When it comes to Estate Planning and providing money to heirs, there are many different strategies that wealthy people use for wealth transfer and wealth preservation, but sometimes it can become tricky when deciding not only who gets what, but also, when. One of the biggest concerns that wealthy people have is the responsibility of their heirs/beneficiaries and how well they will be able to maintain and/or grow the wealth that is passed down to them. As per the numbers, many wealthy families often lose 90% of their wealth by the 3rd generation, so wealth preservation is always a major concern for them.

In that regard, what many wealthy individuals/families do is use certain strategies of ‘wealth sprinkling’, that won’t give their heirs ‘too much, too fast’. This gives them an opportunity to evaluate how responsible they are and what they actually do with the money given to them, before deciding on when/if large chunks of money will be handed down to them upon death. The last thing most of these people want to do is provide their 22 year old grandchild or child who doesn’t have much financial education or discipline, with millions of dollars in one shot. Some strategies that they use are listed below:

Trusts

Trusts are one of the most widely used strategies implemented in regards to wealth transfer. They can serve a purpose both while the individual is living (by use of an inter-vivos trust) and once the individual has passed away (by use of a testamentary trust). An inter-vivos trust allows for distribution of assets while the individual is live, which often occurs gradually over time, so as to not provide too much money all at once. With an inter-vivos trust, the Settlor (individual who is creating the trust) can also maintain full control of the assets within the trust and decide when/if they will be distributed, or terminate the trust altogether. The Trustee can also be given specific instructions on when/how to distribute the assets upon the death of the Settlor — for example, when a beneficiary reaches a certain age. One of the major advantages for the use of inter-vivos trusts is for the potential tax benefits. If beneficiaries are in a lower tax bracket than the Settlor, then this would benefit the family unit as a whole, by lowering the overall taxes in the family. If an individual is intending to leave, for example $250,000 for a beneficiary, the thought process would be “I can either keep it in my name now and invest it, where I pay the taxes on any growth or distributions, or I can take some or all and put it into a trust which distributes it to my beneficiary, so they pay the taxes”. They may feel it’s better to lower their overall tax bill while providing funds to the beneficiary while they are still alive, through the trust.

By doing this, a few things are accomplished:
1) less taxes are paid by the Settlor;
2) you can watch your beneficiaries enjoy some of the money now; and
3) you can assess the discipline and responsibility of the beneficiaries.

Another great benefit of using trusts is that the funds within the Trust are not subject to probate, which can save tens of thousands of dollars in probate/estate fees upon death. The funds would pass directly to the beneficiary either at time of death of the Settlor, or when certain conditions have been met (i.e. when a beneficiary attains a certain age). Using a Trust also maintains privacy on asset distribution. Since the funds don’t form part of the estate, it is not publically known who gets what, which can help to ease the transition of wealth and minimize any conflicts within the family.

For those who have businesses, a Trust can also be set up as a Shareholder of the corporation, which would help to spread income to multiple people and potentially lowering overall taxation on death.

One thing to consider is that Trusts do cost money to set up. Often there are both legal and tax professionals working together on creating trusts and the entire process can cost anywhere between $3000 to $5000+ per trust. Now, this may be a drop in the bucket for many wealth families, but it is something to consider none-the-less.

By using Trusts, it gives individuals/families the ability to accomplish different objectives at the same time. It provides asset distribution while they’re still alive, so they can see their beneficiaries make use of the money, assess their discipline & responsibility of the funds they receive, maintain full control of the assets within the Trust and make use of tax benefits.

Annuities

Annuities is a topic that not enough people discuss in the Financial Planning world these days. Although they aren’t as ‘sexy’ as some of the other products/strategies out there, they still serve a purpose and can fill a desired need within a Financial Plan.

With an annuity, an individual would provide the insurance company with a lump sum of money. In return. the insurance company then provides you with a guaranteed income stream, which can be for a certain number of years, or for life. There are certain ‘bells and whistles’ that can be added to the product, such as ‘indexing’, which will increase the annual payments by a certain percentage to keep up with inflation, however the concept still remains the same. Although it is generally used as retirement income strategy, it can serve a purpose within Estate Planning itself.

If an individual intends to provide, for example, $500,000 to their beneficiary, and don’t want it all to be given at once, an annuity can ensure that the beneficiary will only be provided with a specific amount every year (or month). For example, if the beneficiary was a 45 year old male, this could provide up to approximately $22,000/year in income to the beneficiary. This would entail that after about 23 years, the beneficiary would have accumulated $500,000 in payments. However, the payments would still continue for the beneficiary until they passed away, or until their surviving spouse passed away. This would essentially provide an ‘income for life’ type of strategy for the beneficiary.

