PASSING ON, PASSING OVER
Generation-skipping trusts, can be useful estate planning tools,
but can ignite family squabbles unless carefully managed.
By: Elizabeth Harris
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W HEN JONATHAN M. PLACE’S GRANDFATHER DIED, HE ASSUMED HIS MOTHER WOULD INHERIT THE ESTATE. SO IT REALLY CAME AS A SURPRISE WHEN HE LEARNED THAT HIS GRAND-FATHER HAD CREATED A GENERATION—SKIPPING TRUST THAT INCLUDED HIM AS A BENEFICIARY.
Place, who belongs to the inheritors’ education and advocacy group Heirs, then began assessing his legal rights to the estate . His confusion represents a common problem, according to Heirs founder Standish Smith. “Our experience is, if families don’t sit down and discuss this openly, its a recipe for dissension later,” he says.
Family discord frequently accompanies generation—skipping trusts (GSTs), which literally pass over a generation of heirs. Estate planning remains full of thorny issues, but few are as perilous as those behind GSTs. Designed to ensure that assets will be reserved for future generations, GSTs often also say something about the parent—child relationship. They are increasingly popular as a way to keep money from a child’s spouse in case of divorce or to keep money from a child whose past choices—from career selection to drug use—upset the wealth holder.
Some families use this type of trust to protect property from an estate—tax hit, which the IRS can levy when each generation inherits money from the trust.
However, GSTs of this sort do not carry the same sort of emotional burden because their primary aim is to save taxes, rather than exclude family members.
GST s hold appeal for families whose net worth exceeds $100 million. Tax savings multiply exponentially with each generation that avoids the estate levy. At this level of wealth, when parents skip their children in favor of grandchildren, their children rarely suffer financial hardship. The children usually have sufficient means of their own, or ate already beneficiaries of grantor—retained annuity trusts, according to Jonathan Forster, an estate attorney and co-managing partner with the Tysons Cotncr, Va—based firm of Greenberg Traurig. “For the superwealthy, parents figure they have already done enough for their children,” Forster says.
While some see grantors of these trusts as control freaks, as estate planning tools GSTs provide peace of mind to those worried their assets could be diverted away from the family. These trusts offer numerous protections~not just from taxes, but from creditors as well. “You leave assets to your kids, and 10 years later, they get a divorce,” says Armond Budish, a partner with Beachwood, Ohio—based Budish, Solomon, Steiner & Peck and author of Why Wills Won’t Work Jf You Want to Protect Your Assets) : Safeguard Your Estate for the Ones You Reall y Love. “Nobody wants to picture the money they left to a child paying for an extravagant lifestyle for an estranged son— or daughter—in-law”
Such fear can prompt many families to establish GST bloodline trusts, lBudish says. Still, he finds these kinds of trusts can often create family friction.
This type of estate planning can also lead to messy complications and unintended consequences. One of Forster’s clients, whom he declined to name, received an annual $4 million income as a beneficiary of a GST. He and his wife spent it all on a lavish lifestyle. Neither earned outside salaries and they lacked the financial incentive to find careers or to continue to build their assets.
But when the husband died relatively young~in his 5Os, it transformed his widow’s life; her income stopped and their three children became the beneficiaries. ‘She’s permanently reliant on her children, and there’s confusion about how this really happened,” Forster says.
In retrospect, the husband could have easily avoided this financial crisis by his purchasing life insurance. Instead, the children now give their mother money at the maximum allowable gift rate of $12,50() a year . But this reversal of fortune and their mother’s reliance on her children led to new challenges, because her children and their spouses feel that she and her husband, despite knowing the eventual outcome of the GST, squandered enormous assets when they should have been living conservatively.
Planning ahead and communicating are essential to avoiding future conflicts. Bruce Udell, founder and CEO of Sarasota, Fla. based Udell Associates, urges his financial—planning clients to discuss their estate wishes openly with their children. Most people resist fully disclosing their finances, and sonic may have good reason to fear their decisions might upset their children.
One couple believes their son, a wealthy business owner, would have no need for a share of their $10 million estate, so they plan to divide it between their grandchildren and another less financially successful child. Udell understands why this couple resists his suggestion to explain their plans to all of their relatives at a family meeting, but, nevertheless, encourages them to do so.
“They don’t feel comfortable talking about it,” Udell says. “But you know yotl’re going to have a family meeting it’s either going to be when you’re alive or when you’re dead—and you’re better off having a say in it now.
