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Is Your House In Order?

Plan or have the taxman taketh away

Estate planning is a fancy term for trying to soften the impact of your death on those you leave behind. Most people probably think of wills and the need to distribute assets. Certainly, a big part of estate planning deals with clearly establishing who gets what after you are gone and making sure that your wishes are carried out in your absence. However, estate planning deals with a whole lot more.

Looking beyond the actual material possessions you leave behind, an important part of estate planning is preserving those possessions from unintended recipients. You might have the unsavoury brother doing time for insider trading, or that old friend who introduced you to your wife before you got rich. You can be sure that anyone who can lay claim to your assets will attempt to do so after you are gone. Careful estate planning can eliminate most of the feeding frenzy that often occurs after a person dies.

Presumably, if you are trying to protect your estate from unintended recipients, you must have somebody in mind to leave your assets to. Although financial matters and asset transfers continue to play a major role here as well, there is so much more for you to think about.

What else is there to consider? Estate planning involves providing for the wellbeing and continued care for those you leave behind. Whether you are concerned about leaving a handicapped dependent, a minor child or a cherished pet, estate planning involves creating solutions that help protect those who must carry on without you. Estate planning also involves trying to make provisions in advance for the hundreds of details that are associated with your death. Do you want your remains to be buried or cremated and scattered? If you lived like a king or queen and want to be buried like one, have you planned ahead (financially and otherwise) for this event? These are some of the questions raised during the estate planning process.

Why do estate planning? When Joe Robbie (the former owner of the Miami Dolphins) died, his heirs were forced to sell the team as well as the Joe Robbie Stadium in order to raise the cash to pay the estate taxes. They also lost millions of dollars to lawyers’ fees and other related expenses. In contrast, Sam Walton, the legendary founder of Wal-Mart, left an estate valued at roughly US$25 billion, yet his heirs didn’t pay a penny in estate taxes. The difference – Walton had a carefully conceived and crafted estate plan that took advantage of every legal opportunity offered by the estate tax codes. Robbie, on the other hand, had no estate plan at all.

Estate taxes, death taxes, inheritance taxes – they all mean the same thing. The government is taxing your estate when you die and your family gets what is left over. Estate taxes vary from country to country. Some have abolished estate taxes such as Australia in 1981 and Hong Kong just this year. However, some of these countries tax you on capital gains when your beneficiaries want to transfer or sell the assets. This is what I call estate shrinkage. Your estate shrinks from tax, legal bills and repayment of debt before distribution.

Country of residence with estate taxes (death taxes)

• Singapore 10% • Spain 34%
• Philippines 20% • UK 40%
• Greece 20% • France 40%
• Ireland 20% • Korea 45%
• Chile 25% • USA 47%
• Belgium 30% • Taiwan 50%
• Germany 30% • Japan 70%

Every year, untold millions of dollars are unnecessarily lost to estate taxes due to procrastination. It takes a highly motivated individual to invest their time and energy into planning something that will benefit others, especially when the individual won’t be around to see the results of his or her hard work.

Proper estate planning does far more than just reduce or eliminate estate taxes. It also:

  • Prevents children and grandchildren from fighting over money, the business and sentimental items in the estate.
  • Prepares children and grandchildren for the wealth they will receive.
  • Protects the assets you leave behind from the ravages of divorce, lawsuits and other creditor actions.
  • Creates tax-deferred cashflow streams for yourself if you become disabled and for your family when you die.
  • Maximises the value of your business in family buy-sell agreements or an outside sale.
  • Prepares the business to continue (whether kept or sold) after you are gone.

Creating the estate plan

In order to create an effective estate plan, you must first create a vision and then set concrete goals and objectives. Once you have a clear idea of where you want to go and what you want to accomplish, then you can proceed with building the plan. To provide a blueprint for your estate plan create a ‘family wealth vision’. This vision, typically expressed through a written “family letter of intent”, answers such critical questions as:

  • What are we trying to achieve as a family?
  • What legacy do I want to leave for those who come behind me?
  • How do we want to distribute the family wealth?
  • What goals do we hope to accomplish with this distribution?
  • Discuss financial matters with trusted accounting firms conforming to proper financial planning methods.

Having a family vision helps your advisers understand exactly what you’re trying to achieve, thus ensuring that you drive the planning process rather than your lawyer or tax adviser.