From a tax perspective, the beneficiary would be liable for any taxation of the income received, which removes the tax burden from the individual who wants to provide the funds to the beneficiary. It also ensures that over the long term, the beneficiary would receive more than the original amount provided to the insurance company, so as to ‘enhance’ the value of the estate. The individual would then be able to assess the discipline and responsibility of the beneficiary and can decide if they want to leave them more assets later in life or upon death.

One of the drawbacks of annuities is that, once you give the money to the insurance company, it’s already gone and there’s no taking it back. This is one thing that may make some people think twice about this option more before using it. That being said, it does address the objective of ‘not providing too much to fast’ and does provide for some tax benefits (rather than taking that money and investing it in their own name). Also, the funds provided for the annuity do not form part of the estate, which provides privacy, and reduces the amount of probate/estate fees at time of death of the individual.

Gifting while alive

Gifting is something that many families do in general already. An individual can provide gifts to their heirs in small chunks, rather than providing a lump sum all at once. This allows them to watch their beneficiaries enjoy their gifts while they are still alive — for example, paying for a grandchild’s post secondary education, or the down payment on a child’s home. They will also be able to assess the discipline and responsibility of the beneficiary over time to determine if they really want to continue giving gifts or leaving money to them after death.

From a tax perspective, if the gifted funds are re-invested by adult beneficiaries, then the beneficiaries will be responsible for any taxes associated with that. This would be an advantage where the beneficiary is in a lower tax bracket. However, it is important to note that if gifting assets ‘in-kind’ (such as securities or real estate), this may trigger a capital gain and have tax consequences to the individual providing the gift, so it is important to consult a Tax Professional prior to doing this. The gifted assets also do not form part of the estate, which reduces the amount of probate/estate fees at time of death of the individual.

One thing to consider is that once the assets are gifted, they no longer belong to you, so it should be funds that the individual has no intention of using while still alive.

“Hotchpot Clause”

This strategy is a unique strategy that seems to be getting more interest from an Estate Planning perspective. A “Hotchpot Clause” is essentially a clause within the Will which takes into consideration the value of gifts given during an individual’s lifetime to the beneficiary(ies), when calculating the Estate.

Often it is used to ‘offset’ gifts or loans to heirs that were given during the lifetime of the client, whereas those gifts can be considered as an ‘advancement’ on what they were supposed to receive upon death. It can also allow for ‘equalization’ of payments for beneficiaries. For example, let’s say an individual has an estate worth $1.5M and 3 children. The individual wants to have the estate divided equally among the children, however the first child got $100,000 to start a new business, the second received $80,000 for post secondary education and the third received $120,000 for the down payment of a home, during the life of the individual. If a hotchpot clause was part of the Will, then the gifts provided to the children will be ‘added into the hotchpot’ and added into the estate, bringing a total value to the estate of $1.8M ($1.5M + $100,000 + $80,000 + $120,000). Each child’s share would be $600,000, however will be offset by what they had already received. Therefore, child 1 would receive $500,000 ($600,000 – $100,000 already received), child 2 would receive $520,000 ($600,000 – $80,000 already received), and child 3 would receive $480,000 ($600,000 – $120,000 already received), from the estate.

This strategy can help to minimize or negate a potential future litigation between heirs, especially when they feel there was un-equal treatment between them. It is also generally used in conjunction with other strategies that provide regular income or gifts to the beneficiaries during the lifetime of the individual. It can help to set expectations for the beneficiary that they will only receive a certain amount at time of death of the individual, and the gifts they receive should be used/spent/invested wisely now. It also provides the individual an opportunity to see how gifts are used during their lifetime to asses if they want to continue giving more, or even if they want their heirs/beneficiaries to receive anything at all at time of death.

As you can see, each strategy does have its pros and cons, however, they all address the objective of ‘wealth sprinkling’, which is providing beneficiaries with funds gradually over time as opposed to giving ‘too much, too fast’. These strategies also help to prepare younger beneficiaries for wealth inheritance and ensure that they will not get ‘spoiled’ with one big cash injection, rather they would have to be to take make sure the funds provided to them are used wisely. Since most of these strategies (with the exception of annuity) offer no guarantee to beneficiaries that they WILL receive money, the ‘fear’ of potentially not getting any money later in life can help to shape their spending and saving habits.

Estate Planning can be a complicated and strategic process, especially when dealing with larger values, however, dealing with a qualified and Elite level Advisor can show you all the different options and which ones may be best suited for you. Working alongside professionals such as Lawyers and Tax Professionals is recommended when putting together a strategic plan and can save not only money, but also headache and avoid legal problems in the future.

For any questions on Estate Planning or to do a review of your current Estate Plan, please do not hesitate to contact me!