3 Tax Minimization Strategies for Ultra-High Net Worth Estate Planning
The older they get, the more ultra-high net worth families start to get antsy about how much of their estate will be lost to the estate tax, rather than go to the places, people, and causes they care about.
If you don’t get serious about tax minimization now, you could end up regretting it dearly later.
Full Disclosure: We are not CPAs or Estate planning attorneys and you should consult with one if these ideas are appealing to you. Furthermore, we make zero money from our clients’ establishment of Private Foundation, Family Limited partnerships and the purchase of life insurance. However, we are here to help you, so feel free to reach out to us via phone at 800-669-6780 or email at [email protected]
There are two broad categories of tax minimization strategies for ultra-high net worth families: Trusts, and everything else. See 7 trusts you can use to minimize your estate taxes.
Here, we’re going to explore three different methods ultra-high net worth families can use for tax and estate planning purposes so more of your wealth goes where you want. Not every approach makes sense for every family, so consider each one, discuss it with the specialists on your team, and make a decision to move forward and secure the future of your family.
1. Private Foundation
There are at least two reasons to consider starting a private foundation.
First, charitable giving can be a very effective technique in preventing wealth from having a bad influence on younger family members. If you have heirs or other family members who, for whatever reason, you don’t trust to be good stewards of your wealth once you’re gone, a private foundation can restrict their access to and use of your family’s wealth.
Second, a private foundation is a tangible way to use your wealth to make a difference in the world for causes you care about. Whether you want your wealth to play an active role in world hunger, business innovation, medical research, museums, higher education, or any of the many other good causes you might care about, a private foundation affords you the freedom to pursue those goals, far beyond your lifetime.
See an example of a successful private foundation, plus 9 tips on how to start one
What is a private foundation?
It is a nonprofit entity that can be funded via cash or appreciated assets. The funding of your foundation will result in a tax deduction, and it will also reduce the size of your estate and therefore your estate taxes. Depending on how the foundation is funded, the amount of your tax deduction can vary dramatically.
Keep in mind that your heirs may have opinions about how much of your money and other assets become part of the foundation. This is a conversation you should have as a family, because the foundation will be much more effective if everyone buys into its existence and its mission.
If, for example, you have $200 million in assets, you could fund a foundation with $100 million, and still have that same amount left to distribute to your heirs. Speaking in very general terms, such a move would slash your estate tax by about $40 million, assuming present tax rates aren’t changed before then.
Not a bad day’s work.
A related strategy with a bit less work required is simply to make a very large donation to a particular nonprofit. Common examples of seven, eight, and nine-figure donations include things like funding a new building on your alma mater’s campus, or paying for a new opera house or museum, and putting your family’s name on it.
Yes, you are ‘giving away’ a large part of your estate. But if you don’t do this, the government will take 40% of it anyway, at current estate tax rates. Now, you’re deciding where it goes, rather than them.
When you combine a private foundation with some of the other strategies on this list along with a couple well-chosen trusts, you may have a realistic chance of nearly eliminating your estate tax.
2. Life Insurance
Life insurance can play a crucial role in estate planning for ultra-high net worth families. There are two primary purposes for life insurance employed most frequently.
First, life insurance can be used to pay the estate taxes so the estate itself stays relatively unscathed.
This situation is common in families where a large portion of the estate is tied up in a business or in real estate – illiquid assets. For example, suppose you own a business valued at $150 million, real estate worth $50 million, but have just $25 million in liquid assets.
At the current 40% estate tax rates, that $225 million estate would owe around $90 million in estate taxes – far more than you have in liquid net worth. This would put your heirs in the very undesirable position of having to sell off your hard-earned assets just to pay the tax.
With an adequate life insurance policy, you can work it out so that the life insurance covers most of that tax, and thereby keep the business and real estate assets within the family.
Combined with other tax minimization strategies to reduce that estate tax, this can be a very effective approach.
The second most common way ultra-high net worth families use life insurance as part of their estate plan is to pay proceeds to various family members.