Once you have a working blueprint, creating an estate plan involves four basic steps:

  1. Conduct a current estate analysis. Crunch the numbers to get an accurate value of your estate. Then compare the taxes you owe (prior to estate planning) to your vision and goals. This provides the starting point for identifying the appropriate strategies, tactics and estate planning tools needed to minimise estate taxes and accomplish your philanthropic goals.
  2. Assemble your team of advisers. The team must include your estate planning firm, an experienced accountant or lawyer. It may also include an investment specialist or money manager, a life insurance broker and/or other outside specialists. For very large or complex estates, you may want to add an additional accountant or lawyer that specialises in estate taxes.
  3. Design and implement the plan. A good estate plan includes:
  • Fundamental documentation, including a living trust, wills and other ancillary documents, such as power of attorney for health care and asset maintenance, or cascading powers of attorney if other powers of attorney are out of the country or have died in the interim.
  • Estate planning tools that remove assets from the estate balance sheet, while leaving you in control of the assets.
  • Estate planning tools that set up a gifting programme as outlined in your estate planning family letter of intent.
  • Documentation or language that provides for the transfer of sentimental items that have limited financial value but tremendous emotional value to family members.
  1. Review and update the plan as needed. In general, an estate plan should be reviewed every two or three years. However, changes in tax laws, family circumstances or estate planning goals necessitate an immediate review.

Principles of estate planning

Before engaging in estate planning it helps to understand several big picture principals:

  • Estate planning involves more than just money. Estate planning should address three separate aspects of family wealth: financial, social and spiritual.
  • It’s the people, not the documents. Documents play an important role in the process, but people make the real difference.
  • Communication = success. The ultimate success or failure of your estate plan lies in how well you communicate to your advisers, family and anyone else affected by the disposition of your estate.
  • Educate your children. Lack of education can ruin even the best of estate plans. For that reason, continually educate your children in how to handle money, how to be good business people (in any business) and how to succeed in life.
  • Do no harm. In addition to minimising taxes, an estate plan should ensure that your children have financial incentives to work hard and become contributing members of their communities, prevent family conflicts, prepare your children and grandchildren for the wealth they will receive, protect against divorce and protect your assets so the business continues.

Many things can derail an otherwise sound estate plan. I caution against the following estate planning mistakes:

  • Procrastination/lack of planning.
  • Lack of clear estate planning goals.
  • Failure to update the plan.
  • Lack of succession planning for the business.
  • Thinking your existing general advisers have the answers.
  • Lack of coordination among your estate planning team.
  • Overdependence on life insurance.
  • Ignoring the human dynamics.

Estate planning tools

The following tools form the basic foundation for any effective estate plan:

  • Wills are legal documents that specify what happens to your assets when you die. If you do nothing else in the way of estate planning, at least have a will.
  • Trusts are legal entities that can own assets, are managed by one or more trustees and have designated beneficiaries. They play a vital role in estate planning because they allow you to control and protect assets while minimising tax liabilities.
  • Life insurance is typically used as a source of funds for paying estate taxes or funding estate costs.
  • Annuities are investment vehicles providing income in retirement and are sold by life companies. They are equipped to avoid probate so that the estate saves money upon their distribution.
  • Retirement plans are your pension and superannuation funds that have binding nominations as to which family member would receive your pension funds upon your demise. These nominations are an effective probate avoidance strategy.
  • Joint names for property which can be owned as joint tenants. The rules of survivorship follow that upon death, the property reverts to the surviving spouse without entering probate. However, also plan in the event of both deaths who would receive the property.
  • Powers of attorney should be used to ensure that you can nominate someone else if you are incapacitated or in a coma and cannot act for your financial interests. You must nominate someone you trust in this circumstance as legally that person becomes you!

Communication tools

Communicating your estate planning goals and objectives plays an essential role in the eventual success of your plan. I recommend the following tools for ensuring that everyone involved understands the plan and works toward the same ultimate outcome.

  • Family letter of intent. The family letter of intent identifies specific estate planning goals, provides clarity and direction, and serves as a touchstone for all key decisions during the planning process. It represents the single most important estate planning document.
  • Annual common-sense business letter. This letter addresses critical business succession issues in the event of your premature death or mental disability. You can update the letter each year and give a copy to your family, the executor of your estate and your management team.
  • Annual common-sense personal letter. This letter for your spouse and family members should include a list of all your assets and accounts, location of all legal documents, computer passwords and hidden assets, instructions for disbursement of sentimental items and any imbalances that might cause conflict when settling the estate (ie, a large loan from the parents to one child).
  • ‘I love you’ letter. An ‘I love you’ letter (or videotape) lets family members or other loved ones know what they meant to you during your lifetime. It is often the most valuable thing you can leave behind, especially if you have very young children.
  • Family meetings. These provide a great way to open the channels of communication and discuss business, personal and estate planning issues before the parents die.

Divvying up the estate

In nearly one-third of all estates, the children end up fighting over something, usually sentimental or valuable items. These family feuds often last for years. To avoid conflict among siblings sit down with the children while you have the time and discuss what is important to you and them. Your communication letters and videos will set out how you finally made up your mind, but discussing it will be certain to change your thoughts on who should get what.

By Todd Pallett

Todd Pallett has been working in business and estate planning for nine years as a specialist.