educating and informing the next generation · two common traits among families successful at...

ISSUE 02

EDUCATING AND INFORMING THE NEXT GENERATION

Educate, involve, and communicate with the next generation.

CONTENT

Educating And Informing The Next Generation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Why Is It Important To Educate The Next Generation? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Instill A Sense Of Responsibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Provide Tools And Knowledge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Prepare, Since A Transition Is Inevitable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Ensure Smooth Transition And Continuation Of Family Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Why Is Next Generation Education Frequently Not Happening? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Not Knowing How And When To Communicate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Not Knowing How To Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Not A Priority . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

It Will Take Care Of Itself . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Leading By Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Family Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Family Values, Goals And Expectations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Specifics About Current Plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Areas Of Education . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Financial Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Fiduciary Roles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Retirement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Life Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Protection Planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Philanthropy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

A Daunting Task, A Necessary Step . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

3manchester capital management, llc does not provide tax or legal advice. please consult your tax and legal advisors.2 educating and informing the next generation

Our first paper in this series, Succession Planning – A View From the Top, focused on succession planning from the viewpoint of the senior generation. This is where a comprehensive succession plan starts.

However, unless the senior generation educates, involves, and communicates with the next generation, the senior generation’s time and effort will most likely produce a sub-optimal outcome.

This paper reviews:

Why it is important to educate the next generation.

Why education frequently does not happen.

What are the areas of education to focus on.

Suggestions for sharing goals, wishes, and plans.

EDUCATING AND INFORMING THE NEXT GENERATION

WHY IS IT IMPORTANT TO EDUCATE THE NEXT GENERATION?

Instill A Sense Of Responsibility

In our experience, a common characteristic of successful family succession is the emergence of family members who assume responsibility for managing and guiding the family. Such responsibilities may include managing family assets, running the family business, negotiating internal conflicts, running the family foundation, and educating the next generation. It is these family members who ultimately lead and control the family’s outcome at critical junctures, principally because they take responsibility and communicate well.

Different generations have approached family decision-making in different ways. Households in the Greatest Generation1 , perhaps because many husbands were off fighting World War II, displayed a high percentage of shared decision-making between the spouses. The subsequent Silent Generation reverted back to decision-making predominantly by husbands. Common among both of these generations was a lack of involvement in decision-making by the next

generation, and generally non-existent communication between generations regarding family finances, goals, and planning.

The Baby Boomers, as children of the rights movements, adopted a model of shared decision-making. This generation also increased the involvement of children in family decision-making and generally did a better job of communicating than did prior generations. Generation X-ers, in following the Baby Boomers, were born in the mid 60’s to early 80’s and continued to increase shared family decision-making and open communication. It is at this juncture that families began to adopt more formal family decision-making structures.

Continuing with the trend of using more formal family decision-making structures, current families appear better positioned to improve communication and pass responsibility to the next generation. While the trend is in this direction, it is still not the universal approach, with many families failing to develop family decision-making skills in the next generation. This results in the next generation being unable or ill-prepared to take ownership and responsibility for family decision-making.


Provide Tools And Knowledge

The key to creating next generation family leaders is to provide them the necessary tools and knowledge to lead the family. Next generation leaders must embrace the over-arching objective of perpetuating the wellbeing of the family group, and to do so they must understand family goals and wishes. They will need a strong sense of family culture, an ability to empathize, knowledge of what makes the family “tick,” maturity, social

“abilities,” relevant work experience, as well as leadership skills.

Typically, those skills are acquired through education in areas such as finance, business operations and negotiation. While it is important that the next generation have these skills, it is equally important that they be given the opportunity to participate in decision-making to learn how their family group makes decisions. Through direct experience the next generation learns the “family rules” and, importantly, how to deal with failure as well as success.

For the best possibility of success, the next generation must be provided with appropriate tools.

