High-net-worth households have no shortage of financial tools in their estate planning arsenal.
From sophisticated trusts to shelter their assets, to charitable giving strategies that can minimize taxes, to life insurance products that can help preserve their legacy for future generations, affluent Americans are uniquely positioned to protect their personal wealth.
But not all do. A 2015 CNBC Millionaire Survey found that 38 percent of those with investable assets of $1 million or more have not used a financial expert to establish even the most basic estate plan.1
“People don’t like to think about estate planning, or their own mortality, so they avoid it, even though they know they need it,” said Lou Stanasolovich, a financial advisor and chief executive of Legend Financial Advisors in Pittsburgh, Pennsylvania, in an interview. “That’s true at every income level.”
Indeed, a 2015 report by UBS Wealth Management Americas revealed the greatest fear among wealthy investors is being a burden to their children (42 percent), followed by surviving on life support (34 percent) and living in a nursing home (15 percent).2
Yet, it found, only half have included health care costs in their financial plan and far fewer (23 percent) have earmarked savings for future medical care.
While every household is unique, and different tools are appropriate for different goals, a few key estate planning strategies can help protect your family and maximize the amount of money you may be able to leave behind.
Powers of attorney
Airtight legal documents are mission number one when it comes to estate planning.
Everyone needs a power of attorney, but the financial stakes are higher for those with large estates, said Stanasolovich.
A power of attorney document designates the individual you wish to handle your financial affairs if you become ill, injured, or mentally incapacitated.
Similarly, a medical durable power of attorney designates an individual to make health care decisions on your behalf in the event that you are unable to do so. A healthcare directive (also called a living will) further defines your wishes for medical treatment, including life support and end-of-life care.
Such documents ensure that your wishes will be carried out and relieve caregivers and loved ones of having to guess what you would want in a moment of grief — a common source of family feuds.
Trusts are among the most effective ways to minimize estate tax liability and protect assets from creditors, legal claims, and divorce.
Literally dozens of trust types exist and they accomplish different financial goals depending on how they are structured and the assets involved, which underscores the importance of seeking advice from a trusted source, said Larry Lehmann, an estate planning attorney with the law firm of Lehmann Norman & Marcus in New Orleans, and president of the National Association of Estate Planners & Councils.
“High-net-worth individuals need to engage an accredited estate planner who can put together a team of lawyers, accountants, trust officers, if appropriate, insurance professionals, and other financial service professionals,” he said. “All of these people need to collaborate when dealing with high net worth folks to clarify and document their mission, vision, values, and goals before recommending strategies, tactics, and tools.” (Find a financial professional).
A revocable living trust, he said, in which financial assets and other property are placed in trust and managed by a trustee for one or more beneficiaries, are perhaps the most commonly used. Assets within the trust are not subject to probate, which in many states is a lengthy (and costly) legal process of settling your will in court once you pass on. Instead, those assets can be distributed directly to your heirs or held and administered under the terms of the trust.
As the name implies, a revocable living trust can be altered or dissolved at any point during your lifetime. It becomes set in stone, or irrevocable, upon your death.
But they do have limitations.
“If you put assets into a revocable trust, creditors can potentially get a court order to go after it,” said Lehmann. As such, most wealthy individuals who can afford to surrender control of some of their money, also do an irrevocable trust, which permanently removes those assets from their estate and better insulates them from would-be claims.
Multimillionaires may also create a bypass trust, or a credit shelter trust, to reduce estate taxes payable upon death. Grantors simply name their spouse, children or other persons as beneficiaries of the trust.
Because the trust does not belong to the surviving spouse, it is not considered part of his or her taxable estate and will eventually pass estate-tax free to the designated beneficiaries, said Lehmann.
It may also make sense for wealthy seniors to design the bypass trust as a generation-skipping trust. Using such tools, the grantor (person who establishes the trust) names his grandchildren or great-grandchildren as the beneficiaries. If desired, the income generated by the trust can be made available to the first-generation heirs (the grantor’s adult children), but any assets remaining when they die pass directly to the second or third generation estate tax and generation tax free.
Life insurance policies can help high net worth families hedge against risk, too, especially when placed in trust. (Related: Life insurance overview)
Indeed, the death benefit on life insurance owned by the insured person is normally included in his or her estate. If the death benefit, in addition to other assets owned by the insured, exceeds the current year estate, gift, and generation-skipping tax exemption amount (for 2018, roughly $11.2 million for individuals and $22.4 million for couples) the excess value may be subject to estate tax. (Note: The death benefit on life insurance policies is generally income tax free to your named beneficiaries.)
But by creating an irrevocable life insurance trust instead, it is possible to permanently shelter those assets from Uncle Sam.
How? The trustee of an irrevocable trust purchases a life insurance policy on your life. The trust is the applicant, owner, and beneficiary of the life insurance policy. You make annual gift payments to the trust, which pays the premiums on your behalf — ensuring that the trust falls outside your taxable estate.
“Life insurance trusts are a very important tool and can be structured so the proceeds become tax free -- no income tax and no estate tax,” said Lehmann.
Another effective tax planning tool? Philanthropy.
The charitably inclined can maximize the benefit of their goodwill by donating appreciated securities — rather than cash — to a qualified charity, said Stanasolovich.
Doing so not only enables them to deduct the fair market value of their financial donation, but may also eliminate the need to sell those assets themselves, incur the capital gains tax, and donate the smaller after-tax amount.
Others set up a charitable remainder trust (CRT), which creates a potential income stream for the donor or their beneficiaries, but designates a qualified charity to receive any assets that remain upon the beneficiary’s death. Such trusts may enable donors to take an immediate tax deduction based on the present value of the future gift to charity, and defer payment of any capital gains tax for highly appreciated securities.
Charitable lead trusts (CLTs) are the exact opposite. The income generated by assets held within the trust are paid to a nonprofit organization for a fixed number of years or the lifetime of the donor. Any assets that remain when the trust expires go to family members or other beneficiaries.
One final note: The set-it-and-forget it mentality could come back to bite you or your beneficiaries.
At least every few years, and always after a major life event including a birth, death, divorce, or new marriage, it’s important to revise the beneficiary forms for your tax-deferred retirement accounts, including your IRA and 401(k), said Stanasolovich.
Remember, whoever is named as beneficiary to your retirement accounts gets the money when you die, even if it differs from the beneficiaries named in your will. Absent proper diligence, one of your largest assets could end up in the hands of your ex-spouse.
Trusts and life insurance policies should also be reviewed to be sure they still reflect your financial intent.
“Once their will is done, a lot of people think it’s done forever,” said Stanasolovich. “That’s not the case. You should be sitting down with your attorney every two or three years to discuss your situation and make changes as needed.”
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1 CNBC, “Wealthy Suffer from Estate-Planning Fatigue,” June 29, 2015.
2 UBS Investor Watch, “Beyond the Picket Fence: Unassisted Living,” 3Q 2015.