Withholding Allowances

The method Jeff Scroggin had been taught as a young attorney with Arthur Andersen Nationwide Estate Planning Group was simple: When it came to paying estate taxes, save the client as much money as possible. “It was pretty much all that we focused on,” recalls Scroggins, 51. “We didn’t go much beyond the tax issues when coming up with the best possible plan.”

The same philosophy drove Scroggin’s efforts after starting his own firm in 1981, John J. Scroggin & Associates in the Atlanta suburb of Roswell. He would sit down with clients, discuss how much they had to leave behind, draw up a plan that would preserve as much of those assets as possible, and call it a day. The only problem? After handing over his plans, Scroggin found that his clients were less than thrilled. “It had nothing to do with the plans I drew up,” says Scroggin. “It was just that clients had vague and general misgivings about the whole process.”

So Scroggin began asking questions. What most often irked his clients, especially the self-made-millionaire ones, wasn’t the notion of their own death. It was the effect their large sums of money would have on their heirs. Many felt that inherited money would encourage the heirs to eschew the hard work and entrepreneurialism they’d found so rewarding. Worse, the inheritance might even encourage the development of such distasteful character traits as indolence or eccentricity. “It’s very easy to understand where this was coming from,” says Scroggin. “These were people who had worked very hard to make a great deal of money, and now they were faced with the prospect of simply dumping it on their heirs with no strings attached. They were wondering if they could be doing more harm than good.”

Trillion-Dollar Windfall

This quandary will only gain prominence in the estate planning process in coming years. A variety of studies has shown that, in the next several decades, more wealth is going to be passed from one generation to the next in the U.S. than ever before, with estimates ranging from $10 trillion to $136 trillion over the coming 40 to 50 years. Yet estate professionals like Scroggin don’t believe that the sheer volume of wealth being passed down is at the root of this new concern. Rather, it’s how the wealth was built, and the values that were fashioned in the characters of those who built it. A recent study by U.S. Trust, “A Portrait of the Affluent in America Today,” points out that of all the millionaires in America, only 10% inherited their money, while 46% made their fortunes by building businesses from scratch.

Furthermore, the study shows that the average millionaire had to average a farmer-like 56-hour week over the course of a 29-year career to earn his or her dough. To Herb Daroff, a planner at Boston’s Baystate Financial Services, this is an indication that the self-made wealthy are often unwilling to promote the kind of lifestyle that is associated with the traditional Old Money elite. “I come across this all the time,” says Daroff. “These people are very uncertain about how they would have turned out if someone had dumped millions on them at an early age. They wonder if they would have bothered to build the life they eventually went on to have.” Indeed, the U.S. Trust study found that 91% of the women and 80% of the men who are worth at least $1 million expect their children to support themselves entirely from their own earnings.

But such numbers beg an important question. What’s supposed to happen to all those trillions of dollars that are to be passed down in the coming years, and what is the estate planner supposed to do in dealing with all this money? Is it all supposed to go to charity? The answer, according to Scroggin and other estate planners, is a resounding “no.” There are a variety of ways that the planner can structure an estate plan so that it allays the fears of clients about what their millions will do to their descendants while also keeping the money within the family.

Long-Term Solutions

The majority of these solutions revolve around the idea of paying out money over an extended period. That allows heirs to avoid want, but doesn’t encourage them to skirt work, ambition, and goals. “When you pay out the money over a period of time, you are giving them a chance to adapt to the presence of that kind of money being around,” says James Budros of the Columbus, Ohio-based planning firm of Budros & Ruhlin. “Also, if they don’t get it all in one shot, they are less likely to have the kind of lifestyle my clients want [them] to avoid.” For instance, Budros likes to set up a trust that will pay money out in such small installments that it will not inexorably alter the lifestyle or course of the heir’s life. “It’s a fine line. You want them to live comfortably, but not to have so much that they will abandon all the good things my clients want.”

For instance, what Budros called a “unitrust payout” will allow an heir to receive a percentage of the principal of the trust each year over the course of his life. If there is $5 million in the trust and an heir is scheduled to receive 1% annually, he will get a check for $50,000 each January 1. This limited amount of money presumably will allow the heir to take a vacation that he otherwise wouldn’t have had, or perhaps buy the family a sedan rather than a compact. But he will decidedly not have enough to buy a home in Jupiter Beach, Florida, or fill a warehouse full of classic cars.

If unitrust payouts don’t fit your client’s needs, Budros suggests considering an annuity payout, which works independently of how quickly the money in the trust has grown. In this instance, the heir is paid a set amount each year–much like an annuity–rather than a percentage. There are also trusts that do not make outright payments to heirs, but instead structure benefits within the context of the life the heir would have had if the trust never existed. This is a very important concept, according to Daroff: The money is not meant to materially change a person’s course in life, but simply to give that person a helping hand.

Family Banking

Perhaps the best example of this is the family “bank.” Daroff designs a trust that acts like a bank. It will, say, make mortgage loans to heirs at a rate that is much more favorable than what they would otherwise receive. If a commercial bank would be willing to give an heir a mortgage loan at 8%, for example, the family bank could do it at 2% or 3%. But there is a catch. The family bank trustee won’t give the heir a loan on the purchase of a home that is not in accordance with his income. “Someone making $50,000 a year is not going to be able to get a family bank loan for a $2 million house,” Daroff says. “You want to help them, but also keep them in the type of life that they otherwise would have had. You don’t want to affect things that much.”

Yet Daroff admits that this trust structure could lead to disagreements between a trustee and heir over what sort of house is appropriate, given the heir’s salary. To break any deadlock, he suggests that the heir attempt to get a similar mortgage loan approved by a commercial bank, and, if successful, once again petition the trustee. “The heir has to go off and get the mortgage approved as if the family bank never existed,” Daroff adds. “There might be some ethical questions as to using the bank in this way, but they are receiving a fee for this service.” He says he hasn’t encountered anyone going to this extreme yet.

The family bank also works as a sort of venture capital fund–an idea that Daroff says first came from hearing Scroggin speak at a seminar. An heir would obtain low-interest loans from the family bank to start a business or some other worthwhile endeavor. To prevent heirs from coming up with harebrained schemes, Daroff places the power of refusal in the hands of the trustee, with a commercial bank as a sort of tiebreaker.