Prepare, Since A Transition Is Inevitable

“Where there is life, death is inevitable.”2 One day we will all take our leave from this earth. Therefore, embracing the development of family leaders and transitioning to the next generation is a must for any family wishing to maintain family coherence and purpose. Kicking the can down the road is not a solution or a serious option.

Ensure Smooth Transition And Continuation Of Family Matters

Just like a business that lacks a succession plan, the lack of next generation family leaders will, at the least, result in a messy and probably costly transition. Missed opportunities, disputes, and possibly litigation, as well as poor decisions and damaged relationships, are more than likely. Even if a transition is eventually achieved, the time to achieve it will probably be much greater than if the next leaders had been identified, educated, and involved early.

WHY IS NEXT GENERATION EDUCATION FREQUENTLY NOT HAPPENING?

Not Knowing How And When To Communicate

The main reason a transition of family leadership fails to occur is a general lack of knowledge and understanding of how and when to communicate with the next generation. Although every family is unique, they often face many of the same key communication issues. There are no universal answers, therefore a good start is for the senior generation to begin by asking questions and laying out a strategy to help the next generation plan.

How should the next generation be provided information?

What information should they be provided?

Who is responsible for educating the next generation and how will they do the educating?

When should this begin?

Do all the members of the next generation need to be educated at once?

How does equal treatment come into the equation?

Does providing information regarding family wealth, wishes, and other matters create more issues than it solves?

KEY COMMUNICATION ISSUES

Not Knowing How To Plan

A significant issue is “transitional paralysis,” caused by not knowing how to plan. While family members are typically very skilled in their own affairs, as a group they cannot agree on what considerations, roles, and options are available to them. Additionally, they may view the process as time intensive, costly, and complex, leading to an ongoing delay in the creation of a plan.

Not A Priority

Frequently taking the time to focus on family leadership transition is not a priority. We often hear

“there will be plenty of time to do this.” However, reality is that with busy lives, including many items that need to be addressed in the moment, there may never be a time when this seems to be a priority. It should be. Planning is an important process that will assist the family today and for generations to come.

It Will Take Care Of Itself

From the world of sports to religion, there are many sayings that basically profess “it will take care of itself.” However, is this really true? If you are incorrectly invested, will it take care of itself? If you break your leg, will it take care of itself? If your car doesn’t start, will it take care of itself? The answer is probably no. Likewise, although possible, the next generation will likely not just start leading and caring for the family the way the senior generation hopes or wishes. Even if the next generation of leaders do develop, without a plan and assistance from the senior generation, the process will be less efficient, require much more work, and involve many more mistakes.


LEADING BY EXAMPLE

Family Governance

When families work together, whether in business, managing investments, or philanthropic activities, creating a structure to make decisions that span multiple generations can be very beneficial. This is often thought of as family governance—establishing structures and processes to organize and guide decision-making and relationships. The benefits provided by a structure of family governance include coordination of decisions affecting the entire family, or at least multiple households; maximizing cost and efficiency of services such as accounting, insurance, and investments; creating and managing common family investments, such as multiple-party owned real estate; and running family for-profit and not-for-profit enterprises.

Two common traits among families successful at family governance are:

Structures can take many forms from a formal single-family office structure to a less formal decision-making committee. In addition, where a family business exists, the family business might provide part of the structure. Roles and responsibilities might include fiduciary roles, committee members, and board seats among others.

The adoption of a governance structure.

Identifying who will fill certain roles today and in the future.

ROLE

Family Governance Board

Family Committee Member

Fiduciaries

Foundation Board

Professional Services

RESPONSIBILITY

Responsible for the oversight of all family decisions and decision makers.

Committees are often created to manage and make decisions over specific “topic areas.” Common are finance committees, philanthropy committees, reunion committees, investment committees, etc.

Legal roles that control decisions over certain legal, non-legal, and financial decisions. See Fiduciary Roles in Areas of Education.

Responsible for the management, investment, administration, and grant-making of the family foundation.

Professional services such as legal, accounting, insurance, tax, etc. These services are often provided by outside professionals, however, family members might provide some of these services as well.