Families can avoid the hurt feelings and confusion that sometimes accompany GSTs by openly explaining the rationale behind choosing this type of trust. jack Edgar, managing director of Lcgg Mason Investment Counsel, encourages his clients to share their intentions with their children and clarify the significant upsides of protection from creditors, taxes and divorce.
Even when clients choose a generation—skipping trust that includes their children as beneficiaries—with the grandchildren next in line—their adult children can see it as a vote of no-confidence.
Without a conversation, kids often think, “Why didn’t Mom and Dad leave it to us outright?”’ Edgar says. “With a little education, you can usually get around it and kids realize the benefits.”
Several years ago, Stuart Lucas became an advocate for encouraging his family to develop a plan for educating the next generation. A fourth-generation heir of L.A. Stuart, founder of Carnation, Lucas understood the stakes personally, as well as professionally, through his advisory practice as chairman of the Wealth Strategist Network in Chicago.
He believed that articulating the family’s values by composing a family mission statement could help prepare the next generation of Carnation heirs, some of whom are now in their mid-teens. However, his family refashioned his suggestion. Instead, they began articulating their values more organically by talking about how they would manage a jointly owned summerhouse . The summerhouse (or for another family, perhaps a business) helped the family find common ground—or what Lucas refers to as “finding family affinities.”
Even in cases in which all family members are beneficiaries, unintended tensions can emerge—particularly when individuals believe the trust benefits family members unequally. When creating a GST, grantors must decide whether to divide assets to beneficiaries by family branch or by number of offspring. Those wanting to divide equally among siblings should choose dividing per stirpes, which treats each child equally, as opposed to each grandchild.
Consider a couple with two children. One child has four children, the other just one . If a $10 million trust is divided up per stirpcs, the four siblings would receive $1.25 million each and the fifth grandchild, $5 million . If, however, the trust is divided equally among all five grandchildren, each would receive $2 million. In that case,”Some parents will argue that you penalize them because they only had one child,” Lucas says. This isn’t necessarily so. The key goes back to your communication and values—if you can get the values component right, everyone will understand.”
Grantors can also disrupt future generations if they do not properly plan for how a trust distributes assets. Trusts designed to produce consistent income, for example, are often heavily invested in bonds and fixed—income products . But this mix can fail future generations by hindering growth. A better choice is to align current and future beneficiaries’ interests through paying 2 to 4 percent of trust assets rather than net income, Lucas says. “By setting a fixed spending rate, everybody benefits,” he notes.
Drafting long—range plans for subsequent generations also raises the stakes for choosing a trustee wisely. Thomas Snowden III is the beneficiary of a GST with assets that trace back to trusts created by his great—grandfather, R. Brinkley Snowden, who had named the bank he worked for as trustee. Two generations had run the National Bank of Commerce in Memphis and the hank provided much of the family’s wealth, so it seemed a natural choice.
Twelve years ago, when Thomas, a writer who lives in Sewance, Tenn., began receiving trust distributions at age 30, he knew very little about his trust. Over time, he educated himself and asked officials at the bank (since acquired by SunTrust) to diversify his portfolio beyond its 30 percent in SunTrust stock and the 70 percent in SunTrust mutual funds . He also knew that oil and gas wells owned by the trust had not been recently appraised; he suspected they were overvalued and, thus, the account had paid too much in fees.
Eventually, Thomas sought to transfer the trust stewardship to South Dakota Trust, where he believed he would have more input over investment decisions. Ultimately, Thomas brought his case to probate court and gained control over the trust. He encourages other wealth holders to include a portability clause in their trusts, which gives bankers greater incentive to listen to heirs’ requests. In addition, the trust can name the beneficiary as the investment advisor or delegate, which provides even more financial input. “The whole idea of a trust is to preserve assets and grow assets,” Thomas says. “My grandparents wanted my sister and me to enjoy life, and because all the control was givell to the trust, the trustees disregarded our interests.”
Usually, parents determine how GSTs will work, but sometimes children have a say—and their input can prove life-altering. Clients of Lew Altfest, founder of New York—based L.J. Altfest & Co., drafted a GST to benefit their grandchildren because the funds would be superfluous for their already—wealthy children. Altfest created the financial plans for the parents, as well as their three children, two of whom had children of their own. The plans inspired the son— who at the tune was in his 30s, unmarried and aware of the GST—to get married and start a family so, along with his siblings’ children, his lineage would benefit from the trust.
Altfest recalls the son telling him, “I’ve got to get going here.” Soon after, the son married and became a father.
--------Elizabeth Harris is a staff writer for WORTH.
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