Web site:
The Planned Giving Design Center, LLCs group location on the PGDC website.
Phone:
704.698.4050
I.M. Frugal is a 70-year-old fiercely independent, highly successful entrepreneur who, with the help of his two brothers, built a very large real-estate portfolio. His wife, Lucy, is 69-years-old, and they have three adult children ages 44, 41, and 38. They have enjoyed a very comfortable, but not extravagant, lifestyle. The family has not been very involved in philanthropy. They have given large amounts by most people's standards, but based on their income and assets, their giving has been modest. I.M. has said to me many times, "My family is my charity."
Before I.M. and his family began the family wealth counseling process, the family had struggled for several decades with their estate planning. All efforts to solve the immense tax and business continuity problem with his assets and family-owned business had failed for one reason or another. Not wanting to rock the family boat, confusing professional advice, denial of the aging process, and the pressure of building the business were some of the reasons given for the current dismal state of affairs.
The estate of Mr. and Mrs. Frugal had a daunting estate tax bill of almost $40 million. Most all of his $70 million assets were low basis real estate. If he were to sell these assets, there would be a staggering capital gains tax due of almost $16 million. Our recommended plan solved all these problems, and subsequently created almost $40 million in charitable results, which his children and grandchildren will control for generations.
On the emotional and psychological level, their family was extremely insecure at the prospect of his early demise, given that they had little or no knowledge or experience with the family assets. The fear of death and loss of control paralyzed I.M. into making little or no plans for how to pass on these assets in a productive manner. After I.M. explained all of this to me, I said, "It's time for you to schedule a family retreat."
The most important aspect of the family wealth counseling process is the family retreat. We invite the husband and wife to a full-day session to explore all issues relating to the transfer of their wealth. The purpose of the retreat is to help them clarify their goals on financial, emotional, and spiritual levels. We are not doing therapy, but we do provide a format for them to focus on what they ultimately want to accomplish with their wealth. We ask such questions as, "How much is enough for your children and grandchildren, have you told your children what to expect when you are gone, and how would you describe the trust and communication level between you and your children?" We also ask legacy questions such as, "How do you want to be remembered, what are the values and virtues you want to pass on to your descendants, and what are the core beliefs that you want your plan to communicate?"
After interviewing the entire family, we draft a "Family Wealth Letter of Intent," which is a document that specifically outlines what the family wants to achieve. It becomes the road map for the design of the estate plan. Most traditional planning comes about in the opposite fashion-first comes the planning technique and then the overall plan. Estate planning specialists will agree that the most difficult task in the planning process is to get clients to decide, agree, and commit to exactly what they want to accomplish. The retreat process helps them achieve clarity before we ask them to commit to a finalized plan or make an irrevocable decision.
After much haggling, I.M. did finally schedule his family retreat. However, when I flew in to meet him for the all-day session we had planned, he said, "Let's go shopping!"
The first shop we went into was a fine china store on the famed Rodeo Drive. It was very exclusive, expensive, and stuffy with Mozart playing in the background. A very proper and well-dressed woman came to our assistance.
"May I help you?" she asked, with an upper-crust-type voice.
"What do you have that is 70% off?" I.M. blurted out loudly.
Aghast and with distance she responded, " I am quite sorry, sir, but we have nothing for 70% off."
With a sly grin, he turned toward her and said, "Well, what do you have that is 90% off?" You can imagine the response. With that, I had a very clear picture of what I was up against.
After a full day of this same routine in every store on the block, I had a clear picture of I.M.'s personality. In fact, later that day, I.M. said to me, "You should have a pretty good idea of how I work by now. How did you enjoy the client retreat?"
The more formal client retreat did in fact take place some weeks later with Lucy's involvement. Since I.M.'s attention span was very short, and since according to him anything that took more than two minutes to get to the "bottom line" was obviously a waste of his time, we did the retreat over a series of four meetings. After much debate and negotiation, here is a summary of the family's family wealth letter of intent.
The greatest concern for Mrs. Frugal was the desire to create liquid dollars from their real-estate holdings. Her concern had several aspects-some historical and some prospective. Since the real estate was owned jointly with her brothers-in-law, and since none of her children were working in the business, her concern was that they would end up in a battle for control of the business when her husband died. In addition, she had never worked in the business, and she had no interest in operating this business. A buy-sell agreement had never been arranged because of all the issues it raised. The obvious conclusion would be to liquidate their share of the business, and create cash.
The biggest challenge that had paralyzed any movement in solving their dilemma was capital gains taxes. The tax issue was quite real and staggering in size. If they split up or sold the real estate now, the tax bill would be in the neighborhood of $16 million. If I.M. and Lucy died before anything could be done, the estate taxes would be $35-40 million.
However, as I came to understand the emotional dimension of this family, I learned there was much more to this story than a fear of taxes.
