Hermeneutics presentation nj estate planning council

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A Method in the Madness: The Fine Art of Designing Estate Planning Tools and

Techniques and the Psychological Aspects of Estate Planning

L. Paul Hood, Jr.Greater New Jersey

Estate Planning CouncilApril 11, 2012

(c) 2012 L. Paul Hood, Jr. [email protected]

www.paulhoodservices.com

mailto:[email protected]

http://www.paulhoodservices.com/

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The Fine Art of Designing Estate Planning Tools and Techniques

My background:• B.S. Bus. Adm. (Acct.)-LSU• J.D.-LSU• LL.M. in taxation-Georgetown• Over 25 years in estate planning, about 20 of

which were spent as a lawyer• Now a consultant, author and speaker on estate

planning issues(c) 2012 L. Paul Hood, Jr.

[email protected] www.paulhoodservices.com

(c) 2012 L. Paul Hood, Jr. [email protected] www.paulhoodservices.com

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• I am a firm believer in Kaizen, which is a Japanese principle of continuous improvement

• “After you've done a thing the same way for two years, look it over carefully. After five years, look at it with suspicion. And after ten years, throw it away and start all over.”Alfred Edward Perlman, New York Times, July 3, 1958


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• What follows is my attempt to reverse engineer the estate planning technique selection and design process by doing a brain dump of the process that I went through to evaluate and design estate planning tools and techniques

• There is virtually nothing written about this process, leaving it to the “feel” for the subject that each estate planner must develop on his or her own

• We can do better than that-much better


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In Estate Planning for the Blended Family (Bouchard and Hood; Self-Counsel Press 2012), we identify and discuss 11 separate fears that clients can have about estate planning. Those fears are:

• Fear of mortality• Fear of not doing the right thing in the

planning• Fear of the unknown


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11 Fears of estate planning (cont.)• Fear of hurting someone’s feelings• Fear of estate planners• Fear of the estate planning process• Fear/insecurity of running out of money• Fear of law changes forcing changes to the estate plan• Fear of facing reality• Fear of loss of flexibility• Fear of loss of privacy


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Relations With Children/ In-Laws/Descendants

Mental & Physical Health

Attitude toward Wealth

Attitude toward Death

Siblings / Parents/Birth Order

Other Life Experiences

Inner Child Issues

AdvisorClient Loved Ones, Intended

Beneficiaries, Others

Good Estate Planning Result

Distrust / Fear of Advisors/

Fear of Loss of Control of Planning Process

Listening / Communication Skills

Fear of Costs

Feelings about Taxes

Fear of Death

Ethical Constraints


Limitations / Teachings/Philosophy ofParticular Specialty

Fear of Lawsuit

Need for Business

“Lead Dog” Syndrome

Self Interest

Fear of Collection of Fees


Fear of Loss of Person

Self Interest

Not getting whole story

Advisor

Why is a Good Estate Planning Result so Hard to Achieve?Prior Inheritance Experience

Personality Type

© L. Paul Hood, Jr. 2001-2012

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Relations With Children/ In-Laws/Descendants

Mental & Physical Health

Attitude toward Wealth

Attitude toward Death

Siblings / Parents/Birth Order

Other Life Experiences

Inner Child Issues

AdvisorClient Loved Ones, Intended

Beneficiaries, Others

Good Estate Planning Result

Distrust / Fear of Advisors/

Fear of Loss of Control of Planning Process


Fear of Costs

Feelings about Taxes

Fear of Death

Ethical Constraints


Limitations / Teachings/Philosophy ofParticular Specialty

Fear of Lawsuit

Need for Business

“Lead Dog” Syndrome

Self Interest

Fear of Collection of Fees


Fear of Loss of Person

Self Interest

Not getting whole story

Advisor

Why is a Good Estate Planning Result so Hard to Achieve?Prior Inheritance Experience

Personality Type


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• Knowledge of how to design estate planning techniques is as important as knowledge of estate planning tools and techniques themselves

• There is no “Magic Eight Ball” in how to design estate planning tools and techniques

• The best that we can hope is a hermeneutic, which is a tool or method of interpretation

• What are the parameters of design?


