The Parental Responsibility of Estate Planning

Tax-savvy ways to ensure that your children are financially secure after your death

One of the fringe benefits of being a successful entrepreneur is that you can afford to be generous to your kids. Giving them an extra card on your American Express account, taking them on a Caribbean vacation and paying for an Ivy League education can all be done without breaking the bank.

But when it comes to transferring real wealth to their children, many entrepreneurial parents never get around to it. They're just too busy running their businesses to think about planning for an event--their death--that might be decades away. That can have devastating tax consequences if they die before they put an estate plan in place.

Michael Schwartz, a New York City certified financial planner and a managing director of Pioneer Financial, recalls a client in his late 40s who owned a thriving manufacturing business and dropped dead of a heart attack, leaving a wife and three young kids. After his death, the IRS valued the business at $6 million, far more than the $1.5 million the business owner had told his financial adviser he thought it was worth. Because the manufacturer hadn't gotten around to moving his life insurance policy into a trust for his kids, the policy was considered part of the couple's taxable estate. By signing a single piece of paper, the manufacturer could have spared his kids from paying federal estate taxes of as much as 45 percent on $3 million in insurance proceeds.

"A successful entrepreneur is so wrapped up in his business that his personal affairs often get neglected," Schwartz says. "With a little planning, he could have easily transferred that money to his heirs tax-free."

The key to gifting assets to your kids, Schwartz says, is to "remove as much of the future growth and the future taxable assets from your estate" as you can while you're still alive. This means sheltering the assets that you believe will appreciate most--real estate, stocks, bonds, mutual funds, shares in a family limited partnership and, of course, your business. By transferring a minority interest in your business to a trust for your children early on, for example, you can take advantage of favorable tax treatment that lets you value that minority stake at a deep discount.

Here are some other strategies that Schwartz recommends:

  • Make annual gifts. Under current IRS rules, you and your spouse can give each of your children as much as $13,000 a year tax-free ($26,000 total). Any gifts that you make to your kids while you're alive count towards the "unified credit" that eliminates federal estate tax on the first $3.5 million of your assets when you die.
  • Make sure your assets are titled correctly. Holding assets in your own name can trigger unwanted tax consequences when you die. Re-titling real estate and other assets so that they're wholly or partially owned by a trust for your children is a fairly simple process that can be done without triggering capital gains taxes, Schwartz says.
  • Update your will. Schwartz recalls one client who had remarried and neglected to update her will. After she died, her second husband and her son from her first marriage ended up in a nasty fight over her $500,000 life insurance policy.

How can you avoid problems like these? While the principles of estate planning sound straightforward, putting a good estate plan in place requires close coordination among you, your financial planner, your attorney, your accountant and other advisers. Estate planning will require an investment of time and money, but it may very well be the best investment you ever made.

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Rosalind Resnick is a New York-based freelance writer, entrepreneur, investor and author of The Vest Pocket Consultant's Secrets of Small Business Success.

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This article was originally published in the February 2010 print edition of Entrepreneur with the headline: Parental Responsibility.

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