ALL WITHIN THE FAMILY

Family Values, Goals And Expectations

It is important for the senior generation to communicate clearly their thoughts on family values as well as their goals and expectations. Should the family business be kept in the family? Is it expected that all family members be involved in the family foundation? Are trusts intended to be used primarily for education and business pursuits? Is there a family investment philosophy? In addition, it is important that the next generation (and the generations thereafter) have an active voice and participate in these discussions providing their own insights, goals and expectations. Often we see these goals and expectations form the basis for a family mission statement that will help guide the generations to come.

Include all family members in a collaborative effort

Call a family meeting and start with a dialogue

Listen as well as talk

Write things down and create lists

Consider using outside advisors to assist

Be respectful of other’s thoughts and wishes

Agree on what should be in your family mission statement

Draft an actual mission statement

Expect and welcome changes to your mission statement over time

Review annually

FAMILY MISSION STATEMENTS—BEST PRACTICES


Specifics About Current Plan

One of the most significant communication mistakes we see is not providing details and specifics about the current plan. We often see families where there is a fairly sophisticated estate plan in place including trusts and other estate planning vehicles. The plan was generally created through a long, time consuming, and often expensive process with much thought put into it. However, once completed, the plan is put in a drawer and very little of it is shared with the next generation.

THE BREAD HASGONE STALEAnother consequence that often occurs with families when they create a plan and put it in a drawer is that it gets stale. Whether because of changes in goals, finances, laws, family situation, etc., yesterday’s plan may not be entirely appropriate today. Therefore, it is a best practice to review the family estate plan annually and to modify it when and where needed. This can be a great exercise to do with the entire family at an annual family meeting.

BREAKOUT BOX

The consequence of putting the plan in the drawer and not communicating it with the next generation is that those who will be affected by, benefit from, and responsible for the plan will not be prepared. As part of the education process, explaining what is in place and how it works is imperative. In addition, as part of this process, informing and educating the next generation regarding the roles (see A World of Fiduciaries) they will be called upon to play should also be done.

AREAS OF EDUCATION

Education is perhaps the most important building block to create the next family leaders. Educating the next generation will provide them with the foundation they need to be successful in their individual affairs as well as good stewards of the family wealth and legacy. Education includes the range of roles one may be appointed to and what is required of each role. We have identified eight

“subject” areas where education is imperative.

Financial Management

Financial management education should span from the basics of budgeting, how credit works, and the nature of stocks and bonds to more complex topics like asset allocation, risk management, the time value of money, compounding, returns, and taxation. The more confidence the younger generation has that they have control over their money, rather than their money controlling them, the better prepared they will be to handle planning and stewardship topics.

Fiduciary Roles

Being a “fiduciary” can mean many different things. In the business context it could mean being a board member or an executive, in the investment world it could mean an investment advisor, and in the family context it can mean a number of different roles. Ultimately, a fiduciary has the responsibility to take a cautious approach to seek out the best interest of the owner and/or beneficiary.

Generally, in the family setting, fiduciary means taking on a formal, legally-defined role. Common roles important to wealthy families include personal representatives and executors, trustees, guardians, attorneys-in-fact and health care surrogates3. In addition, investment advisors, distribution advisors, and trust protectors are becoming increasingly common. Another fiduciary role common in wealthy families is the manager of family partnerships and LLCs.

ROLE

Executor/Personal Representative

Trustee

Guardian

Investment Advisor

Distribution Advisor

Trust Protector

Health Care Surrogate

Attorney-In-Fact

General Partners & Managing Members

HOW APPOINTED

Named in will

Named in trust agreement or will

Named in will or standalone document




Named in health care proxy

Named in power of attorney

Named in operating documents

RESPONSIBLITIES

Responsible for administering the estate of a deceased person.

Responsible for handling the administration, management, investment, distribution, and other aspects of a trust.

Empowered to make legal and related decisions for a minor and/or incapacitated person.

Responsible for handling the investments of a trust.

