--or Planning for Family Harmony
Verlyn De Wit, CLU, ChFC
Maybe his words struck me because I have three daughters myself.
A 65-year-old father of two sons and two daughters was explaining his will to me. The $3 million family trucking business was going to "the boys," and his daughters would receive a grand total of $100,000. Thatís right, $50,000 apiece.
"Well the boys have helped me in the business," he said. "And the girls have married pretty well. If I treat all four kids equally, my boys wonít be able to make payments to the bank and to their sisters. Weíre already up to our eyeballs in debt."
I asked him if he had discussed his plan with his children. "No," he said. "I know if I tell the girls theyíll be upset, and I donít want the boys to think theyíll be rich some dayóit might take away their motivation. Theyíll all find out in due time." I wondered how old his kids would need to be before "due time" arrived. The oldest children were already in their early 40ís.
His wife silently served us coffee. This issue had obviously been discussed before, and he wasnít searching for input.
What a recipe for disaster! Consider the following:
It is easy to talk about tax law since it is a science. Family harmony, on the other hand, is a very personal art.
Most of my clients would agree that family harmony is more important than the things they own. How can family harmony be maintained? And, is equal the same as fair?
Here is your assignment before proceeding to Part II. Imagine yourself in the place of each of your children. How does what they are getting, compare with what they are expecting?
How does what your children are inheriting, compare with what they are expecting?
You know how kids can be. Sometimes they are more concerned about what their brother or sister receives than what they receive themselves. So regardless of family and business circumstances, you can figure that your off-dairy children are expecting very equal treatment. Since our flawed human nature is difficult to shrug, perhaps you should remember this principle when planning your estate. Who wants to leave a legacy of feuding children?
The Classic Dilemma
You have some kids in the business who are contributing to the dairyís success, and other kids pursuing their own ventures. You love them all the same, but they are in different situations. Your on-dairy heirsí future depends on how you treat them in your estate plan, whereas the off-dairy heirs view their potential inheritance as a simple bump up on their balance sheet. What should you do?
Pitfalls to Avoid
Perhaps the greatest pitfall of all is neglecting to recognize the input of the child(ren) who is active in the business. According to a study done by Prince & Associates, the vast majority of family business founders have no faith in their kidsí ability to run their businesses. But for a smooth transition to occur, children simply must be given the opportunity to "try out their wings."
So, what are some creative ways of rewarding the efforts of on-dairy children, and still arrive at an estate distribution plan that is equitable to all?
You love your kids the same, but they are in different situations. Some are involved in the dairy business with you and some are not. What should your inheritance plan for them look like?
Should you do what Jack and Mary did?
Though not their real names, the situation Iím about to describe is very real. Jack and Mary run a family dairy in central California. Their wills presently give all property to their four children in equal shares. Business in the last couple of years was good to them, and even though they are only in their mid-fifties, Jack and Mary realize its time to look at a business transition plan. They believe that the dairy business is important, but family harmony and fairness come first.
Their oldest son, Brian is very involved in the dairy. Itís great that Brian can take care of the place so Jack and Mary can travel more these days. Brian has done an excellent job keeping the dairy on the cutting edge of technology. The dairy benefits from Jackís wisdom and stability, but Brianís enthusiasm and creativity will define the dairyís future.
Jack and Maryís other three children are off doing their own thing. They are certainly interested in the success of the dairy, but donít visualize it in their business future.
So here is the classic dilemma: If Brian continues his hard work, is he simply building up something heíll have to buy back later from his brothers and sisters? The dairy already has some debt, but a cash flow analysis shows that upon Jack and Maryís death, taxes and payments to his siblings would increase Brianís debt load to more than 70% of his asset base. Should Brian shoulder all the business risk so his brothers and sisters can simply cash a bigger inheritance check?
Here is what Jack and Mary did to avoid a dismal business future for Brian, and be fair to the other children at the same time.
Jack and Brian entered into a dairy partnership. Brian purchased a 50% interest in the business, and is making monthly payments to his parents for a number of years. The loan is at a favorable interest rate, and projected cash flow from the business should be sufficient to keep Brianís payments on schedule.
Jack and Mary changed their wills so that any dairy assets they have not sold or given to Brian during their lifetimes go to him at their deaths. Their wills also release Brian from any debts owed his parents at that time. Brian will, however, be responsible for any debt the dairy owes, and the estate tax the dairy assets generate. Brian has purchased a survivorship life insurance policy on his parents to help clear up these obligations. Brianís salary from the partnership enables him to pay the premiums.
Jack and Mary are using a portion of the payments from Brian to purchase a survivorship life insurance policy. This policy will be held in a special type of trust for the benefit of Brianís brother and sisters. The policy is relatively inexpensive, and if properly structured, the trust will distribute the insurance money free of income tax and death taxes. These tax savings are so significant; the non-dairy heirsí after-tax inheritance under this plan is actually a little more than what the original "share-and-share-alike" wills would have given them.
