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On Doctors Passing Wealth to Children

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Limiting your kid’s ability to tap principal

By Rick Kahler CFP® http://www.KahlerFinancial.com

Rick Kahler CFPWhen passing wealth to your kids, some medical professionals should consider creating a trust to limit the later generation’s ability to tap into the principal. Several astute readers suggested this strategy after my recent column citing research that shows 90% of inherited wealth is gone by the third generation.

Preserving Wealth

There is no question that a trust, done correctly, can go a long way to preserve wealth after the death of the wealth accumulator. Let’s explore what “done correctly” means.

1. Trust law is complex. Engage an accountant and attorney with strong skills and expertise in trusts.

2. Be sure the assets you intend to go into the trust will actually transfer.

Retirement plans like IRA’s, 401(k)’s, and profit sharing plans will pass to whomever you listed as the beneficiary. This must be the trust. In addition, the trust must include a number of special provisions in order for a retirement plan to be distributed according to your wishes and not as a fully taxable lump sum.

Annuities, insurance policies, and accounts with a TOD (transfer on death) clause will also pass to the named beneficiary.

Assets held in joint tenancy will not pass to the trust. Many married couples jointly own most of their major assets, such as the family home, investment real estate, brokerage accounts, or bank accounts.

3. Be sure there are enough assets in the trust to justify the trustee fees. Most professional corporate trustees charge $3,500 to $10,000 annually, or up to 1% of the trust assets. If a trust with $100,000 incurs an annual fee of $3,500, your hard-earned estate will benefit the trustee as much as your heirs. A trust probably doesn’t make financial sense if the total fees will exceed 2%.

4. If a trust still seems like a good strategy after the above caveats, the next question is how much to limit heirs’ ability to withdraw money. From an actuarial standpoint it’s fairly simple. If you limit annual withdrawals to 3% of the principal, there’s a strong probability of the money lasting several generations with its buying power intact. Provided, that is, the trustees pay close attention to the next point.

5. To generate sufficient returns to pay out up to 3% annually to heirs and also keep up with inflation, the majority of the portfolio must be invested in assets that will grow over time, such as stocks, real estate, and commodities. It needs to be broadly diversified among many asset classes and countries. The trustees must also limit the fees paid to manage the investments. Many corporate trustees have an inherent incentive to use their own bank’s mutual funds, which can have annual fees as high as 1.5%. One way to avoid this conflict of interest is to instruct the trustee to place the funds with a fee-only investment advisor who has a largely passive approach to managing money. This could cut the portfolio fees by 50% or more.

6. Finally, before setting up any trust, pay close attention to taxes. Congress recently increased the top income tax bracket to 39.6% on wealthy taxpayers. Any trust which keeps more than $11,950 of annual income is considered “wealthy.” So here is the problem. If the trust retains enough earnings to increase the principal to offset inflation, it will have to pay substantial income tax and will probably need to restrict withdrawals to 1 or 2%. All of a sudden a multi-million dollar inheritance becomes simply a source of secondary income similar to Social Security.


Tax and Financial Strategy 2012


Trusts are valuable estate planning tools. But like any other powerful tools, they are best employed by someone with the skills to use them well.



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One Response

  1. Adult Kids

    I remember my mother shuttling three kids to simultaneous and overlapping doctor appointments, music lessons, Boy Scout events, school, and athletic events, with timing precise enough to make an air traffic controller jealous. As parents, my wife and I had our turn as taxi drivers. And like many of our contemporaries, our time is soon coming to help shuttle parents to their activities and appointments.

    As parents age, many adult children begin to not merely provide taxi service but to accompany parents to appointments, especially doctor visits. This is often helpful for both generations.

    Yet it’s much less common for children to sit in on their parents’ meetings with financial advisors. In almost 35 years as a financial planner, I can count on one hand the clients that have taken the initiative to involve adult children in their financial review meetings. This is something I now recommend. At a minimum, it’s wise to regularly include children who are designated in powers of attorney or as executors in estate planning. I advise involving them in meetings with attorneys, accountants, and financial advisors long before a health event demands they take over your financial affairs.

    If this transition happens suddenly, it can be emotionally and financially painful. I have witnessed parents’ meticulous financial planning undone in almost an instant by children thrown into a situation where they have complete decision-making authority but no education or preparation to help them use it well. In such instances, the advisor often becomes the target for the children’s displaced anger and fear around being thrust unprepared into this difficult role.

    Actively involving adult children in meetings with legal and financial advisors can greatly smooth the transition when they do need to step in as the decision makers. By attending several years of meetings, children gradually become educated on the intricacies involved in many estate plans and investment portfolios.

    Here are some tips to bring children into your relationship with an advisor.

    1. Start slowly. While a gradual education of your children on the particulars of your financial affairs can pay significant dividends, that doesn’t mean it is easy. Both generations may be uncomfortable at first. One option is to start with a discussion about the parents’ general philosophy around managing money and their plans for their estate. Then the conversation can gradually proceed to more specifics.

    2. Make it easy. Probably your adult children are busy with jobs and families of their own. Offer to bring financial meetings to them via technology. A host of options can allow them to participate remotely.

    3. Be clear on confidentiality issues. Before bringing children into any meeting, discuss with your financial advisor the degree of disclosure and specificity you desire.

    4. Pay attention to emotional as well as financial issues. Disclosing to adult children the intricacies of parents’ financial affairs can be overwhelming and fraught with difficult emotions for both parents and kids. Although it is seldom expressed, perhaps the strongest reason for not discussing estate plans with family members is fear. It’s natural for parents to be afraid that children will be angry or disappointed, will build too much on their expectations for an inheritance, or will be resentful of other heirs. Beyond that, some family situations are complicated by such factors as stepfamily issues, difficult relationships, or children with widely differing capabilities around money. In these cases, it may be helpful to bring a financial therapist into the picture.

    Involving adult children in aging parents’ financial affairs and meetings with advisors is not always easy. Yet the benefits for both parents and children make it well worth the effort.

    Rick Kahler MS CFP


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