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The proper evaluation and design of an estate planning technique involves a three part consideration:

• factors peculiar to the technique itself, i.e., the essential nature of the technique qua technique

• factors peculiar to assets that may be involved or affected by the technique

• factors relating to the “players”, i.e., persons (including the client) who are involved in or potentially affected by the technique


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Assets

Techniques

Players


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Possible client estate planning goals• Retention of control• Asset protection• Flexibility in distribution of income• Flexibility in distribution of principal• Access to capital• Access to income


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Possible client estate planning goals (cont.)• Transfer of future appreciation and/or income• Transfer of opportunity• Generation skipping• Income tax deferral• Transfer tax deferral• Qualification for tax benefits


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Possible client estate planning goals (cont.)• Use of gift tax exemptions and exclusions• Maximize use of estate tax exemptions and

exclusions• Equalization of estates• Lifetime satisfaction of making gifts• Improving or protecting lifestyle• Facilitating charitable or civic desires


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Possible client estate planning goals (cont.)• Tax finality or predictability in tax result• Providing tax-deferred diversification• Providing guidance and management• Encouraging or discouraging certain behavior• Leveling the playing field or providing checks

and balances, including alternative dispute resolution provisions


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Possible estate planning risks• Risk of loss of access to capital• Valuation risks• Risk of family disharmony• Risk of tax recharacterization• Risk of loss of tax benefits qualification• Risk of loss of flexibility


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Possible estate planning risks (cont.)• Risk of estate tax inclusion• Risk of law change• Risk of doing nothing• Risk of use of technique that has effect

contrary to client’s intentions• Risk of changes in circumstances• Risk of transfer tax overpayment


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Possible estate planning risks (cont.)• Risk of law uncertainty


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What makes designing estate planning tools and techniques so hard?

• Requires more than competence in knowledge of estate planning tools and techniques.

• It separates “estate planners” from mere estate tax technicians .

• Perils of hindsight, which is always 20/20.• Could you be held liable for poor design of an

estate planning tool or technique?


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Real world examples of poor estate planning design

• Martin v. The Ohio State University Foundation, et al.

• Armstrong cases (discussed in the accompanying article)


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Martin facts:• Clients were in their 60’s and had annual

income of approximately $24,000• Husband was in poor health and uninsurable by

himself • Owned one piece of non-income producing real

property worth $1.3 million• Clients’ estate planning goals-sell the real estate

and buy a retirement home in Florida


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The proposed estate plan:• 7% NIMCRUT funded with the real property• Purchase a $1 million second-to-die life

insurance policy, with an annual premium of $45,000

• Clients paid the first year life insurance premium and made a down payment on Florida property


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The plan quickly implodes• The NIMCRUT makes no distributions to the

Martins because the real estate never sold• Clients were unable to pay second year

premium and reduced the death benefit by 75%; ultimately, the policy lapsed because the clients were unable to pay the premium

• The clients sue their former advisors and the charitable beneficiary of the NIMCRUT


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Hints that the estate plan was ill-conceived from the start:

• The life insurance premium was almost twice the clients’ annual pre-tax income

• The real estate put into the NIMCRUT had been actively for sale for five years prior to being put into the NIMCRUT

• The advisors only presented two possible plans: the NIMCRUT/insurance and a sale (which they called a “bad plan”)


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The advisors won at the trial court level, but appellate court found the following problems with the advisors’ work:

• They only presented one real plan, one that benefitted them

• Their NIMCRUT illustrations showed immediate distributions from the NIMCRUT

• They omitted giving the clients a memo from the charitable beneficiary that the clients wouldn’t get anything from the NIMCRUT until the property was sold, which never occurred


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Problems with the plan (cont.)• The advisors arranged for the clients’

NIMCRUT to be drafted by a lawyer who had no relationship with the clients, who didn’t even see the NIMCRUT document until the day that they signed it


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Possible reasons for poor technique design:• Lack of sufficient accurate information• Lack of sufficient due diligence by the estate

planner• Changes in client circumstances• Over focus on certain facts and under focus on

other facts• Belief that doing planning beats doing nothing


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Possible reasons for poor technique design (cont.)

• Poor drafting• Inaccurate valuation• Failure to adequately consider “side effects”• Failure to consider a contingency or exit

strategy for foreseeable changed circumstances


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Possible reasons for poor technique design (cont.)

• Failure to adequately inform clients of uncertainties in the law

• Failure to properly administer or follow through• Adverse foreseeable developments in, or

interpretations of, the law• Advisor self-interest


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Assets

Techniques

Players


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Asset-based factors• Valuation issues• Use and management issues• Ease of transfer/division issues• Asset as collateral issues


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Valuation questions• Does the asset have a value that is readily

ascertainable without having to resort to an appraisal?

• Where is the asset’s current value in relation to its historical high and low values?

• If the asset must be appraised, what is the range of possible values of the asset?


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Valuation questions (cont.)• What is the volatility of the asset’s value?

What factors contribute to the value volatility and how might any of those factors be affected by use of a particular estate planning technique?

• What is the asset’s present value relative to its adjusted tax basis?


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Valuation questions (cont.)• Could a technique impact, either by pre- or

post-implementation, value volatility of the asset, and if so, how?


