You need a life plan, not a death plan

There is an army of real-life lawyers who don’t ever seem to get things done. I’ll bet the farm that most contractors reading this column — who have done estate planning — can relate to the sad story that follows (true and, unfortunately, often repeated).

Here’s the story. A reader (Joe) of this column lives in Florida. Joe (age 62) started his business (Success Co.) from scratch. Now, Success Co. is a profitable and growing corporation with 87 employees. Joe's son, Sam, runs the day-to-day operations.

When Joe got the itch to do his estate plan, he went to see his lawyer, Lenny. Joe brought a package of information. (He learned what to bring by reading this column). Here’s what the package contained, plus the essence of what Joe told Lenny: My wife Mary is 63. We have three kids and seven grandkids. Everyone is healthy. Sam (age 38) is the only child working at Success Co. (an S corporation) and runs the business like a pro. Joe wants to keep working to the day he goes to heaven.

Then Joe spelled out his basic goals:

1)        Transfer Success Co. to Sam without him or his son getting beat up by income taxes.

2)        Minimize (if possible, eliminate) the estate tax bite.

3)        Treat the two nonbusiness kids equally.

4)        Keep control of his assets, particularly Success Co., for as long as he lives.

Success Co. is worth about $9 million. In addition Joe's four most valuable assets are: (1) real estate leased to Success Co. ($1.3 million); (2) 401(k) plan ($1.8 million); (3) various liquid investments, including stocks, bonds, CDs and other cash-like assets ($4.6 million); (4) two homes ($1.9 million).

Other assets bring Joe’s total net worth to a bit over $20 million. Joe has no debt. Finally, Joe owns a life insurance policy insuring him for $3 million with a cash surrender value of $462,000.

Lenny took copious notes, asked many questions and after two hours concluded the meeting saying, “I’ll create your estate plan and send it to you.”

From time to time, Joe would call Lenny to check the status of his estate plan. Nine months after the initial meeting (Joe later quipped, “Just like having a baby.”), Lenny delivered the completed plan. Guess what? The plan was simply two documents: a pour-over will with an A/B revocable trust.

Frustrated, Joe called me, and then overnighted to me the same package of information he had given to Lenny and the documents Lenny created.

First, the good news: Lenny’s traditional documents were fine, and with a few minor changes were used as part of Joe’s final estate plan. The letter also suggested that the $3 million insurance policy be transferred to an irrevocable life insurance trust, but did not draft the document.

So how do you create a lifetime plan that will work for you, your business and your family?

What’s wrong with Lenny’s plan? Technically, nothing. That’s the problem. On the surface, a pour-over will, accompanied by an A/B trust (called a “traditional estate plan”), looks good and sounds good. But the sad fact is a traditional estate plan is nothing more than a death plan. It does not go into action until Joe and Mary are dead. It’s a one-trick pony: it avoids probate.

It’s a good start. But standing alone, a traditional estate plan does not have a chance at conquering the estate tax and accomplishing the goals of the typical Joe and Mary, particularly if they own a family business and/or have a large net worth.

So, what’s the answer? Two plans: first, a traditional plan (yes, the old-fashioned will and A/B trust is still a worthy friend) and, second, a lifetime plan, designed to accomplish your goals, based on each significant asset you own.

So how do you create a lifetime plan that will work for you, your business and your family? It’s a rather simple three-step process:

Step #1. Make a list of each significant asset you own (if you own lots of real estate, stocks, bonds or other assets, they can be grouped).

Step #2. Across from each asset (or group of assets) write down your goals for that asset (a) for the rest of your life (usually includes maintaining control) and (b) disposition when you (and your spouse) are gone.

Step #3. Select the appropriate strategy (we will use Joe and Mary as an example, so you can see how easy it is to do) to accomplish your goal for each significant asset.

So here’s the lifetime plan.

To Sam. Success Co. was transferred to Sam using an intentional defective trust (ILIT). This type of trust transfers the nonvoting stock of Success Co. (via a sale) to the trust with Sam as the beneficiary — tax-free. No income tax. No estate tax, to either Joe or Sam. Joe keeps control of Success Co. by retaining the voting stock (only 100 shares) while selling the non-voting stock (10,000 shares) to the IDT. Dividends from Success Co. (tax-free because it’s an S corporation) pay Joe for the nonvoting stock and purchase some second-to-die life insurance.

To the nonbusiness kids. The liquid investments and the real estate are transferred to a family limited partnership (FLIP). These assets are now entitled to a discount (about 30 percent) for tax purposes. The two nonbusiness kids get the limited partnership units (99 percent), while Joe and Mary maintain control over the assets by keeping the general partnership units (only 1 percent).

The two homes are left to the two nonbusiness kids using a strategy called a “qualified personal residence trust”.

In the end, the lifetime plan created for Joe and Mary easily accomplished all of their goals.

Let’s summarize: A traditional estate plan (typical pour-over will and A/B trust) is a death plan (how to distribute your assets). In addition, to accomplish your goals a lifetime plan is a must.

It should be noted that no attempt is made in this article to cover all off the possibilities, strategies, rules and exceptions to structure every conceivable lifetime plan. Yet, in practice, every challenge presented by a client or column reader has been easily met.

Finally, make sure you use an experienced professional who knows how to draft more than just a traditional plan.

Want to learn more? Browse my website, http://www.taxsecretsofthewealthy.com. Any questions, call me at 847/767-5296 or email me at [email protected].

Irv Blackman, CPA and lawyer, is a retired partner of Blackman Kallick LLP and chairman emeritus of the New Century Bank, Chicago. He can be reached at 847/767-5296, email I[email protected] or on the web at www.TaxSecretsOfTheWealthy.com.