My motivation for writing this article is to comment on the don't-ever-seem-to-get-done work of many real-life lawyers, particularly those who specialize in estate planning. I'll bet the farm that at least one-half of you reading this column, who did estate planning, can relate to the example that follows (true and unfortunately, often repeated).
Here's the story. A reader of this column, Joe, and his lawyer, Lenny, live in Florida. Joe (age 62) started his business from scratch (in a friend's garage). Now, he's successful: a profitable and growing corporation (Success Co.), 82 employees and a son, Sam, who runs the day-to-day operations.
When Joe got the let's-do-my-estate-plan itch, he went to see Lenny. Joe brought a package of information. (He learned what to bring by reading this column). Here's what the package contained, plus the essence of what Joe told Lenny: My wife Mary is 63. We have three kids and seven grandkids. Everyone is healthy. Sam (age 38) is the only child working at Success Co. (an S corporation) and runs the business like a pro. Joe wants to keep working to the day he dies, but less hours, less days and longer vacations.
Then Joe spelled out his basic goals:
1) Get Success Co. to Sam without Joe or his son getting killed by taxes.
2) Treat the two non-business kids equally.
3) Keep control of his assets, particularly Success Co., for as long as he lives.
4) Minimize (if possible eliminate) the estate tax bite.
5) Make a substantial contribution to charity if the gift does not reduce his children's inheritance.
Success Co. is worth about $9 million. In addition, his four most valuable assets are: real estate leased to Success Co. ($1.3 million); 401(k) plan ($1.8 million); various liquid investments, including stocks, bonds, CDs and other cash-like assets ($4.6 million); and two homes ($1.9 million). Other assets bring Joe's total net worth to a bit more than $20 million. Joe has no debt. Finally, Joe owns a life insurance policy insuring him for $3 million with a cash surrender value of $462,000.
Lenny took copious notes, asked many questions and after two-hours concluded the meeting saying, "I'll create your estate plan and send it to you."
From time to time, Joe would call Lenny to check the status of his estate plan. Nine months after the initial meting (Joe later quipped, "Just like having a baby."), Lenny delivered the completed plan. Guess what? The plan was simply two documents: a pour-over will with an A/B revocable trust. Frustrated, Joe called me, then mailed me the same package of information he had given to Lenny and the documents Lenny created.
Now, first the good news. Lenny's traditional documents were fine, and with a few minor changes were used as part of Joe's final estate plan. Lenny's cover letter made three major points: after Joe's death, Success Co. would go to Sam; after both Joe and Mary were in heaven, the rest of the assets would be divided equally to the two non-business children (but significantly less to each child than the $9 million current value of Success Co.) and the $3 million life insurance policy, plus the liquid assets would easily be enough to pay the anticipated estate tax. The letter also suggested that the $3 million insurance policy be transferred to an irrevocable life insurance trust, but did not draft the document.
What's wrong with Lenny's plan? Technically nothing. That's the problem… on the surface a pour over will, accompanied by an A/B trust (called a "traditional estate plan"), looks good and sounds good. But the sad fact is a traditional estate plan is nothing more than a death plan. It does not go into action until Joe and Mary are dead. It's a two-trick pony: defers the estate tax until Mary dies and avoids probate.
A good start. But standing alone, a traditional estate plan does not have a chance at conquering the estate tax and accomplishing the goals of the typical Joe and Mary, particularly if they own a family business and/or have a large net worth (typically, $5 million or more).
So, what's the answer? Two plans: first, a traditional plan (yes, the old-fashioned will and A/B trust is still a worthy friend) and second, a lifetime plan, designed to accomplish your goals, based on each significant asset you own.
So how do you create a lifetime plan that will work for you, your business and your family? It’s a rather simple three-step process:
Step No. 1: Make a list of each significant asset your own (if you own lots of real estate, stocks, bonds or other assets, they can be grouped).
Step No. 2: Opposite each asset (or group of assets) put down your goals for that asset for the rest of your life (usually includes maintaining control) and disposition when you (and your spouse) die.
Step No. 3: Select the appropriate strategy (we will use Joe and Mary as an example, so you can see how easy it is to do) to accomplish your goal for each significant asset. Hint: Life insurance, either already owned or to be acquired, is consider an asset.
Following is an outline of the lifetime plan Joe and Mary want to put in place. The goals are to get Success Co. to Sam ($9 million) and the rest of the assets ($9.5 million) to the two non-business kids. Of course, to get equal value to each of the kids we need $18 million ($9 million X 2) for the two non-business kids. The shortage will be made up with the purchase of second-to-die life insurance on Joe and Mary, including the $3 million in current coverage on Joe, which will be replaced with second-to-die coverage. The 401(k), $1.8 million, was used to fund an additional purchase of $3.6 million in second-to-die life insurance going (a) $1.8 million to charity and (b) $1.8 million to the non-business kids.
So here's the lifetime plan (finished in 12 weeks).
For Sam, Success Co. ($9 million) was transferred to him using an "arbitrage ILIT" (a combination of an irrevocable life insurance trust and an intentional defective trust). This type of ILIT transfers the nonvoting stock of Success Co. (via a sale) to trust with Sam as the beneficiary… tax-free. No income tax and no estate tax to either Joe or Sam. Joe keeps control of Success Co. by retaining the voting stock (only 100 shares) while selling the non-voting stock (10,000 shares) to the ILIT. Dividends from Success Co. (tax-free because an S corporation) are used to pay Joe for the nonvoting stock and purchase some second-to-die life insurance.
For the non-business kids, the liquid investments ($4.6 million) and the R/E ($1.3 million) are transferred to a family limited partnership (FLIP). These assets are now entitled to a discount (about 30%) making their value about $4.1 million (rounded) for tax purposes. For 2011 and 2012 a temporary gift tax window allows $5 million per person ($10 million if married) as a one-time tax-free gift. Joe and Mary take advantage of this law by gifting the limited partnership units (99%) to these two kids. Joe and Mary maintain control over the assets by keeping the general partnership units (only 1%).
The two homes are left to the two non-business kids using a strategy called a "qualified personal residence trust" and a small portion of the $5 million window.
In the end the lifetime plan created for Joe and Mary easily accomplished all of their goals: Success Co. to Sam, two non-business kids treated equally, a significant gift to charity without reducing the children’s inheritance and eliminating the impact of the estate tax.
Let's summarize: A traditional estate plan (typical pour-over will and A/B trust) is a death plan (how to distribute your assets). In addition, to accomplish your goals a lifetime plan is a must, modeled after the lifetime plan for Joe and Mary described above. No estate is too large or too complex that it cannot be designed to accomplish all of your goals with a lifetime plan.
It should be noted that no attempt is made in this article to cover all off the possibilities, strategies, rules and exceptions to structure every conceivable lifetime plan. Yet in practice every challenge presented by a client or column reader has been met.
Finally, just make sure you use an experienced professional who knows how to draft more than a traditional plan. And get it done in four months or less.
Irv Blackman, CPA and lawyer, is a retired founding partner of Blackman Kallick Bartelstein LLP and chairman emeritus of the New Century Bank, both in Chicago. He can be reached at 847-674-5295, e-mail [email protected], or on the Web at: WWW.TAXSECRETSOFTHEWEALTHY.COM.