The capital gains taxes were what everyone talked about, but the real problem was much deeper. At age 70, I.M. had spent over 40 years working closely with his brothers to build what amounted to a real estate empire. As with many families, the glue that held their relationships together was the assets. Selling could mean the loss of love and connection with his brothers, not to mention the difficulties in negotiation. Therefore, nothing happened for decades even though there was a strong desire for change. There were many family stories of years and years of meetings with the leading estate planning experts that always ended up with the same frustration and results?no change.
There was a moment in the client retreat where I realized that as I.M. described his great hatred for taxes, what he was really saying was that he didn't want to lose or damage his relationship with his brothers. As he described his pride of ownership, struggles, and triumphs with his siblings, it became clear to me that it wasn't the taxes that held up the status quo, but rather it was the fear of loss.
Another emotional factor to surface in the retreat was the family's intense loyalty to their father. I.M. had started it all and encouraged the brothers to work together and stick together at all costs, which at times was very high. Their success was so tremendous, it almost seemed they were inviting bad luck if they divided up the assets, sold out, or made any independent moves.
These issues all came out in the family retreat. Over and over again, both I.M. and Lucy expressed their desire to sell their assets. But the fear of loss was too great to move forward.
Our challenge was twofold. First, we had to find a way to bring this emotional issue to the surface in a non-threatening manner. Secondly, we had to solve the tax problems.
The entire family was willing to sell at least some portion of the real estate assets. We designed a charitable remainder unitrust (CRUT) to which the Frugals transferred a large block of the real estate. This "tax-free investment environment" allowed for the transaction to occur without creating any current capital gains tax. An 8% net income trust with $21 million of assets created an initial annual income of $1,680,000 and a $6 million current income tax deduction.
The second step was to take the balance of the real estate and put it into a family partnership. We then used various strategies, including a sale to a defective trust, to freeze and transfer in trust a substantial amount of real estate to the children. A wealth replacement trust (complete with generation-skipping provisions) funded with life insurance was established to replace the assets that went to the CRUT. A family foundation, structured as a type-three supporting organization, was also formed. A substantial initial gift was made to the family foundation, which is ultimately the recipient of all of the charitable distributions from the estate. The wealth replacement trust was financed through a combination of (traditional) split-dollar and the tax deductions created by the charitable strategies.
After the second death, the estate tax is eliminated through the use of a charitable lead annuity trust. This came about because I.M. indicated that his children did not necessarily need all the assets right away. Therefore, the trust was designed so that the income goes to the family foundation for 11 years after the second death, and then the balance of the trust goes to the children. Because the assets are anticipated to provide a high payout of 12.75% based on their value, the trust's remainder value will "zero out" at the end of the term, resulting in no gift or estate tax.
The wealth replacement and grantor defective trusts were designed to provide the children with access to the income, but included preventative measures so that the assets could be protected from creditors, bad marriages, and poor judgment. The net result of this plan is that the family foundation ultimately will receive almost $45 million, the children will receive $70 million, and the government will receive no transfer taxes.
In summary, this plan provided the liquidity the Frugals were looking for, the ability to sell property while not paying current capital gains taxes, and for the elimination of all estate tax. On the emotional level, since the plan did not call for a mass sale of all real estate, there is still an ongoing relationship with the brothers, yet the liquidity issues have been solved.
Although there was some tension between the brothers as they discussed the issues of selling some of the real estate, they developed ideas to create a continuity plan and made a commitment to each other and their families for the long term. Since we had eliminated the daunting capital gains tax problem on the sale of real estate, everyone felt comfortable. That was enough fuel to propel them forward with their plan.
The second big issue, or family goal, was to include the children in the management of the family assets. This goal sounded fairly ordinary when I first heard it. However, as with the other issues, there was much more to the story.
All three children appeared to have successful lives and careers. However, as we dug deeper during the client retreat, it became clear that there were some serious disappointments. The children exhibited behavior not uncommon in wealthy families; they suffer from the guilt and shame of growing up with immense wealth. They are always wondering "Do my friends like me for who I am or is it our money and power?" or, worse, the deeper worry of "Could I succeed in life on my own without all this money?"
Although the kids got along with each other and with their parents, the children were by their own admission and their parent's standards "underachievers." The unspoken, underlying feeling was that given the tremendous advantages they received from the family's wealth, they should have accomplished much more. This is very typical in wealthy families. The parent's expectations are quite high and the children's guilt for not living up to those goals goes in step. Throw shame into this mix, as the kids felt they could never accomplish what this wealth "should" allow them to accomplish, and you have a real recipe for disaster. The self-esteem of children of wealthy parents suffers a severe blow by this vicious cycle of emotions. This "affluenza" destroys the children's motivation and creates all varieties of mental, physical, and relationship maladies. (Note: Kathryn Gibbon of the Inheritance Project speaks at length on countless case studies that highlight this vicious process.)
All the aspects of this complex emotional web were translated by the parents into this benign goal of " including our children in the management of the family assets." When the goal was articulated at the family retreat, I didn't give it much consideration. Previously many other families had identified similar hopes for their children. What I hadn't realized was that for this family, as perhaps for many others, this goal was the tip of the iceberg that could sink the Titanic.
