The Parental Responsibility of Estate Planning

Tax-savvy ways to ensure that your children are financially secure after your death
Magazine Contributor
5 min read

This story appears in the February 2010 issue of Entrepreneur. Subscribe »

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.

Test Your Estate Planning Knowledge

There are myriad online resources that can help you bolster your familiarity with estate planning. Here are a few examples from a quiz offered by Zulick Law:

Q: True or false: Mr. and Mrs. Smith would like to leave everything to each other, so they don't need a will.
A: False. The disposition of your property is only one function of a will. A will allows you to direct the disposition of your personal effects, select an executor, choose the source for payment of taxes and, in some cases, save or eliminate taxes at the death of your spouse.

Q: Mrs. Hunt is widowed and has one daughter. She does not need a will because she put her house and all her accounts in joint name with her daughter.
A: False. Mrs. Hunt still needs a will to name an executor, make directions for the payment of taxes and provide for the orderly disposition of her estate.

Q: Mr. Peabody believes that he doesn't need a will because his only asset is his pension plan, which he is leaving to his son.
A: True. Although it is true that Mr. Peabody doesn't need a will, because the beneficiary designation governs the disposition of the pension, Mr. Peabody could control other aspects of his estate with a will, such as who serves as his executor, who receives his personal effects and how and where he would like to be buried.

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