Responsible for handling the distribution decisions for a trust.

Responsible for appointing and removing other trust fiduciaries; can have other powers.

Empowered to receive medical information and provide direction and consent regarding medical decisions.

Empowered to make financial decisions regarding someone else’s assets.

Responsible for managing and administering the partnership or LLC.

A WORLD OF FIDUCIARIES


Investments

Covering more than just the basics of stocks and bonds, investment education should encompass the risk/return tradeoff, asset allocation, alternative investments, and the basics of account structures. Because of the scale of family wealth, alternative investments

frequently play a significant role in family portfolios. Understanding the nature of long/short funds, venture capital funds, and private equity reinforces the sense of having control over one’s assets instead of being at the mercy of the assets or one’s advisors.

TERM

Common Stock

Bond

Alternative Investments

Private Equity

Hedge Fund

TERM

Venture Capital

Stock Markets

Asset Allocation

Return

Interest

Dividend

EXPLANATION

Owning common stock gives the stockholder the right to share in the profits of the company and to vote on corporate policy. Common stockholders earn money through payment of dividends or capital appreciation of their shares. When an investor buys common stock, he/she is buying a piece of a company.

A bond is a debt security, sold by corporations, governments and municipalities to investors. The investor receives interest payments from the issuer until the bond matures. When an investor buys a bond, he/she is loaning money at a set interest rate for a specific length of time.

An alternative investment can be any asset that is not a conventional stock or bond. They are generally held by institutions and accredited, high-net-worth individuals due to their complex nature. Alternative investments include hedge funds, private equity, real estate, commodities, and derivatives contracts.

Private equity is composed of funds and investors that invest directly in private companies, or engage in the buyout of public companies. Private equity investors specialize in acquiring partial or complete ownership in companies, with the goal of improving the prospects and profits of the company. It is a less liquid form of investment, which may offer investors more control in the operational aspects of a company.

Hedge funds employ various investment strategies in an attempt to generate attractive absolute returns, often with low correlation to the stock market, for their investors. They are generally classified by the strategy they employ, e.g. equity long/short, merger arbitrage, relative value.

EXPLANATION

Venture Capital is a form of private equity, focused on investing in early stage companies. As early stage companies are more fragile, these investments can be riskier but can also yield attractive results when circumstances are favorable. Venture capital funding is a common source of financing for small companies who lack access to traditional capital markets.

There are many different stock markets in the US. In most circumstances, the main markets you will hear of are the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), and the NASDAQ. The markets are basically where people and companies trade securities.

Portfolio managers will strive to diversify portfolio allocations among asset classes in order to provide the highest return for a given amount of expected risk and seek opportunities in different types of markets including stocks, bonds, and other investments.

The amount earned on your investment from income and capital gains or losses.

Interest is the charge for borrowing money, typically expressed as an annual rate. An entity that issues $1,000 of bonds at an interest rate of 5% would be required to pay its investors $50 per year in interest.

A dividend is a distribution to stockholders of a portion of a company’s earnings. A company is not required to pay dividends, and payouts can change upon approval of shareholders and the board of directors.

INVESTMENTS “INTELLIGENCE”


TERM

Capital Gains or Losses

Risk

Time Horizon

Liquidity

Investment Policy Statement

EXPLANATION

Capital gains or losses represent the difference between the price at which you purchased an investment and the price at which you sold it.

Portfolio risk is typically stated in terms of statistical measures such as standard deviation, or the probability of remaining within a range of gains and losses during an average year. As these statistics are based on historical data, they may not represent future results. But they tend to serve as a reasonable basis for comparison among differing investment opportunities.

Most portfolios have an explicit time horizon that defines their purpose and may include planning for retirement, gifting assets to charity, or passing them to future generations.

Investments that can be sold at a fair price on short notice are deemed to be more liquid than those that cannot. A portfolio manager will design a more liquid portfolio for beneficiaries that have specific needs for periodic cash flows for periodic or planned expenses.

