Financial Planning > Tax Planning

What I Do in My Practice, Pt. 3: My Role With Other Advisors

Your article was successfully shared with the contacts you provided.

As part of AdvisorOne’s Special Report22 Days of Tax Planning Advice for 2012, throughout the month of March, advisor and regular AdvisorOne blogger Mike Patton is sharing how he handles tax planning in his practice.

I had a friend approach me recently about a situation involving his parents. Basically, his parent had sold their business and it was suggested to them by an advisors that they place the proceeds in a Special Needs Trust in a western state. The goals of the parents? To reduce their federal estate tax, avoid state income tax, avoid probate, and take advantage of generational gifting (i.e.; not running afoul of the generation skippikng tax). In short, this trust would accomplish the clients’ goals, but is it the right thing for the client? Is there a better way? 

The advisor who recommended this approach has a specialty working with these trusts (that provided clue No. 1 to me), and because the tax law is scheduled to change at the end of 2012, he had created a sense of urgency (Clue #2). Again, though this trust would accomplish all of the clients’ goals, there are other questions that should have been asked. But first, let’s examine the aforementioned clues. 

Clue #1: The Specialist
When an advisor has a specialty, and that’s all they do, the potential exists that the advisor is more salesman than advisor. After all, if that’s all they do, if they don’t do much of it, they won’t be around for long. My issue is with his process. For example, did the advisor gain a thorough understanding of the clients’ overall financial picture? In other words, did he take a complete inventory of the clients’ wealth and/or create a comprehensive financial plan? No. Why is this important? In this particular case, the client would be transferring just under half of their net worth to this irrevocable trust. Would this leave the client enough money to maintain their standard of living?

Clue #2: The Urgency
The advisor attempted to create a sense of urgency to my friends’ parents by telling them that the maximum gift tax exemption is scheduled to be reduced after this year. True, the current $5 million exemption will fall to $1 million if Congress fails to act this year. But does the client need to take action now? Couldn’t they wait until later this year?

Alternate Strategies to the Special Needs Trust
With the number of children and grandchildren my friend’s parent have, they could give away $182,000 per year without paying gift tax or filing a form 709 (gift tax return). Assuming no increase in the annual gift tax exemption (currently $13,000), after five years, the client would have given away nearly one million dollars. If they needed to “bleed” their estate further, a better alternative might be a grantor retained annuity trust (GRAT), or an IDGT (intentionally defective grantor turst). Of course, with a GRAT, the client would need to outlive the trust term or it all comes back into their estate.

Final Concern
What if a patron of the store that my friend’s parents sold were to sue the clients for something that occurred while they were owners? Is there a statute of limitations? What if they gifted this large amount into the trust, were sued, and had to use the remaining assets to settle the lawsuit? Wouldn’t that impede their lifestyle? 

To summarize, in my opinion, this particular client does not have enough wealth to give away the amount the advisor suggested. All in all, I feel the plan is far too aggressive. But because it was the advisor’s specialty, it’s what he recommended. Where’s the ethical coordinator in this scenario? Absent, that’s where! 

Thanks for reading and have a nice week! 

See AdvisorOne’s Special Report22 Days of Tax Planning Advice for 2012, throughout the month of March.