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Design Options for Education Trusts

Boarding School Cross Country MeetI often work with “Wealth Creators” who have built substantial wealth themselves, most notably as founders of companies or early-stage employees at startups.

I also work with “Inheritors” managing wealth built in prior generations for the benefit of descendants.

Although every instance has unique aspects, in general, I find that Wealth Creators have conflicted feelings about what being Inheritors will mean for their descendants.

They often tell me they don’t want their children to have “too much” wealth.

Obviously, this presents a difficult question: how much wealth is too much? Answers to that question vary.

Amidst that variance, a very common instinct is that even if they aren’t confident about whether their children (or, instead, charity) should receive the bulk of their wealth, they do want to leave assets in trust to pay for their descendants’ education.

This instinct makes a tremendous amount of sense, and I never discourage it.

Education is a critical component of human capital formation, and human capital has often been the unique element in why any particular Wealth Creator built such success.

If funds are going to be left in trust for descendants’ education, what should the key provisions of those trusts be?

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distributing tangible personal propertyDuring an estate or trust administration, it’s easy to divide and distribute financial assets. Distributing tangible personal property (such as furniture, collections, artwork, jewelry, etc.) can be much harder.

Executors, trustees, and beneficiaries are usually very surprised by how little household goods and personal property are worth in an estate administration context.

Nonetheless, simply because property isn’t economically valuable doesn’t mean it might not have substantial emotional and sentimental value.

This makes it all the more important to be thoughtful about ways to thoughtfully avoid conflict, expense, or even litigation relating to personal property.

There are several ways to approach these issues.

The simplest approach (but in my experience, one that is not that common) may be to sell all of the property and divide the proceeds as directed in the estate plan.

Positives of this approach include transparency and fairness, because sale proceeds can be accounted for, and money can be divided easily.

Negatives include the typically low sale value of the property, and a lost opportunity to preserve its sentimental value within the family.

A far more common approach is to “work it out” among the family.

The executor or trustee might ask beneficiaries which items they want and see if a consensus appears. If a particular item is a focus for more than one family member, a bit of trading might occur, or (in extreme cases) those items might be sold.

This approach often sorts itself out with surprising speed and not that much fuss.

Its advantages include keeping items in the family that family members want.

Disadvantages may arise if one beneficiary is particularly pushy, and another is conflict-avoidant. In these instances, items may be distributed, but bad feelings among beneficiaries may simmer afterwards.

Families use a “draft pick” approach less frequently, but this offers the opportunity for increased fairness, and a structure that may reduce conflict.

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Avoiding Family Fights In Estate Administration

1962 VolvoEstate administration can be a frustrating experience for families and their advisors, because it’s an occasion when families fight. Sometimes the fights are necessary, and unavoidable. Many other times, to a detached observer, the fights seem silly.

Whether justified (or not), whether necessary (or not), conflict makes estate administration cost more (even when litigation doesn’t occur). When tensions boil over into litigation, costs skyrocket.

Because I think preventable conflict is wasteful, I want to offer some perspective on some of the most predictable conflict triggers in estate administration, along with suggestions for how clients and their advisors can reduce the risk of some of these pitfalls.

Pitfall: End of a Dependent Child’s Financial Support

Many clients have children with very divergent career and life incomes as adults (for more on this, see here). It’s not uncommon for one child to be much less economically secure than his or her siblings. Sometimes the cause is downsizing that ended a career early. Other times, it’s serially unsuccessful entrepreneurship, divorce(s), and/or unresolved addictions.

This sort of child (let’s call them, bluntly, a “dependent” child) has often received financial support from parents that other siblings don’t receive in similar amounts.

In extreme situations, the dependent child continues to live at home with his or her parents and “help” them with various home maintenance and aging issues, often in return for access (direct or indirect) to the parents’ pension income, Social Security, and retirement account required minimum distributions.

Invariably, the dependent child will view financial support he or she received as “gifts,” while his or her siblings will view the same transfers as “loans.”

In a perfect world, aging parents of dependent children would keep clear records clearly proving whether the transfers were gifts or loans. In the real world, those records are usually incomplete or nonexistent.

When the alleged loans aren’t documented, and a sibling other than the dependent sibling is named executor, estate administration can turn into an ugly “witch hunt” that in some ways seems like an effort by the executor to punish a dependent child for having been unsuccessful or irresponsible.

On the other hand, when the dependent child is named executor, any undocumented loans (that weren’t really gifts) are very unlikely to ever be repaid.

Solutions: When a client has a dependent child that receives financial support, keep careful records clarifying whether the support is a gift, a loan, or an advancement against a future inheritance.