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Use and management questions• Is an asset’s value or present use tied or related in

anyway to any other asset or purpose, and, if so, to what asset or purpose, e.g., closely held business entity operating on real estate owned separately by the client or by other players?

• What management skills or efforts does the asset require, and how might the estate planning technique or the players involved impact the management of the asset?


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Use and management questions (cont.)• What are the costs of maintenance and capital

requirements of the asset to be used in the technique?

• What is the asset’s remaining useful economic life? What factors might affect the asset’s useful life, e.g., technological obsolescence, demographic shifts, real estate neighborhood trends, etc.?


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Use and management questions (cont.)• Does the asset generate current net cash flow, and, if

so, how much, and is the cash flow positive or negative?• Does the asset possess, by its nature, separate

management authority or control from the right to economic benefits of the asset?

• What is the prospect for appreciation or depreciation of the asset? What is the expected level of appreciation or depreciation, and when might it be reasonably expected to occur?


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Ease of transfer or division questions• How susceptible to transfer is the asset? Is

third party consent required?• How marketable is the asset? What is a

realistically probable time to sell the asset? Who are likely potential buyers?

• What transfer costs would be incurred in transferring the asset?


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Ease of transfer or division questions (cont.)• Is the client or any of the players emotionally

attached to the asset to be used in the technique for the asset itself (instead of the economic value represented by the asset)?

• How susceptible to division is the asset?• Has the client already promised the asset to

anyone or otherwise intimated that the asset would go to someone, and, if so, to whom?


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Ease of transfer or division questions (cont.)• Is the client, or any of the players, either

currently, or in the future, economically dependent upon either the income or capital represented by the asset?

• Are there any income tax consequences involved in transferring a particular asset, and, if so, what are those consequences?


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Asset as collateral questions• Is the asset to be encumbered by a security

interest or lien?• How difficult is it to seize the economic

benefits represented by the asset?• Would a third party consider the asset to be

good collateral?


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Assets

Techniques

Players


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Technique related factors• Creation and separate existence issues• Valuation issues• Taxation issues• Financial and management issues• Clients and players issues• Complexity and sophistication issues


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Creation and separate existence questions• Does the technique involve the creation of a

separate entity?• Are there any governing instrument language

requirements for the technique?• Does the technique have to remain in existence for a

period of time to become a net benefit? If so, is it a matter of the technique either providing less benefit or actually becoming a detriment (compared to doing nothing)?


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Creation and separate existence questions (cont.)

• Can the technique remain in existence for too long period, i.e., provide no benefit if it is in existence for too long?


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Valuation questions• Does use of the technique require a valuation, and,

if so, how many and when?• Does the valuation volatility of the asset used affect

the technique, and, if so, how? May valuation volatility be minimized, and, if so, how?

• Does the effectiveness of the technique depend upon the subsequent appreciation of the asset and, if so, how, and may the risk of depreciation be minimized?


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Taxation questions• Does the technique require filing of a tax return, and, if so,

how many?• Is the technique a tax-reportable transaction, and, if so,

what taxes are involved?• Does the technique offer any transfer tax finality?• What is the level of tax law uncertainty of the technique?

How vulnerable is the technique to law changes, either through legislation or jurisprudential/regulatory developments? Can these risks be minimized and, if so, how easily? How easy would it be to minimize these risks?


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Taxation questions (cont.)• Are there risks of gift tax audit of the

technique, and, if so, how severe are they and can they be minimized?

• What is the risk that the technique can be recharacterized, and what effects would likely flow from recharacterization?


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Taxation issues (cont.)• Is there a risk that the technique will implode

if the client does not survive for a specific period of time, and, if so, what are those risks and how can those risks be minimized?

• If the technique does not involve a gift tax reportable transfer, what is the ultimate transfer tax risk of the technique?


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Financial and management questions• Is the technique use impacted by the cash flow

of the asset used, and, if so, how? • If the technique requires payments back to the

client, what form of payment does the technique permit?

• How is the technique affected by interest rate fluctuations or levels?


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Financial and management questions (cont.)• Does the technique itself offer any appreciable

level of asset protection?• Does the technique depend upon the credit-

worthiness or cash flow of the client or of any of the other players?

• What is the cost of implementation of the technique?


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Financial and management questions (cont.)• What ongoing administration will the

technique require and what will that administration cost?

• Does the technique require the use of assets that are liquid or that produce cash flow?

• Does the technique offer any asset diversification possibilities for the client?


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Financial and management questions (cont.)• How does the technique impact the classification of

property as separate or community?• If the technique requires payments back to the

client, what timing of payments are permitted (immediate only, deferred, etc.)?

