Estate Planning Strategies to Give and Protect Wealth

Many people know why making gifts is part of most estate planning strategies. Yet, they hesitate to make the gifts, because they see potential pitfalls.

They fear that the gifts might be spent unwisely or wasted. The donee could squander the assets on gambling, substance abuse, or other activities. Or the wealth could be well-managed for years only to have a chunk of it end up in the hands of an ex-in-law after a divorce or premature death. After that, the assets could belong to a subsequent family of the new owner.

These and other factors keep many from making substantial estate planning gifts. There is no reason to let these fears prevent execution of a good estate plan. There are ways to protect wealth from these potential pitfalls and still reap the benefits of estate planning gifts.

Estate Planning Strategy #1

529 plans. These education saving plans also have some excellent estate planning and asset protection benefits. The account owner can put up to five years’ worth of tax-free gifts in an account in one year. That is $60,000 per donor in 2006, or $120,000 if a married couple gives jointly.
In the plans sponsored by most states, the owner can direct how the account is invested from among several choices. The account owner might be able to shift the investments a limited amount of times each year.

The accounts can protect the assets, because the tax law allows the owner to get the assets back. As long as the assets stay in the account, they are out of the owner’s estate. But he has the option of taking them back if he needs or wants to. The plan sponsor can impose a penalty of up to 10%, but there is no tax penalty to a return of the money.

In addition, the owner can change beneficiaries of the plan. If the initial beneficiary does not go to college or develops some personal problems, the owner can name another child, grandchild, or other relative as the beneficiary. The money still is out of the estate, but the member of a future generation to benefit from it is changed.

The 529 plan might not be a permanent solution. The plans in most states require that the account be spent within a certain time frame. Sometimes the account’s life ends by the 25th or 30th birthday of the initial beneficiary. Other states limit the account to a number of years. Not all states have this restriction.

Estate Planning Strategy #2

Pay the bills. Gifts can be made without the beneficiary’s ever touching the money. One safe and very flexible way to give is to make direct payments on behalf of the beneficiary. Then, the money cannot be squandered or be the subject of a divorce. Many people pay for the education or medical expenses of a beneficiary. Paying for education and medical expenses also has the benefit of increasing the annual tax-free gift limit, as we discussed in last month’s visit. Those gifts have an unlimited annual tax free amount.

You can pay any expenses for loved ones. Pay for vacations, summer camp, furniture, clothes, cars, and anything else the loved ones need or you want them to have. Keep in mind that the annual tax-free gift limit of $12,000 applies to the total of all gifts, whether made directly or by paying someone’s expenses.

Keep in mind that if you buy things ? such as furniture or cars ? they could be split up in a divorce or sold to pay for bad habits. If you pay for services or items that lose value quickly, the risks are reduced. Your loved ones get the use of the items, but they aren’t likely to be pawned or leave the family in divorce.

When paying bills directly, it is best to have a clear plan. Most advisors recommend not getting loved ones in the habit of asking for help whenever they want or need something. Instead, define at the start of each year what you will pay for or how much you will pay. The loved ones then know they have to pay for anything else.

Estate Planning Strategy #3

The mortgage match. Suppose you do not have a large lump sum to give or want to stay within the annual tax-free amount. But your children need help with a large expense. If your children have home equity, try this strategy. They can take out a home equity loan to pay for the big expense. You agree to make gifts each year that are enough to make the loan payments. That spreads out your cash payments and saves gift taxes. In addition, the children are forced into the discipline of making the loan payments.

Estate Planning Strategy #4

Cost sharing. If your concerns are that the children not be spoiled and that they develop good habits, consider making matching payments. Suppose the adult children cannot fully afford their children’s education. Or they need a new car but cannot afford one as large as they really need. In such cases, you can offer to match whatever they spend. You could pay fifty cents or one dollar for every dollar they spend. This lets you help them while ensuring that they are not dependent.

Estate Planning Strategy #5

Require separate accounts. In most states, assets owned before a marriage plus gifts and inheritance are not part of the marital estate. That means they are not part of a divorce settlement. In such states, you can make a gift directly to an adult child and ask that he or she protect it by keeping it in a separate financial account.

You must be sure that the state in which your children reside exempts gifts and inheritances from the marital estate. Also, it is important that your children not add marital property in the account. If they do, the entire account can become marital property.

Estate Planning Strategy #6

Trusts. Trusts are the standby for asset protection and probably provide the most protection. Give directly to an irrevocable trust and it will not be part of a marital estate. Also, the loved ones can get the property only under the terms of the trust. You can set specific distribution rules or give the trustee discretion over when to make distributions.

We have discussed different Types of Trusts in past visits, and these are in the Estate Watch section of the Archive on the members’ web site.
Here are some examples. A trust could pay income regularly but condition principal payouts on the beneficiary’s reaching certain milestones. Some trusts pay principal after the beneficiary reaches certain ages. Other trusts have achievement milestones: graduating college or remaining employed, for example. Some trusts match the income earned by the beneficiary. The pros and cons of the different trusts, and more examples, are on the web site.

Estate Planning Strategy #7

Marital agreements. The easiest way to protect assets from a divorce is for a couple to have premarital agreement or a marital agreement that sets the terms of the property division if there is a divorce. In many couples, at least one spouse resists signing an agreement. But the agreements make things easier if there is a divorce and encourages the parents to be more generous during the marriage because they know the assets will stay in the family.

It never is too late for a couple to draft an agreement. They can be made at any time. Marital agreements won’t help if the problem of concern is gambling, substance abuse, mismanagement, or wasteful spending. But the agreements can help if the main concern is what would happen to the assets in a divorce. Many parents and grandparents will not make direct gifts to younger families unless there is a premarital or marital agreement.