Hermeneutics presentation nj estate planning council

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 Council
April 11, 2012
(c) 2012 L. Paul Hood, Jr.
paulhood@acadiacom.net
www.paulhoodservices.com
1

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

2

• 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

3

• 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

4

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

5

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

6

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

Relations With Children/ InLaws/Descendants

Attitude toward Wealth

Attitude toward Death

Mental & Physical Health

Other Life Experiences

Inner Child Issues

Siblings / Parents/Birth Order

Personality Type

Client

Advisor

Advisor

Distrust / Fear of Advisors/

Ethical Constraints

Fear of Loss of Control of
Planning Process

Listening / Communication Skills

Fear of Costs
Feelings about Taxes
Fear of Death

Limitations / Teachings/Philosophy of
Particular Specialty
Fear of Lawsuit
Need for Business

“Lead Dog” Syndrome
Self Interest

Loved
Ones, Intended
Beneficiaries, Other
s
Fear of Loss of Person
Self Interest
Not getting whole story

Fear of Collection of Fees

Good Estate Planning Hood, Jr.
(c) 2012 L. Paul Result
© L. Paul Hood, Jr. 2001-2012


7

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

Relations With Children/ InLaws/Descendants

Attitude toward Wealth

Attitude toward Death

Mental & Physical Health

Other Life Experiences

Inner Child Issues

Siblings / Parents/Birth Order

Personality Type

Client

Advisor

Advisor

Distrust / Fear of Advisors/

Ethical Constraints

Fear of Loss of Control of
Planning Process


Fear of Costs
Feelings about Taxes
Fear of Death

Limitations / Teachings/Philosophy of
Particular Specialty
Fear of Lawsuit
Need for Business

“Lead Dog” Syndrome
Self Interest

Loved
Ones, Intended
Beneficiaries, Other
s
Fear of Loss of Person
Self Interest
Not getting whole story

Fear of Collection of Fees

Good Estate Planning Result
8

• 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?

9

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

10

Assets

Techniques

Players


11

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

12

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

13

• 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

14

• 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

15

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

16

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

17

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


18

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?

19

Real world examples of poor estate planning
design
• Martin v. The Ohio State University
Foundation, et al.
• Armstrong cases (discussed in the
accompanying article)


20

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

21

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

22

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

23

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”)

24

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

25

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


26

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

27

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

28

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

29

Assets

Techniques

Players


30

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


31

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?

32

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?

33

Valuation questions (cont.)
• Could a technique impact, either by pre- or
post-implementation, value volatility of the
asset, and if so, how?


34

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?

35

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.?

36

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?

37

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?

38

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?

39

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?

40

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?

41

Assets

Techniques

Players


42

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

43

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)?

44

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?


45

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?

46

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?

47

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?


48

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?

49

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?

50

Financial and management questions (cont.)
• Does the technique itself offer any appreciable
level of asset protection?
• Does the technique depend upon the creditworthiness or cash flow of the client or of any
of the other players?
• What is the cost of implementation of the
technique?

51

• 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?

52

• How does the technique impact the classification
of property as separate or community?
client, what timing of payments are permitted
(immediate only, deferred, etc.)?
client, what flexibility does the technique offer
relative to the amount of payments back to the
client?

53

• 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?


54

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?

55

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?

56

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?

57

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?

58

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, “skippersons” by the ETIP restrictions of the GST Tax
and S corporation shareholder limitations?

59

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?


60

• 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?

61

• 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?

62

Assets

Techniques

Players


63

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


64

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?

65

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?

66

Financial and control questions (cont.)
• Is the client’s economic livelihood/security
and/or income dependent substantially on any
particular asset?


67

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)?

68

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?

69

• 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?

70

• 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?

71

• 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?

72

Assets

Techniques

Players


73

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

Questions???


74

Hermeneutics presentation nj estate planning council

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