Family Legacy Planning

Life insurance can help clients achieve their legacy planning goals.

By Michael M. Babikian, J.D., LL.M.

A common concern of many wealthy people is that their assets will be lost or reduced when transferring wealth to future generations. Obviously, wealth can be lost to transfer taxes such as estate or gift taxes. However, if transfer taxes did not exist, would wealth be transferred from generation to generation without incident? Many advisors focus their planning on merely saving their clients money on transfer taxes, but forget to incorporate planning that protects the client from other pitfalls. Wealth can be also lost from generation to generation due to divorce, creditors and beneficiaries who lack the asset management skills required to preserve wealth. Finally, it can be depleted by the lifestyle choices beneficiaries make, including those who pursue an excessively materialistic lifestyle.

Legacy planning can help ensure the wealth of a client is not lost from generation to generation by taking their special needs or circumstances into account. It may also be more asset focused if the clients goal is simply to ensure a particular asset, such as a family home or business, is available for the next generation. Yet, the basic foundation of any family legacy plan is an irrevocable life insurance trust (ILIT). Whether it is a dynasty trust, special needs trust or a blended family situation, the plan designs include a variation of an ILIT.

How can I encourage my children and grandchildren to follow my values?
Many wealthy parents have two major concerns: Their children are not going to live as well as they do, and the wealth they leave their children is going to spoil them. An incentive trust is a way to put measures in place to minimize these concerns. It is an ILIT that contains provisions for distributions to beneficiaries based on incentive provisions. These provisions encourage certain positive behaviors in beneficiaries that reflect a clients values and encourage beneficiaries to be productive members of society. Typical incentive provisions support behaviors such as formal education, starting a family, purchasing a home or establishing a business.

How can I leave assets to benefit many generations of my family?
A dynasty trust is often referred to as a family bank trust, a legacy trust or a generation-skipping trust.

It is often structured so that each successive generation of beneficiaries can receive income from trust property. Although it is an irrevocable trust that owns life insurance, a dynasty trust goes a step beyond a standard ILIT. It can extend over several generations by taking advantage of a generation-skipping transfer tax exemption. In addition, by giving the trustee broad discretion in making distributions, the trustee can exercise great flexibility in meeting the different financial needs of beneficiaries through several generations.

Can I provide for the needs of my disabled child without disqualifying him from governmental benefits?
The goal of a special needs trust is to provide a surrogate parent in the form of a trust to care for a loved one with special needs, such as an illness or disability. A special needs trust can be created for anyone with additional care requirements whether a blood relative or not including a child with special needs or a dependent adult. These trusts are designed to provide funds to supplement the finances a loved one receives from governmental assistance programs. The trusts are also carefully drafted so they do not disqualify the loved one from governmental assistance. Life insurance owned by a special needs trust is an ideal way to provide for a disabled child or a dependent adult because the death benefit is income tax free, available quickly and usually received without having to go through probate.

How can I provide for my children from a prior relationship while still taking care of my current spouse and children?
In a blended family, one or both spouses bring children and assets from a previous marriage into their current marriage. A traditional estate plan may not always address the specific needs and potential conflicts unique to a blended family. Under a traditional estate plan consisting of a living trust, children from a former marriage may not be provided for directly by their biological parent. Rather, these children may be forced to wait until the surviving spouse dies to inherit. This arrangement has the potential to effectively disinherit children from a prior marriage if they are close in age to the surviving spouse. Moreover, tension between family members may arise if it appears that the surviving spouse is spending the step-childrens inheritance or controlling their financial future.

One effective solution to the estate planning problems blended families face is to combine an otherwise traditional estate plan with a separate ILIT-owned life insurance policy to specifically benefit only those children born of a previous marriage. This solution demonstrates the intent to be fair and provide equally for all loved ones.

How do I ensure the family or vacation home remains available for my children and grandchildren?
Qualified personal residence trusts (QPRT) can be used to ensure a family home remains available for a clients children and grandchildren. Use of a QPRT enables a grantor to preserve the familys memories of their home and connection with a long-standing tradition that may now continue indefinitely. A QPRT is a type of irrevocable trust funded with the grantors home. The grantor would keep the right to live there for a period of time, and after that, its ownership passes to the trusts beneficiaries. Because the grantor retained the right to live there, the gift value of the home is less than its fair market value. Consequently, the gift tax due would be much lower than giving the house to a clients heirs outright. Life insurance, properly structured outside of the grantors gross estate, could offer liquidity at his or her death to pay estate taxes or any remaining mortgage on the property, or to equalize the estate should the property be intended for one heir rather than to benefit all of the heirs.

How can I transfer the family business to my heirs while limiting gift and/or estate tax exposure?
An installment sale to an intentionally defective irrevocable trust can be used to transfer the family business to heirs while limiting the gift and/or estate tax exposure due to the transfer. It is a sale between a grantor and a grantor trust. By selling assets such as a family business or highly appreciated assets to the grantor trust, the grantor is usually able to make federal-gift-tax-free transfers to the trust, and the assets and all the subsequent income and appreciation attributable to those assets will accumulate inside the trust and outside of the grantors estate.

How can I transfer my highly appreciating assets to my heirs during my life, while minimizing gift taxes?
An essential objective in estate planning is to transfer an estates assets to loved ones in the most tax-efficient manner available. The grantor-retained annuity trust (GRAT) increases the tax savings accomplished through gifting by discounting the value of the gift for gift tax purposes. GRATs are often used to pass on highly appreciated assets with a low-cost basis, such as stock or real estate, to the grantors heirs. When combined with life insurance, the amount to be left to heirs can be magnified.