live on in the next generation, including establishing a family legacy that could make a profound impact on your favorite charity or social cause, your alma mater or a much-loved community or organization.
"Most financial planners will simply ask clients what will they like to do in their estate plan." says Richard Tanner, president of Ownership Advisors Inc., a Cleveland-based family-wealth counseling firm "Most people really don't know how to respond, or when they do respond, they give answers that are not well thought out. What we do with wealth counseling and coaching is to get people to think about what the significance of what they want their life's work to be now, in the future and after they die."
While many affluent parents want to pass on their wealth to their children and grandchildren, Tanner believes there will be an emerging trend to impart a positive legacy on charitable or social causes. According to the Social Welfare Research Institute at Boston College, an estimated $41 trillion is expected to be transferred via estates over the next five decades. Of that total, $6 trillion is expected to be funneled to charity.
But before rich people decide how to impart that wealth, they first need to iron out what type of legacy they will leave to their heirs.
"One of the fears that affluent people have is that the impact of their wealth will actually produce negative results, that their heirs will lose their motivation or incentive to work, or that they may be in some way damaged by inherited wealth," Tanner says. 'What affluent people are going to do with their money, how they are going to divide it up among their children, is where many get stuck, and they usually had no one to talk to about their conflicting feelings."
For example. Tanner has husband-and- wife clients with six children. The parents have strong religious beliefs. One child is gay, while some of the other children share the beliefs of their parents and others do not.
"They were stuck on how do they remain consistent with their Christian faith on making sure they would be good stewards with their wealth while at the same time treating their children fairly and equally," Tanner says. "Well, that’s very difficult. But being able to talk about it helped them gain more clarity about what they wanted to do. When people think and talk about these issues, they come up with solutions."
Tanner invites his clients to a retreat where they can do some soul searching about what their wealth means to them, and how it affects their values and obligations to each other, their children and their community. After they determine what they want their wealth to accomplish, Tanner helps his clients draft a plan that can help them enhance their wealth and minimize or eliminate tax liabilities.
Although the federal estate tax is being reduced, it's not out of the picture. Congress passed legislation in 2001 that will repeal the tax, but the full repeal won't be effective until 2010. In the mean- time, you still have to pay a hefty and, some might argue, obscene, tax. For example, if your estate is worth more than $1 million, the tax rate is 49 percent. Next year, you get a little bit of a break in that if your estate is worth more than $1.5 million, the government's tax rate is 48 percent. By 2005, the rate drops to 47 percent. There is no tax imposed on estates worth less than $1 million.
"Our process gives people a chance to slow down and devote a sizable amount of time to think about what they want to do with their money," Tanner says.
Dan Merkel, a senior vice president at Republic Bancorp Inc. in Pepper Pike, went through Tanner's process.
"My wife and I discussed where are we, where we want to be and what do we want to do with the rest of our lives," Merkel says. 'We looked at what we value most and where do we want to see our assets go. We all have a choice. Your assets are either going to go to the government for taxing purposes, or you can direct where they are going. I'd rather direct them to charities or other organizations."
Merkel set up a charitable remainder trust (CRT) to hold his assets. By putting your assets in a CRT, you remove them from your estate and eliminate the estate tax. In addition, you receive a charitable income tax deduction in the year you set up the CRT. What's more, your surviving spouse can receive income from the CRT. When the second spouse dies, the assets are donated to charity.
It’s a win-win situation," Merkel says. "It's good for charities and it's good for you."
With the CRT you are allowed to replace the value of the assets you donated to the charity with a wealth replacement trust or irrevocable life insurance trust, Tanner says. You provide the life insurance premiums to the trust and the trust pays those premiums. After your death, the life insurance proceeds are passed federal estate tax-free to your beneficiaries because the trust, not you, owned the insurance policy.
The CRT is just one estate planning instrument; there are hundreds of ways to set up trusts in an estate plan, says Thomas H. Craft, a certified public accountant and president of Artista Financial Group LLC of Westlake.
"But you can't just rubber-stamp an estate plan, it has got to fit the needs of the individual," Craft says.
First, he says, you have to get a good understanding of your assets - not just the business, your home, your boat and the condo in Florida -but your 401(k) plan, your IRA, your stocks and bonds, your savings and life insurance policies.
Craft doesn't even talk about a plan until he and the client have an understanding of what the client owns. His clients own estates in the $1 million to $15 million range.
"A lot of people don't have a really good understanding about the extent of their estate," Craft says. "If you keep hoarding assets, in most cases the children won't get them; the government will if you fail to devise an estate plan."
One of the most popular and effective tools to avoid paying the federal estate tax is the AB Trust, a legal document that allows you to have your cake and eat it, too.
For example, let's say a couple owns an estate worth about $2 million. If the husband dies, the wife inherits the estate, tax free. When the wife dies, the estate is worth $2.5 million. Although $1 million is exempt from any tax, the government can tax nearly 50 percent of the remainder.
A simple way to avoid that, says Joe Kampman, an estate planning lawyer with Ziegler, Metzger and Miller in Cleveland, is to set up what's called an AB Trust, commonly known as a revocable living trust.
Here's how it works: A couple can put their assets in an AB Trust. When one spouse dies, the surviving spouse can use that trust for certain living expenses. Kampman says the trust has a standard of distribution to provide for the health, education, support and maintenance of the surviving spouse in his or her accustomed manner of living. But when the second spouse dies, the assets in the estate are transferred to the children tax free. The assets are not subject to the estate tax because the second spouse never legally owned them. The trust did.
Not all trusts work this way, however. You still have to pay the estate tax when you transfer assets into certain trusts.
The Dynasty trust works this way. But the assets are not taxed when they are used by future generations, Craft says.
'The Dynasty trust is a tool to transfer wealth to future generations of your family, but you may not want them to control it because you don't want the wealth to be squandered," Craft says.
The Dynasty trust can be set up in a way that will allow future generations to use the trust's assets, but only for specific purposes such as buying a new home or launching a business. These assets are owned by the trust. So when they are sold, the money goes back into the trust, which perpetuates the wealth for future generations.
"People, no matter if they have an estate worth $100 million or $1 million, have very strong beliefs about their bloodline, and they want to protect the family's assets knowing that they are going to benefit their children, grandchildren and future generations," Craft says.
Trusts also can be structured for incentives. For example, Kampman says, a grandchild can have access to a trust only after he or she attains a college degree or becomes gainfully employed.
'The beauty of the trust is that you can tailor it to any situation," Kampman says.
For more information, contact Ownership Advisors at 216-328-5538.
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