An Investment Policy Statement is a formal document, mutually agreed to by a portfolio manager and client that defines the key objectives and constraints for a specific portfolio.

Retirement

Although people are living and working longer and hence retiring later, it is never too early to start thinking about and planning for retirement. Employer pension plans, once the norm for the working person, have decreased significantly since the early 80s with the onus now put on the individual to fund his or her own retirement. In addition, Social Security, once a prominent source of retirement funds, continues to provide a decreasing percentage of a retiree’s cash flow needs and at best has a questionable sustainability in the future. Therefore, knowing the different tools and ways to plan for retirement is an important part of the education process.

THE POWER OF COMPOUNDINGThe earlier one begins to put money away for retirement the better. Just waiting a few years can have a dramatic affect on available funds. For example, let’s compare the balances in the retirement accounts of three individuals, all planning to retire at age 61, who began putting aside funds for retirement at age 21, 26, and 36 respectively.

21 YEAR OLD 26 YEAR OLD 36 YEAR OLD

$700,000

$1,500,000

$2,000,000

Projections assume $10,000 invested annually every year from inception through age 61 and an annual return of 7%. Amounts rounded.

INVESTMENTS “INTELLIGENCE” (CONT.)


TYPE OF PLAN

Defined Contribution Plan (e.g., 401(k)s, Roth 401(k)s, etc.)

Defined Benefit Plans (e.g., Pension Plans)

Deferred Compensation

TYPE OF PLAN

Individually Established Plans (e.g., IRAs, Roth IRAs, etc.)

Life Insurance and Annuities

Personal Savings/Investments

HOW IT WORKS

The most common retirement planning vehicles available, these plans are provided by employers for employees. Employees elect to contribute with pre-tax wages (traditional 401(k)) or after-tax wages (Roth 401(k)) to an investment account that then grows tax- deferred (traditional 401(k)) or tax-free (Roth 401(k)). Funds can only be withdrawn upon reaching a certain age, generally 59.5, and in the case of a traditional 401(k) must start to be withdrawn at age 70.5. Withdrawals from a traditional 401(k) are taxed as income but withdrawals from a Roth 401(k) are tax free. Generally most defined contribution plans have an employer match element where, in addition to the employee’s contributions, the employer will contribute some amount to the plan on behalf of the employee.

Once the standard, these types of plans are seldom available today. Defined Benefit Plans provide for the payment of certain amounts upon retirement dependent on the employee’s, earnings, tenure, and other factors. Payments from these plans are generally taxable to the recipient.

These corporate plans are still available at many larger employers. The plans generally allow certain employees to defer part of their current earned income to be received at a later date. The deferred income is not currently taxed and can grow tax-deferred in the plan until receipt. There are certain risks that come along with these plans including the deferred funds possibly being exposed to employer liabilities.

HOW IT WORKS

Self-established and self-funded defined contribution plans. An individual with earned income can establish a plan and contribute certain amounts to the plan annually. Much like defined contribution plans, the contributions are made pre-tax, grow tax-deferred and are taxed on withdrawal (traditional IRA) or contributions are made after-tax, grow tax-free and are distributed tax-free (Roth IRA). There is no employer match, contribution limits are generally low, and other restrictions apply. For self-employed individuals, there are a number of self-established plan options that will allow for larger contributions.

Life insurance and annuities can be used to segregate funds that can grow tax-deferred or tax free and can be drawn upon in the future for retirement (and non- retirement) needs.

One of the main sources of retirement funds is a person’s savings and investments.

WHO BENEFITS?

Employees whose employer has established a plan.

Employees whose employer has established a plan.

Generally only available to high- level employees (executives).

WHO BENEFITS?

Persons who do not have access to an employer plan but have earned income.

Available to everyone, appropriate for some.

Everyone.