Suppose you have already minimized your estate tax using trusts and other strategies on this list. If, however, you own a business or real estate, and only one of your heirs is up to the task of taking the lead with those, your assets will be divided unevenly.
Using the previous example, suppose you have two kids, but only one of them is capable or interested in taking over your business. That heir would then be inheriting a business worth $150 million. Even if you gave the $50 in real estate and most of your liquid assets to your other child, this is still a very unbalanced payout.
With life insurance, you can set it up so that the child not running the business gets additional compensation.
A life insurance policy valued at these amounts will cost a lot. But you can set it up so that the premium payments get removed from your estate without counting against your net worth or your annual gift exclusion.
You can do this through an irrevocable life insurance trust, or ILIT. Learn more about ILITs and other trusts here.
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3. Family Limited Partnership
The family limited partnership offers a possible strategy for reducing the value of your estate while protecting your assets from loss, especially if family dynamics change over the years. As with many estate planning and tax minimizations strategies, these are very complicated to set up, and you need to work with a specialist.
Pillar Wealth Management can recommend specialists such as estate attorneys, tax attorneys, CPAs, and other members of your estate planning team who have deep experience working with ultra-high net worth families.
In general, a limited partnership means you have two types of partners – general partners and limited partners.
The general partners control all the management and investment decisions for the assets owned by the partnership, and they carry all of the liability. Typically, in a family limited partnership, the general partners will be the patriarch and matriarch in the family. Limited partners do not participate in any management of funds, and they have limited liability.
The general partners will contribute assets to the partnership, and then give all or a portion of the interests in those assets to their children or grandchildren. It can go directly to them upon the deaths of the general partners, or be set aside in a trust.
It is in this transfer to the limited partners that the size of your estate will be reduced, and thus your estate taxes as well. Unlike a trust, however, the family limited partnership allows the general partners to retain control over investment decisions, as well as with any distributions.
When the transfer of wealth takes place, the limited partners are eligible for a valuation discount, and this plays a major role in the reduction of taxes owed. This transfer of interest in the partnership effectively reduces three taxes at once – the income, gift, and estate taxes.
The family limited partnership also protects your assets if family circumstances change.
For instance, if one of your children gets divorced, you can arrange it so their spouse will not be able to access the money owned by the limited partnership. Similarly, creditors cannot get to the money either. An FLP protects your wealth if the family situation turns sour.
The partnership model also makes it easier than a trust to manage your wealth, because all the money can be managed in the same brokerage account. This takes a big bite out of your investment fees. With trusts, you often need to have separate accounts for each trust, and thus more fees.
For All Tax Minimization Strategies…
Make every effort to ensure your family is in agreement on whatever you’re planning to do, and understands why you’re pursuing the strategies you choose.
Whether forming a private foundation, using life insurance, forming a family limited partnership, starting a trust, or a combination of these, your family needs to be united around the concept and know their roles.
If family discord prevents you from achieving this level of agreement, you may want to seek the help of the various specialists in these fields we’ve been talking about. You can still work out a plan even if you don’t have agreement. The process for navigating that may just be a little less smooth.
Ideally, you will want to have long and detailed conversations with your family and your team of advisors about what will happen to your estate after you’re gone.
If starting a foundation, for instance, everyone in the family should be excited about the idea and about the impact it will have in the world. To reach that point may require a discussion of your values, your passions, and your interests, and those of the other closest people in your family.
Pillar Wealth Management has extensive experience in moderating these sorts of family discussions and we are here to help. You can reach us by dialing 800-669-6780 or emailing us at [email protected]
Hopefully, after reading this article, there is no question in your mind about the urgency of creating a plan to minimize your estate taxes. The question you now face is, how do I go about making that plan?
We are very passionate about this aspect of wealth management. We would be honored and excited to help your family conduct the necessary discussions, develop the strategy that will achieve all your long term goals and plans, get your heirs excited, and unify your family around the mission and purpose you’ll be pursuing together, moving forward.