Why do the affluent often fail to protect the family fortune?Article added by Steve Savant on February 21, 2013
Steve Savant

Steve Savant

Scottsdale , AZ

Joined: January 28, 2005

​It is shocking that so many ultra-wealthy family business owners do a poor job of protecting their fortunes for future generations. But for those who want to plan to advantageously transfer the family business to the next generation, now is the time.

The combination of today’s historically low interest rates and depressed asset values are certain to cause heartburn for many family business owners. And heartburn of this nature is impervious to Tums, Pepcid or Prilosec. However, today’s economic environment may provide business owners with the opportune time to transfer their family businesses and minimize potentially growing estate and gift taxes. After all, the next round of government tax revenue may come from estate transfers, because it’s easier to take money from the dead than it is from voting taxpayers who work.

Unfortunately, most succession plans are rarely acted on and are sitting on shelves gathering dust, according to a 2008 study by Prince & Associates, as well as Campden Research for U.S. Trust, Bank of America’s Multi-Family Office Group. The studies found that families are simply not implementing asset protection strategies. Only 38.3 percent of those who have succession plans are implementing them. Paying for a succession plan and not implementing it only serves to comfort a misguided sense that the problem is being addressed. But it is not a true solution.

This inaction also has a negative impact on the economy, because family owned businesses play a crucial role in America, which inevitably affects all of us. Eighty-five percent of all new jobs are created by family owned businesses and more than 50 percent of the U.S. gross national product is produced by U.S. family owned business. Given the issue’s importance, it’s surprising that so few successful business owners effectively and advantageously pass family ownership from generation to generation. According to one study, only 30 percent of family businesses make it to the second generation and only 15 percent survive to the third generation. The fact that no ongoing legacy is bequeathed is tragic enough, but economic loss to progeny can damage the financial security for generations. This would never happen on Downton Abby.

Why the inaction? More than three-quarters of the 242 family business owner survey respondents said they had succession plans, but they are dominated by strategic business issues rather than family considerations. In other words, families need to work with an advisory team that not only looks at estate and succession planning and asset protection, but also tends to family dynamic issues. The personal and financial objectives of the various family shareholders often change, so they may become less cohesive as the family grows.

Families will be most successful in crafting and implementing wealth planning strategies if they work with an advisory team that can recognize when it is necessary to bring in outside governance and family dynamic specialists.

It's important to note that estate planning is not the same as wealth/business succession planning. Most clients think they need an estate plan to address what are really lifetime planning issues. Most estate plans focus on managing the testamentary estate as a whole, as well as tax avoidance. A family wealth transfer plan focuses on specific assets that comprise a client’s wealth, rather than the estate as a whole or the tax incurred because of the total value of the estate.
The bottom line is that a wealth succession plan is a lifetime planning opportunity, designed to be integrated with the client’s plan for death, the estate plan. Two considerations should be addressed in the wealth succession planning universe – business succession and life insurance. Wealth succession planning is its own universe, a big topic that should be segmented into areas of expertise because of its size and scope.

Business succession

More than 75 percent of wealthy clients typically own all or part of a closely held family business. Sooner or later, every family business must be transferred. Unfortunately, many advisors are putting off dealing with this issue for a variety of reasons, not the least of which are family relationship dynamics. Nevertheless, an unplanned transfer, especially if caused by death, can be an economic and tax disaster. The business itself is usually jeopardized.

There are many viable business succession strategies and lots of planning material available to the adviser, so I've decided not to provide that material here. It would fill volumes. Suffice it to say that this issue is not being adequately addressed by most advisors to the wealthy. For the sake of getting started with wealth succession planning, utilizing a quick and effective planning opportunity and showing your clients you've at least considered these matters, focus on the next topic – life insurance.

A client’s assets can generally be grouped into five categories: residences, businesses, income-producing assets (IRA, 401(k), qualified plans), all other assets (cash, securities, real estate, partnerships) and insurable interest. There are a bevy of insurance strategies that can be designed to address these five categories. But for now, the basic concepts are more in order to introduce the players on the chess board.

Why do the wealthy need life insurance?

Life insurance is the only product that can provide lifetime tax free benefits and also deliver a large, tax-free death benefit to the heirs and estate. Because the wealthy are so heavily taxed, they are always looking to make money or preserve assets in a tax free or tax advantaged environment.

During life, life insurance cash surrender values accumulate tax free. Policy loans can facilitate tax-free cash flow. Loans are repaid by the death proceeds. At death, life insurance proceeds are tax free to the heirs with any number of commonly available strategies. There are specific cash flow designs using asset backed insurance lending. That’s code for premium financing with collateral. But with certain indexed universal life insurance contracts, early cash values are large enough that client collateral is relatively small for the first couple of years to cover any policy shortfall.

It’s amazing that the wealthy and most of their attorneys are not aware of or do not understand the tax free aspects and other planning benefits of life insurance. The insurance industry is squarely to blame for not reaching out to tax attorneys, CPAs and trust officers as part of their evangelism of the tax advantages and economic leverage of life insurance. But despite their shortfalls in knowledge concerning life insurance, they do understand banking. And this may be the new entry point into the fiduciary market for advisors to introduce premium financing, even if it’s not adopted as a remedy to the financial challenges of the wealthy. But one thing is for sure: No real planning of any magnitude will occur outside their purview.
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