Since the children are all adults, I requested the opportunity to meet with them separately to hear their goals, dreams, and overall perspective on the state of wealth transfer in the family. Typically parents and children don't view these issues in the same way. Because the communication is so poor in most families, there are great discrepancies in the perception of each other's goals. In most cases, I find a complete lack of knowledge of the financial facts.
In the Frugal family, the children had some knowledge of the family assets, but were completely in the dark in terms of how to manage them. The children, who were in their 30s and 40s, had multimillion dollar portfolios, but weren't allowed to make decisions about their investments. I.M. followed the philosophy of most highly successful, fiercely-independent entrepreneurs, "If I want your opinion, I'll give it to you." He made all the decisions and thereby communicated in a nonverbal manner to the children that they were not capable of making investment decisions. More subtly, the message was "I don't trust you, and I can make a better decision." This behavior squelches any self-confidence in the children's ability to manage important affairs and usually leads to various types of negative behavior, and worst of all it leaves them no opportunity to grow and learn.
One day, as we reviewed the Family Wealth Letter of Intent, I asked I.M. "How do you expect your children or your wife to manage and carry on the family wealth if they have no idea how to operate the business?" I pressed further, "You have given them no responsibility and no power to make decisions. Is it any wonder that they have a low confidence level and lack motivation?" Although this may seem harsh, it was a harsh reality that this family had created. The reality was that without a change in course, in all likelihood the children were on many roads to failure.
Fortunately, I.M. took the opportunity to change the way he communicated and dealt with his family. Once he acknowledged his approach wasn't producing the results he wanted, he opened up to new ways of thinking and doing. We set up an action plan for each of the children to raise their level of competency in several key areas. The plan was designed to heighten their knowledge and expertise in the three critical areas:
Most critically, the children were left to make their own decisions regarding their portfolios and future investments. The key to the plan is they had to be left to succeed or fail on their own. Under the new rules they would request "input" from I.M., but he was restricted from imposing his advice, direction, and control.
Each child made a personal commitment to these steps, as did their parents. All family members acknowledged that this process would not happen overnight. Years of non-productive interactions cannot be reversed quickly. However, with a strong commitment and a lot of hard work ahead, the family is on its way to a much more productive and happy future.
The philanthropic results of the plan were so dramatic that the impact will probably not be fully understood for many years. We anticipate that the family foundation will distribute more than $500,000 a year and several million dollars each year once all the charitable gifts "mature" (i.e., both parents die). The foundation plays a major role in the lives of I.M.'s children and certainly will have a dramatic impact in their community for generations to come.
Perhaps more important than the dollar amounts, the "act of giving" has become a central point of conversation in their lives. The operation of the family foundation has become an important activity. Now the focus of many family conversations is the selection and review of the needs of charities, the efficiency with which they operate their organizations, and most importantly the impact they have on society. The family's focus is on something outside themselves-the service of others. The act of giving also places I.M.'s children in a unique position in the community. They now not only have wealth, but they have an opportunity to influence others and the ability to put into action a list of social, religious, and artistic goals that they think are important.
Before the family wealth counseling process, the family most certainly could have afforded to make these types of charitable contributions. However, in all likelihood they never would have been considered. Their success in the charitable arena was achieved through a combination of factors. On the financial level, our plan provided them with an option they never knew was available: the redirection of taxes to charity, particularly a charitable entity that the family controlled. On the emotional and family level, there were tremendous non-financial rewards involving the family in the act of giving. A whole new environment was created for them to work together and learn about what was truly important to each other. These two elements drove the overall success of the plan. As the oldest daughter said to me recently, "Wow, we can fill a lot of soup bowls with our foundation!"
As we presented financial solutions and the plan began to be implemented, it occurred to me that the greatest value our plan would deliver was not the $40 million in tax savings, but rather that the adult children were now on their way to being more mature, responsible, and motivated.
I.M., who in our almost daily phone calls had for months only asked about the financial implications of the plan, is now asking 90% of his questions about the children's progress on their goals. Perhaps for the first time in his life, I.M. was truly engaged in the goals of his family and rooting for those around him without interfering and controlling all the results.
After the plan was implemented, I asked him what were the best things that he felt came out of the entire family wealth counseling process. He said, "The process helped me realize what my wife and children's goals are. This created a much closer relationship between all of us. It also created much more trust and communication with them, as each person had the opportunity to express their feelings. We are a closer family as a result."
When I reported this back to Lucy, she said with a laugh, "I have been saying the same thing for 40 years. It is about time he listened to me!"
In fact, this was exactly on target. For 40 years no one in this family had been listening to anyone. Now some communication had begun, and their lives could begin to move forward toward their common and individual goals. The family wealth counseling process had helped them enrich their lives as well as society as a whole, and as a result the Frugal family has become very wealthy indeed.
