Posted August 1st, 2007

Avoiding ‘Bad Heir’ Day

In recent months, there has been no shortage of publicity surrounding the irresponsible behavior of wealthy young persons, some of whom have inherited their assets and others who are earning monumental sums on their own. Some have even gone so far as to point to these “bad heirs” as prime examples of why heavy estate taxes may not be such a bad idea.

In any case, there is nothing new about wealthy individuals worrying about how an inheritance could impact their children or other loved ones. We have even heard of cases where donors were concerned that too large a bequest to a charity might diminish its motivation to raise funds from additional sources.

One of the central themes of the original wealth transfer study by Robert Avery and Michael Rendall of Cornell University was a discussion of the possible impact of an inheritance on baby boomers’ initiative and willingness to work. Would the windfall from the wealth transfer trigger large numbers of baby boomers to drop their goals and aspirations in pursuit of frivolity?

Curing ‘affluenza’?

Warren Buffett has addressed this question in his own estate planning, saying publicly that he intends to leave his children enough money so they can do whatever they want with their lives, but not so much that they will have to do nothing at all. With millions of potential heirs who possess differing degrees of personal and professional industriousness currently in line to inherit trillions of dollars over the next few decades, the concerns of the possible negative effects of what has been termed “affluenza” are spreading to the broader middle class.

Assets that a person, or a couple, may have spent a lifetime accumulating can be wasted in a relatively short period of time. Not only that, the experience may leave heirs in a worse position than they were before receiving and squandering a windfall.

According to a survey conducted by HNW, Inc. for the PNC Financial Services Group, almost two-thirds of high net worth individuals believe that it is important for each generation to take responsibility for creating its own wealth, yet, unlike Warren Buffet, less than one-third of those with estate plans take specific steps to encourage this goal.

Getting what they need, not what they want

There are many ways to thoughtfully place restrictions or conditions on an inheritance. In some instances, an heir may receive only an income stream for life, or some other period of time designed to give them a start in life. In other cases, a beneficiary may receive the right to use the property for life only.

In the past, various charitable gift planning vehicles have been used to deal with this problem. For example, through a charitable trust or gift annuity arrangement, an heir was left an income for life or a set number of years. Or beneficiaries received a “Second Chance” inheritance upon the termination of a charitable lead trust that made payments to charity while the heirs learned to provide for themselves.

Others chose to provide a life interest in a personal residence or a farm so a child or other loved one would always have a place to live. The use of these types of planned giving techniques was also particularly attractive when dealing with a variety of gift and estate tax problems.

Times have changed

Today, however, thanks to current federal gift and estate tax exemption equivalents, the vast majority of people no longer need to worry about death taxes. Reduction in gift and estate taxes provides gift planners with vast new planning opportunities. Instead of having to qualify under various rules and regulations applicable to popular gift plans like CRATs, CRUTs, GAs, DFGAs, CLATs, CLUTs, and PIFs, donors and their advisors may structure arrangements that will encourage more positive outcomes for their heirs and support charitable causes as well.

If donors and planners do not have to worry about conforming to rigid, tax-qualified structures, they may instead decide to provide income for heirs conditioned on some event, such as finishing school, being gainfully employed, getting married, etc. The remainder may then go to charity after a term of years, on the failure of an heir to qualify for the income, or at the death of an heir. As a variation on the lead trust theme, a trustee may be instructed to match the amount earned by an heir each year with any remaining income devoted to charity.

In addition to providing incentives for positive activities, disincentives may help encourage heirs to avoid potential destructive behavior in order to receive income. In such trust arrangements, there can also be a final charitable beneficiary, even though the trust is not drafted as a qualified charitable remainder trust.

More opportunities to achieve goals

Gift and estate planners may thus discover that the practical elimination of estate and gift tax concerns for most of their clients and donors will provide additional planning flexibility, thereby allowing more people to address their personal and philanthropic goals than can currently be accommodated in the existing menu of tax-qualified options.

Concerns about the effects of affluenza on heirs may drive an increased prevalence of charitable remainders in estate plans. Instead of having to conform with the tax rules and regulations for qualified charitable remainder gifts, greater numbers of people will be able to structure gifts that provide both for family and loved ones, while resting assured that funds not used in this fashion will still ultimately benefit their charitable interests.

Ironically, because most people’s estate plans will no longer revolve around dealing with estate taxes, we may see a golden age of estate planning where the goals of the individual—both personal and philanthropic—are met without having to comply with artificial constraints previously imposed by inflexible tax laws, regulations, and the courts that have interpreted them.

The publisher of Give & Take is not engaged in rendering legal or tax advisory service. For advice and assistance in specific cases, the services of your own counsel should be obtained. Articles in Give & Take may generally be reprinted for distribution to board members and staff of nonprofit institutions and other non-donor groups. Proper credit must be given. Call for details.

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