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Portfolio > Asset Managers

Protecting Family Assets

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Last month We looked at the emotional and financial challenges of advising a client during a divorce settlement. When analyzing the client situation, advisors have learned that the division of assets is not a simple case of dividing everything by two. Divorce specialists run scenarios of different possible settlements. If a spouse accepts a particular settlement offer, how will it look five or 10 years later? What will be the cash flow? How will expenses grow?

On the other hand, wealthy families can take steps to protect assets before a marriage occurs. If a divorce subsequently results, the settlement is much simpler since many fewer holdings are attachable. Protecting assets properly to fulfill a family’s wishes and having the right documents implemented, however, is what separates advanced planning from theory.

Once Burned, . . .

The experience of an ultra-high net worth family and its surprising lack of planning show how asset protection and estate planning intertwine. Arthur Bavelas of Resource Network, LTD. in Radnor, Pennsylvania, (and a consulting private wealth specialist to my firm, Advanced Planning Group) came to advise this three-generation legacy family that had substantial assets consisting of operating companies and investments held in and out of trusts. The family made significant money primarily in two sectors, real estate and financial markets. The second-generation children participated actively in the family businesses. Some of the grandchildren also worked in the business while others pursued interests outside of the business.

The primary beneficiaries of the family assets were the grandchildren. All of them had been married at least once, and two had been divorced. Unfortunately for the family, the assets the divorcing spouses received far exceeded the settlements the family had anticipated.

When Bavelas first met the family, he identified a number of critical problems: massive amounts of assets subject to claims of creditors; potential lawsuits by interlopers; inadequate protection against risks; insufficient estate planning; and high estate taxes in the future. Lack of prenuptial planning was also a problem.

Bavelas and other advanced planning advisors have noted that even very sophisticated, highly successful clients have trouble understanding that an ex-spouse is a creditor. Although they can accept the idea that the spouse of an offspring shouldn’t have access to certain assets, the idea of the “ex” being a legitimate creditor–just like a bank–doesn’t resonate until advisors explain all of the hazards.

With this family primed for a new solution after the high payout for the two divorce settlements, Bavelas offered solutions that prepared for future marriages by orchestrating protection not only with prenuptial agreements, but by organizing the assets to make them independent of the agreement or its expiration. The majority of the assets passed via a variety of trusts and other techniques to the great-grandchildren and the generation after that. The solutions structured assets in such a way that a divorcing spouse would get access to only a modest amount of assets. The team also created strategies to protect ongoing investments and businesses. Revised estate plans made sure that family assets would go where intended using trusts for asset protection, generation skipping, and estate planning, among others.

The family invested venture capital in a variety of well-thought-out investments, some with the typical high risks for this kind of investing. Among their investments was a social network that was worth little when they originally invested and ultimately sold for several hundred million dollars.

Start at the Beginning

Fortunately for the family, Bavelas and his team worked with them at the inception of the investment when it was worth a crumb of its selling price.

They structured the investment in such a way that it was not subject to personal income tax and not subject to estate tax. The key was that this solution was applied at the launch of the investment when it was worth very little–otherwise it wouldn’t have worked.

Bavelas also created a solution for the expected royalty income streams that would start if the small company were successful. He determined their present value at the inception and the family sold the rights to them to a third party. Since there was no constructive receipt of the revenue prior to their monetarization, those revenue streams could be deferred as long as the family liked. If they took distributions, they would be taxed. The additional benefit to these two solutions provided was to protect these assets, as well.

“The real simple method of giving away value in a company is when it’s worth nothing,” observes Bavelas.

Getting the Docs Right

A family falsely believing that it has the right documents to secure assets is worse off than the family that knows it needs a plan but just hasn’t acted. Unintentional defects in documents or execution all too frequently occur, resulting in some combination of expensive legal solutions, excess taxes paid, or unprotected access to assets.

Errors in documents result less from technical misjudgments or editing errors than from lack of coordination, misinterpretation of family wishes, and/or inflexibility to adjust for changing circumstances. A will with boilerplate language could be legal, but its limited scope could financially harm a family in the future. Financial advisors and estate attorneys, for example, have observed that many problems evolve from lawyers who practice estate planning as a sideline rather than as a specialty.

Flexibility for the Future

The planning process should result in a plan that works today but is flexible enough that it can’t accommodate some possible new family scenarios in five or ten years without requiring major modifications. An attorney may want or need to draft a family trust when the assets are relatively small. Unlike the sophisticated solution mentioned above for that family’s asset that had significant growth potential, some trust may not adequately account for changes in principle. For example, a trust–with the grandchildren as the primary beneficiaries and once-rural undeveloped land as the asset–can dramatically increase in value as small towns become suburbs. With the grandchildren as beneficiaries, the trust could become subject to generation-skipping tax.

When assets dive in value, other problems arise. A trust with a highly concentrated portfolio, which may be the result of stock options, could seriously underperform. For a trust originally worth $10 million, the $500,000 left for a cousin may have made sense since the four children were dividing the rest. If the trust dips in value to $2 million at the time of distribution, the cousin receives an embarrassingly large share compared to the children–inheritances that don’t reflect the original wishes of the parents. Requests should be tied to inflation or if specific amounts are required, they should be reviewed annually.

Getting the Desired Outcome

A family’s complex emotional dynamics can’t be ignored in the planning process, notes Bavelas, as it drives the mechanics and the end result. Most advisors with a technical focus have difficulty asking the hard questions about the desired outcome of the planning process and focus more on crafting legal documents. The other members of the team must step up to ask the family to identify the desired outcome of the proposed work and to explain the interpersonal relationships among siblings and the parents and grandparents.

Most of the asset protection work that an advance planning team can perform for a client can only be done during the estate planning process for the matriarch or patriarch. It establishes a variety of benchmarks that helps support the notion that the planning was done not just for asset protection purposes but in the spirit of good and thoughtful estate planning. “Doing asset protection work and estate planning work together is a very defensible asset protection position, from a legal standpoint,” notes Bavelas. “If it were ever contested, you could say, yes, it does protect my assets, but it also allowed me to do the estate planning that I needed to do.”


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