THE RETIREMENT PUZZLE


Term

Whole Life

Variable Life

Universal Life

Variable Universal Life

TEMPORARY OR PERMANENT

Temporary (i.e., coverage only lasts for the stated term of the policy)

Permanent

`

Permanent

Permanent

Quasi-permanent

TYPE SUMMARY & GENERAL USE

Used for a period of time to protect against premature death. Often used as a cash flow and capital building replacement. Also commonly used by businesses to help fund buy-sell agreements.

Premiums and amount of death benefit in these polices generally stay constant through the life of the policy. Meant to fund a permanent need such as providing liquidity for estate tax purposes or to fulfill a desired bequest. Cash value build up is generally modest.

Similar to a whole life policy, however the ability to build up larger amounts of cash value is greater as the cash in the policy can be invested in stocks and bonds. There is also an increased risk that the policy cash value will decline, which may result in a reduction in the death benefit. Polices often used where there is a permanent insurance need and also a desire to have the potential to enhance investment returns.

Premiums and amount of death benefit in these policies can fluctuate. Policies often used where permanent insurance is needed but where some flexibility around amount of premiums and death benefit is desired. Cash value build up is modest. Generally more upside than in a whole life policy.

Combines the investment features of a variable policy with the premium and death benefit flexibility of a universal policy. Also has the investment risks of a variable policy. Policies are more often used to build up investments in a tax-efficient manner and death benefit is generally secondary.

THE DIZZYING WORLD OF LIFE INSURANCELife Insurance

Life insurance tends to be a very confusing topic for most people. The key to understanding life insurance and its uses is understanding several basic elements:

Often these elements, especially the purpose for and amount of coverage required, will change over time. Understanding these basics enables informed decision making.

Recognizinga need

Understanding different types of life

insurance policies

Determining how much is the right

amount of coverage

The taxation of life insurance


Protection Planning

Incredibly important, and often overlooked, protection planning refers to protecting one’s assets against potential liabilities and creditors. Understanding potential liability risks and how to protect oneself and one’s family is crucial to preserving wealth. Liabilities can arise from

PROTECTION TECHNIQUE4

Property and Casualty Insurance

Fiduciary and Professional Insurance

Entity Structuring

Spendthrift Trusts

Asset Protection Trusts

Prenups and Postnups5

WHAT DOES IT DO?

Insurance obtained to protect against potential damage to property and assets from events like car accidents, fires, floods, and other risks as well as from general activities, such as driving, that might give rise to liability.

Certain roles one assumes or tasks one performs might give rise to personal liability. Being a board member of a for-profit or not-for-profit, or being a trustee or performing professional services such as legal services can be the basis for personal liability. Insurance can be obtained to help cover legal fees to fight claims and pay settlement costs and judgements.

The ownership of certain types of assets like rental real estate, yachts, or aircraft, creates a potential liability risk. Owning such assets in an entity, such as a limited liability company, may help limit potential future liability exposure. In addition, performing services, such as consulting services through an entity structure might also provide some legal protection.

Trusts created by another person for one’s benefit are generally protected from creditors and other potential liabilities (such as divorce) if such a trust is a “spendthrift trust” and otherwise properly structured. Often when considering where to make a gift or bequest it is advisable to consider a spendthrift trust as the recipient to protect the assets from potential creditors of the beneficiary.

Like the spendthrift trust, an asset protection trust generally refers to a trust that one sets up for oneself. Although generally untested, properly structured asset protection trusts are thought to provide protection against liabilities and creditors. Generally these trusts are void as to pre-existing creditors and liabilities at the time the trust is established.

“Divorce liability” is unfortunately one of the most prevalent liabilities in the United States. To help plan around this liability, agreements between married persons, either entered into before or after marriage, might help protect the assets of the divorcing spouses.

DEFENDING THE CASTLE

many different areas including from the ownership of a rental property, a natural disaster, creditors, activities on a board, or divorce to name just a few. Periodic (at least annual) reviews of family activities, structures, assets, and insurance coverage is strongly recommended.


