Taxes have long been a driving motivation in estate planning. Tax avoidance often seems to override all other concerns, making the guiding goal of estate planning to maximize wealth transfers to family members while incurring as little tax as possible. This tax-driven goal subtly suggests that family assets are more important than family itself. Increasingly, estate planning professionals and consumers alike are beginning to recognize that this is a misplaced emphasis that focuses on structure rather than perspective, putting tax savings over family need. When protecting and preserving assets is the primary, if often unstated, goal, the estate planning emphasis is on structures that preserve the assets from taxes or family misuse. When protecting and preserving the family becomes the ultimate goal, estate planning must deal with difficult family issues that might once have been ignored.
It was Ben Franklin who said that “in this world, nothing can be said to be certain, except death and taxes.” Inadvertently, this quote also captures the mistake in many estate plans. The focus is too often on the death of the client and the taxes that death may create. Instead, the focus of estate planning should be on the living, with the goal of creating a lasting positive legacy for future generations.
This new perspective inherently involves some limitations on an inheritance, a perspective captured most succinctly by Warren Buffett in a 1986 Fortune article: The perfect inheritance, Buffet said, provides “enough money so that [heirs] feel they could do anything, but not so much that they could do nothing.”
Why the Change?
What’s driving this shift? The first reason is the explosion of wealth in this country over the past two decades, even with the market correction of the last two years. Boston College researcher Paul Schervish estimates that between now and the year 2050, between $41 trillion and $136 trillion will be passed on by gifts or inheritance. A recent study by U.S. Trust noted that only 10% of today’s millionaires inherited their wealth, and that the average millionaire comes from a middle-class or blue-collar background.
Second, estate taxes have declined. A married couple can transfer up to $2 million tax-free to heirs, a sum that could increase to $4 million by 2006. The 2001 tax bill provides for the elimination of the estate tax in 2010, though its continued elimination is highly unlikely. Even without elimination, significant estate tax exemptions will probably remain, reducing the tax confiscation many parents expected and increasing the concerns those parents may have about passing on too much wealth to their heirs.
The third reason for the shift in priorities is that wealthy people are increasing their involvement in philanthropy. Schervish says that a growing number of wealthy Americans are shifting their financial legacies “from heirs to charity.” Schervish has the data to back up that assertion: From 1992 to 1997, the value of charitable bequests went up 110%, while bequests to heirs only grew 57%. For estates above $20 million, charitable bequests went up 246% while the value of bequests to heirs went up only 75%.
The fourth reason is that clients are increasingly examining estate-planning approaches that provide for asset protection. States are adopting statutes that make it easier for clients to use trusts to restrict the claims of creditors. With more than 40% of first marriages ending in divorce, more clients are also reviewing how to protect their heirs from the fallout of divorce.
Finally, two demographic imperatives are pressing governmental social programs. The number of Americans aged 65 and older as a percentage of the total population is expanding rapidly, and people are also living longer. The Social Security Administration estimates that by 2037, the Social Security system will be bankrupt; other observers expect a much earlier demise. Medicare may be insolvent by 2008. Estate planning is beginning to reflect growing concerns about the availability of government benefits for family members.
Contrary to general perception, Social Security benefits are not guaranteed. In Flemming v. Nestor (363 U.S. 603 (1960)), the Supreme Court ruled that Congress retains the ability to reduce or even eliminate benefits at any time. For an excellent review of this issue see Andrew G. Biggs’ “Social Security: Is It a Crisis That Doesn’t Exist?” (Cato Institute, October 5, 2000. SSP No. 21.)
These demographics are changing how clients are addressing the legacy that an estate plan represents. Clients are looking for solutions that involve more than form-driven, cookie-cutter documents. In fact, one of the more uncomfortable aspects of this approach is that standard forms will no longer be as helpful (see sidebar on page 76). Many documents will have to be client-specific. This may result in both higher fees and a cost-based counterbalance to this growing revolution in estate planning.
A Question of Values
In order to understand why these changes are so important, some basic perspectives need to be understood. Clients and planners often avoid delving into the personalities of heirs, or into their spending habits, or into the stability of their marriages, or into their relationships with other family members, or possible health, drug, or alcohol problems. These issues have not usually been perceived to be within the purview of the planner’s responsibility. Unpleasant experiences are changing this perspective.
Furthermore, one of the basic laws of science is that for every action there is an equal reaction. This holds true for an inheritance: It will inherently change behavior. The central question that must be addressed is how to encourage positive change. It is simplistic and potentially damaging to ignore the impact of an inheritance.
In addition, inherent in this new perspective is that values count. Including phrases such as “drafting to influence behavior” or even “values-based planning” in estate documents is a recognition that values lie at the core of this new perspective. Unfortunately, this also provides critics with an easy target. While values lie at the heart of this type of estate planning, the goal of the client should not be to preserve his or her values, but to preserve the family; the two goals are not identical. For example, a plan that seeks to demand adherence to today’s societal values 100 years from now will be felt as punitive and probably prove destructive to the family.
Influencing the behavior of heirs has always been a part of the estate planning process. For example, placing marital assets in a QTIP trust will by its very nature influence the behavior of both a surviving spouse and the remainder beneficiaries of the trust. Placing assets in a trust for children to delay their ownership of the funds beyond age 21 will influence the life decisions of the children.
Values-based planning is not a single planning device or tool. Instead, it devises a plan designed to protect and preserve the family as the first priority. The tax structure is then built around the family’s intentions. The two ideas are not in conflict. Rather, the priority of asset preservation must come second to protecting the family. The planning process should not begin at death. Having someone mentor an heir in financial responsibility should begin in the early years of the heir’s development.
Who Are We?
At its core, the estate planning process deals with a major psychological issue: How do we define ourselves as people? This is not a new problem. As King Solomon said thousands of years ago: “Whoever loves money never has money enough; whoever loves wealth is never satisfied with his income. This too is meaningless. As goods increase, so do those who consume them. And what benefit are they to the owner, except to feast his eyes on them?” (Ecclesiastes 5:10-11).
An approach to estate planning that is clearly designed to influence the behavior of heirs should be structured to create opportunities and incentives, not provide an unearned lavish lifestyle to future generations. As with any plan, such an approach will create its own problems. A detailed “risk-reward” evaluation should be made of each proposed opportunity or incentive to determine if the potential new problems outweigh the expected benefits.
An attempt to influence behavior should encourage responsible behavior rather than punish unacceptable behavior. For example, a provision that denies all trust benefits to an alcoholic or drug-addicted heir may be too punitive. Instead, the denial might be predicated upon the heir refusing treatment (at the trust’s cost) for his or her addiction.
The behavior that is being influenced necessitates careful drafting. For example, if the desired goal is to encourage people to attend college, drafting a trust that provides “$20,000 a year to my daughter as long as she is in college” may not be sufficient. The $20,000 might be used to pay for a wild lifestyle. Moreover, at age 45 she might be working on her eighth Ph.D.