How To Distribute Wealth To Your Heirs

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Most individuals choose to give their children their inheritances directly. Proper
trust  planning is  a  golden  opportunity to  do more  for  your  families. You  can
provide  your  families  with  many  generations  of  protection  from:  Creditors,
Predators, and Estate taxes.
 
A TALE OF TWO FAMILIES
 
Consider this tale . . .
 
The Knight Family:  John Knight inherited $1 million from his family directly.
His inheritance was titled in his own name. He owned it.
 
The Day Family: William Day  didn’t inherit anything  from  his  parents. They
did  leave  him $1  million  in  trust.  He  could  control  and  could  enjoy  the  $1
million as co-trustee and beneficiary, but his trust owned it.
 
You  might  think  that  John,  who  inherited  his  $1  million  directly,  would  be
happier than William, who inherited  his  $1 million in trust. But if the Knight
family knew what the Day family knew, he would not be. If John could see the
future,  he would  rather control and enjoy  his wealth than  own it. Let's take a
closer look.
 
THE KNIGHT FAMILY
 
Estate Taxes:  Estate tax rates begin at 37% once estates reach $650,000 and rise
to 55% when estates  reach $3 million. Since the government taxes everything
we  own  at  death,  John  would  pay  estate  taxes  on  his  $1  million  because  he
owns  it  outright.  If  his  descendants  inherit  their  wealth  outright,  too,  the
govern-ment will tax their wealth each time they pass it from one generation to
the next because each generation will own what they inherit.
 
Q:  Assuming each generation doubles its inherited wealth, what will happen in
three generations if each generation is in the 55% estate tax bracket?
 
A:  John’s $1 million will grow to $2 mill-ion, shrink to $900K when it passes
to his children, will grow to $1.8 million, shrink to $810K when it passes to his
grandchildren,  grow to  $1.62  million,  shrink to  $729K  when it  passes to  his
great-grandchildren.
 
Creditor  Claims:  To  make  matters  worse,  anything  one  of  the  Knight
descendants  owns  is  subject  to  claims  by  creditors.  Lawsuits  can  wipe  out
inheritances long before estate taxes do.
 
Predator  Claims:  Who  are  Predators?  Predators  can  come  from  within  the
family  –  particularly  the  spouse  of  an  unsuccessful  marriage.  Unless  each
family member  diligently  obtains a  prenuptial agreement and  diligently  keeps
inherited  property  separate  from marital  property,  a  soon-to-be-ex-spouse can
make  claim  to  it  in  a  divorce,  adding  financial  loss  to  a  family  member’s
personal one.
 
THE DAY FAMILY
 
Control  and  Enjoyment  without  Ownership:  Unlike  John  Knight,  William
Day’s $1 million is owned by a trust created by his parent’s estate plan, not by
William.  Even  though  William  can  spend  all  trust  income,  can  use  the
principal, and can control the trust assets as a cotrustee  of  his trust,  he is  not
deemed  to  own  the  trust’s  assets,  provided  the  trust  is  properly  drafted.  The
terms  of  the  trust  must  limit  William’s  access  to  trust  assets  to  his  health,
education, support and maintenance. Actually these limitations are so slight that
William  will  regard  the  trust’s  assets  as  his  own,  even  though  he  does  not
legally own them.
 
You  Cannot  Lose  What  You  Do  Not  Own.  Because  William  and  his
descendants do not legally own the trust assets, those assets are not subject to
claims of creditors and spouses of failed marriages.
 
Estate Taxes: Likewise, since they do not own the trust assets, these assets are
not included in their estate for estate tax purposes, even though they can direct
where they go at death.
 
Q:  Again  assuming  each  generation  doubles  its  inherited  wealth,  what  will
happen in three generations if the prop-erty is kept in a properly drafted trust?
 
A:  William’s $1 million will grow to $2 mill-ion, no shrinkage when it passes
to  his  children,  will  grow  to  $4  million,  no  shrinkage  when  it  passes  to  his
grand-children,  grow to  $8 million,  no  shrinkage when it  passes to  his  great-
grandchildren. An increase of over 10 times the amount passing to the Knight Family.
 
THE GENERATION-SKIPPING TAX
 
There  is  of  course,  a  catch.  The  estate-tax-free  nature  of  this  type  of  trust
planning did not go unnoticed by Congress.  In 1986, Congress enacted a 55%
generation-skipping transfer tax (GSTT) that applies whenever trust assets pass
to a new generation free of estate taxes.
 
The GSTT Exemption: Congress did however, provide a $1 million generation-
skipping transfer tax exemption. Individuals can contribute up to $1 million to a
specially  drafted  trust  that  is  exempt  from  both  estate  taxes  and  generation-
skipping  transfer  taxes.  With  proper  estate  planning  a  married  couple  can
transfer up to $2 million to such trusts.
 
Growing $1 Million Estate Tax Free:  As we have already seen, your family can
do a lot with $1 million over time in an estate tax free environment. With a 6%
annual  growth  rate  $1 million  dollars left to a child in a GSTT Exempt Trust
could  grow  to  almost  $80  million   as  it  passed  through  three  generations  of
family members, all without incurring additional estate taxes.*
 
If the  Knight  family  were to invest the  same  $1  million,  at the  same  rate  of
return,  for three  generations, they would  have  approximately  $7 million  after
paying estate taxes three times.**

 
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*At a 6% rate of growth, $1 million would grow to almost $80 million in the 75
years  it  would  take  to  pass  through  3  generations.  Assuming  a  25-year  age
difference between generations.
**Using  the  same  assumptions  as  the  preceding  footnote,  $1  million  would
grow to only $7.2 million if 55% is paid as estate taxes when it passes to the
next generation in years 25, 50, and 75.
 
Thanks  to W.  Edward  Dean,  Dean  &  Associates,  Estate  and  Charitable  Tax
Planning,  One California  Street,  19th  Floor,  San  Francisco, California  94111
(415) 352-1440. 
 
Mr. Dean is a tax attorney in San Francisco.  He protects wealth through estate,
income  and  charitable tax  planning.   Mr.  Dean  received  a  B.A.  and M.B.A.,
magna  cum laude,  Phi Beta  Kappa,  from  Dartmouth College,  a  J.D.  from the
University of Virginia, and an LL.M. in Taxation from New York University.
He  is  former  editor  of  the  Virginia  Law  Review,  the  Virginia  Journal  of
International  Law,  and the New  York University  Law Review.   Mr. Dean is a
California Bar Association-certified tax specialist.   He is a member of the San
Francisco Estate Planning Council and the Northern California Planned Giving
Council.   He is a founding member of and instructor for the National Network
of  Estate  Planning  Attorneys.   He  co-authors  and  teaches  the  Network's
Charitable Trust Institute and its Generation-Skipping Trust Institute.

 
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