Consider not having a dependent child serve as executor, and consider the risks a more financially successful child serving as executor might seek “payback” against a dependent child.

Consider whether use of a bank or trust company executor or co-executor might better preserve sibling relationships.

Pitfall: The Family Home Becomes a Long-Term Holding

Estate administrations often last much longer than they should because children cannot agree about what to do with their parents’ house (particularly if they grew up there and are sentimentally attached to it).

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Avoiding Probate: Myths and Realities

530439Many clients I work with have done a little bit of research about estate administration before we meet.  Often, they are surprisingly focused on “avoiding probate.”

This is such a common part of the client mind map that I think it’s worth examining myths and realities of avoiding probate in Kentucky.

Myth: Probate is expensive, so avoiding probate saves money.

Reality: In Jefferson County, the filing fee to probate a Will and appoint an executor or administrator is $193. If $193 is not expensive for you, then probate’s not necessarily expensive.

Myth: Avoiding probate saves taxes.

Reality: Federal estate tax laws are agnostic about whether assets are included in the probate or non-probate estate.

Myth: My heirs will fight over my estate in probate, so if my estate isn’t probated, there won’t be a fight.

Reality: Non-probate assets such as transfer-on-death accounts cause some of the most bitter inheritance disputes.

Probate provides an organized process for wealth transfer, and the transparency and structure it offers sometimes prevents sibling discord from boiling over into litigation.

Myth: My privacy will be compromised when my estate is probated, so I should avoid probate.

Reality: The extent to which probate discloses your wealth and the way you transfer it to your beneficiaries is up to you. If you use a “pour-over” Will and a Revocable Trust, your distributions to beneficiaries can remain private.

If you fund your revocable trust (at least in part) while you’re living, the inventory filed for your probate estate won’t disclose the complete extent of your wealth.

In addition, non-probate assets also include life insurance and retirement accounts that are designated to beneficiaries other than your estate.

For most of the upper middle and lower upper class, these non-probate assets (even without any lifetime funding of a revocable trust) constitute the majority of wealth.

Even without any extraordinary efforts to avoid probate, this wealth will be “off the grid” for privacy purposes.

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37Flood-1stBreckLately I’ve been thinking a lot about what a “Corporate Event” at Humana might mean for Louisville. A rosy analysis I’ve heard suggests that Aetna might buy Humana, and then move its headquarters here.

We’d all love that outcome (sorry, Hartford).

Other Humana transactions may have collateral effects on our city that are, to put it mildly, non-accretive.

But, if Tip O’Neill was correct when he famously observed that “all politics is local,” then it’s probably equally true that “all merger impacts are personal.”

  • What would regional economic risk like a Humana event mean for you?
  • What are your particular exposures?
  • Most importantly, what can you do to get ahead of those risks?

Because I believe the right pictures help clarify things, I created an Economic Risk Quadrant to evaluate your personal impacts from regional economic risk (whether sudden, or gradual).

Locating yourself, your business, or your employer on the Economic Risk Quadrant suggests how you might be affected, what you can do to prepare, and how you can most effectively adapt and respond.

Economic Exposure Grid

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burbsSeveral months ago I read Cut Adrift: Families in Insecure Times by Marianne Cooper, a Stanford sociologist. Cooper’s chapters on the extremely professionally successful upper middle class and their project of “doing security” were particularly interesting.

These families were operating an increasingly unstable career and social environment, and devoted tremendous energy to enhancing their own financial security.

At the same time, parents also worried about launching their children on career and life pathways from which they could realistically hope to replicate their parents’  outcomes.

In the wake of the Great Recession and in a context of increasing global competition and winner-take-all income stratification, these concerns of Cooper’s upper middle class families seemed justified.

If the inheritance project of the Upper Class is managing abundance to enhance overall thriving of children and grandchildren, and the project of the Lower Upper Class is managing volatility in descendants’ upward or downward mobility outcomes, the project of the Upper Middle Class is managing risk.

Risk management is paramount for the Upper Middle Class because this class is still building wealth, but doesn’t yet have a capital base larger than what they might realistically need themselves.

Nonetheless, as life expectancy increases, children and grandchildren need to be launched in life when parents are still living.

More so than for their wealthier colleagues and relatives, Upper Middle Class wealth needs to be adroitly managed to hedge against several genuine risks. Some of the most significant are unplanned early retirement, a long term care event, or unexpected longevity.

If any of these risk events occurs (let alone more than one), it can dramatically transform a family’s balance sheet for the worse. To explore these effects, I updated our inheritance model. Results of the model runs are summarized in the two charts below.

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