• If the technique requires payments back to the client, what flexibility does the technique offer relative to the amount of payments back to the client?


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Financial and management questions (cont.)• Does the technique permit the client to retain

continuing control or security over the economic benefits represented by the asset used in the technique, and, if so, what and how much control?


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Clients and players questions• Does the technique meet the client’s goals and

objectives?• Does the technique require disclosure of

personal financial information of the client or any of the players to third parties, and, if so, to whom and how extensive must that disclosure be?


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Clients and players questions (cont.)• Is the technique impacted by the age or health of

the client or that of any other player?• How will the technique help or hinder players other

than the client who might be affected after the client’s death, and, if so, how?

• Are there any risks of mortality of persons other than the client who are involved in the technique and, if so, what are those risks and what can be done to minimize those risks?


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Flexibility questions• Can the technique be undone if circumstances

warrant and, if so, how easily can the technique be unwound and what will it cost? Will there be any tax consequences? Can an exit strategy be devised in advance?

• What retained flexibility does the technique offer relative to changing needs of the client and the other players?


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Complexity and sophistication questions• How complex is the technique to design and

implement?• How complex is the technique to explain to

clients and other players?• How important is it that the client obtain

continuing professional advice with respect to the technique after it is implemented?


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Complexity and sophistication questions (cont.)• Does the illustration capability for the technique

accurately and completely depict the reasonable outcomes and, if not, how may of the excluded factors be illustrated?

• Is use of the technique effectively precluded for use with certain persons, e.g., non-citizens, “skip-persons” by the ETIP restrictions of the GST Tax and S corporation shareholder limitations?


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Complexity and sophistication issues (cont.)• Does the essence of the technique cause use of

any particular asset to be either foreclosed or not attractive?

• How easily undone or modified is the technique if relationships sour?


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Complexity and sophistication issues (cont.)• Does the technique require ongoing

communication and cooperation after implementation between the players amongst themselves as well as with the client, and, if so, how important is it that the players and/or the client are able to communicate and cooperate? Can the technique be designed to contemplate and/or accommodate a failure in communication and/or cooperation?


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Complexity and sophistication issues (cont.)• Estate planning advisors too often persuade a

client to implement a recommended estate planning technique on the ground that the “cost of doing nothing” is too high. However, the cost of doing nothing often is greater or even less than the cost of implementing the “wrong technique.” Has the estate planner estimated the potential cost of the technique where its use is improvident or improper?


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Assets

Techniques

Players


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Players related factors• Financial and control issues• Personal and health issues


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Financial and control questions• What contractual obligations exist between the

client and others that can impact the planning?• Does the client want to risk loss of control of the

economic benefits represented by the asset to be used in the technique, and, if so, what is the client’s comfort level with respect to loss of control? Can the technique be designed to protect against damage occasioned by the client’s loss of control?


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Financial and control questions (cont.)• Can the client risk loss of access to capital

caused by the technique?• Can the client afford to pay the gift or income

tax associated with implementation of the technique, including possible increases on audit, and, if so, does the client want to commit to doing so?


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Financial and control questions (cont.)• Is the client’s economic livelihood/security

and/or income dependent substantially on any particular asset?


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Personal and health questions• How is the status of the client’s marriage and that

of any players who could be affected by a marital dissolution?

• Do any of the client’s goals potentially or actually conflict?

• What is the client’s age, health and remaining expected life expectancy (considered not just from actuarial tables but also considering the particular client’s health and family history)?


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Personal and health questions (cont.)• How are the client’s relationships with the players and

the relationships of the players amongst themselves?• How important is retaining future flexibility in estate

planning for this client?• What are the relationships between the players (other

than the client) amongst themselves and how will the technique work if those relationships change? Can anything be built in to the technique to allow for solving these problems?


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Personal and health questions (cont.)• Could the client’s death affect the technique

after implementation, and, in particular, the post-death relations between the players, including the relative economic positions of the players?

• Does the client have any real current charitable or donative intent?


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Personal and health questions (cont.)• How well do the client and players

communicate, and how might poor communication impact the implementation or administration of the technique?

• Is the client dependent upon any of the players, and, with respect to each player, are any of the players dependent upon or vulnerable to one another?


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Personal and health questions (cont.)• What is the client’s risk tolerance for

uncertainty of for IRS audit and/or recharacterization with respect to the technique?

• What kind of witnesses could the client, the players and other advisors make?

• Do the players appreciate, accept and respect the complexity of a proposed technique?


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Assets

Techniques

Players


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In conclusion, with this hermeneutic, it is possible to design estate planning tools and techniques more safely than ever

Questions???

Hermeneutics presentation nj estate planning council

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