Sure, it may be that Brian ends up with more value than his brother and sisters, but he is saddled with the bulk of the estate tax and all of the business risk. Brianís siblingsí inheritance is insured and protected, while Brianís financial future still depends on the success of the dairy. Brianís siblings have at least one bird in the hand; Brian may have two in the bush. The dairy business is like that.
This plan will keep Brian financially independent from his brother and sisters. No need to enter into partnerships with them, or ask them for a loan. Brian is his own man. Best of all, Jack and Mary have decided to explain the plan to their children at a family meeting so they can answer questions now.
Obviously there are other approaches that could have been taken in this case. Jack and Maryís family was fortunate since there was harmony to begin with, they were willing to start the planning process early, and they were willing to allocate some money to an essential life insurance program.
It is often said that if you want to know a person's true character, share an inheritance with him.
While you may have a great relationship with each of your children, the question responsible parents ask is, "How will my kids feel about each other when they divide the money?"
Warning signs may be difficult to pick up. It may be as subtle as an uncooperative son-in-law or daughter-in-law. Perhaps one of your children resents the fact that you spent a large sum of money educating one of his/her siblings. Maybe there is the perception (or the reality) that you gave special help to one child's business development and not another's.
Weaknesses or addictions (alcohol, drugs, gambling) financial failure or marital strife in one of your children's lives may make them desperate and impossible to work with.
An ounce of prevention
a) Document transactions properly. Was the $50,000 check you gave to Johnny 10 years ago a loan or a gift? While your intent (and your family's understanding) might have been that it was a compassionate loan, if Johnny hasn't made any payments and there is no IOU, you've set the stage for a battle.
b) Don't punish success. You might be flattered and surprised to know how hard your children are working simply to gain your approval. Giving more to a needy child is a devastating blow to the successful child, and may be perceived as a lack of affection.
c) Be fair. Lifetime is the best time to play "catch up" with the children that have been financially overlooked. An unexpected gift now would be a heartwarming pleasure for you and a memorable surprise for overlooked child.
d) Be discreet. If it is absolutely essential to help one child out more than another, do so discretely. Don't let your will or trust publicly announce your favoritism. Give confidential lifetime gifts to the needy child. Or purchase a life insurance policy on your life for the needy child's benefit.
e) Be creative. Sometimes business or family situations are too complex for a "share and share alike" distribution plan. There can be different ways to provide fairness for each child. Please see last month's article for a more thorough discussion of this issue. If that magazine has already gone to the recycle center give me a call.
f) Pay careful attention to family heirlooms. While there may be no emotional preference for IBM or AT&T stock, your child may be hurt if someone else gets the gun collection they were expecting. Leave detailed instructions and talk to your children about this emotionally sensitive issue.
A ton of care
Face it folks. You aren't perfect and your kids aren't either. If in spite of your best efforts, your family appears headed for a train wreck you may wish to consider the following options:
a) No contest clause. You should consider placing a "no contest clause" in your will or trust to discourage disgruntled heirs from attempting to invalidate your estate plan. According to Michael Noland, partner in the law firm of Kahn, Soares & Conway, LLP of Hanford, Calif., "the 'no contest clause' provides that if any beneficiary contests or attacks the will or revocable trust or any its provisions, any share or interest in your estate given to that contesting beneficiary is revoked. The laws of your state or residence should be consulted regarding the enforcement of such 'no contest clauses.'" While this may force the peace on a legal level, it probably won't heal personal relationships.
b) Disinheritance. You normally are not under any legal obligation to leave a portion of your estate to your children. So if your child's conduct has been singularly reprehensible, you may wish to disinherit them. Noland relates that, "The laws of the state in which you reside must be carefully reviewed to determine how your estate planning documents must be prepared in order to disinherit a child. In California, the provisions of the will or revocable trust must identify the child and also disinherit the child."
Some attorneys have encouraged clients to be examined by a doctor and/or psychiatrist at the time the will or trust is written. The professionals' opinions concerning the client's mental fitness is filed away as ammunition for a potential legal battle. Other attorneys have actually videotaped clients to show that they were thinking clearly and that it was their unmistakable wish to disinherit a child.
Before you take drastic steps such as these, consider talking to the wayward child and tell them, lovingly, what they are forcing you to do. You may open up communication and perhaps take a step toward reconciliation.
© 2000 Western Dairy Business. Printed with permission. These articles are part of the Itís your money series. Verlyn De Wit helps successful dairymen make smart decisions about their money. He can be reached toll-free at 1-888-468-1728 or by E-mail firstname.lastname@example.org. Neither the Western Dairyman nor Verlyn De Wit is qualified to offer legal or tax advice. Consult your attorney and/or tax professional for a qualified opinion regarding your personal situation. No specific endorsement form the University of California should be inferred.
15 November 2004