Taxes

The United States has one of the most complex and comprehensive tax systems in the world. A person might be subject to federal income tax, gift tax, estate tax, generation-skipping transfer tax, employment tax, excise tax, as well as other taxes. In addition, depending on the state laws that apply to an individual, there might be state level income tax, inheritance tax, and sales tax among others.

TYPE OF TAX

Income Taxes

Inheritance Taxes6

Employment Taxes

Investment- Related Taxes

Sales Taxes

Non-Resident Taxes

SUBJECTED TO

Individuals, trusts, estates, and entities

Individuals and estates

Individuals




BASIC RULES

A tax charged against income from wages, investments, and other sources. Depending on residency and source of income can be a federal and state tax.

A tax charged on gifts and bequests at death. Depending on residency and location of assets can be a federal and state tax.

A tax charged against the wages and/or earned income of an individual. Can be both a federal and state tax.

Various taxes that are charged against investment income and capital gains.

State-level tax charged upon the purchase of certain goods and services.

Taxes that are charged by a foreign state or country to a non-resident.

THE UNITED STATES OF TAXES

Furthermore, if there are trusts involved, the trusts themselves might be subject to various federal and state taxes.

It is imperative that every individual has a basic understanding of taxes. Taxes affect many of the decisions one makes, particularly related to residency, investments, estate planning, and retirement. Family leaders often have to take taxes into account when making decisions that affect the family.

Philanthropy

The word philanthropy has many different meanings. However, common to families with philanthropic activities, regardless whether these activities are minimal or extensive, philanthropy is the activity of giving: giving resources, giving time, giving assets.

PHILANTHROPIC ELEMENT

Giving Structures

Family Strategy

Taxation

Governance

Finance and Legal

Grant Making

TOPICS OF EDUCATION

Provide an understanding of the different ways to fund charitable giving including the use of direct gifts, donor advised funds, foundations, and other charitable vehicles.

Educating how the senior generation views the family’s charitable legacy and how the next generation fits into this including incorporating the next generation’s own thoughts and wishes.

Provide a basic understanding of the various income, estate/gift, and other tax ramifications and benefits of giving and how the type, amount, and structure of gift and recipient affects these tax elements. Basic training in governance and decision-making. From grant making to other decisions, educating the next generation how decisions are made.

Provide a basic understanding of the finances of funding and running a family charitable giving program. In addition, provide an understanding of some of the basic legal concepts such as compensation, expenses, self-dealing rules, etc.

Provide education and experience in the mechanics (e.g., reviewing requests, evaluating progress, etc.) and process of making grants.

A GIVING EDUCATION

Many families have developed a family giving structure often through a donor advised fund or a private foundation. Generally this has been both funded and largely directed by the senior generation. Crucial to creating the next generation of giving leaders is educating the next generation about the how, what, and why of philanthropy.


FIRST MORTGAGE

SECOND MORTGAGE

IRA 401(K)BENEFICIARYDESIGNATION

WILL

PRENUP

BENEFICIARYDESIGNATION

REVISEWILL

TRUSTPLANNING

529 PLAN

SAVING

PLANNING GOALS

MORTGAGES

INVESTING

COLLEGE SAVING

CHARITABLE GIVING

ESTATE PLANNING(INDIVIDUAL)

RETIREMENTSAVING

ESTATE PLANNING(FAMILY)

RETIREMENT SPENDING

A DAUNTING TASK, A NECESSARY STEP

As discussed above, there are many possible reasons why senior generation family leaders might not be communicating with and educating the next generation. However, in our opinion, if communication and education are ignored, they will become barriers

PLANNING TIMELINE

to success. The family that embarks upon and follows through on a plan to empower the next generation today will benefit tomorrow. Take the first step. We think you will find it less difficult than you might think and we know it will be beneficial for your entire family.

GRADUATECOLLEGE

FIRSTJOB

MARRIAGEFIRSTHOME

SECONDHOME

CHILDREN’S COLLEGE

RETIREMENTCHILDREN

Part of empowering and educating the next generation is helping them plan for themselves.


1 The Greatest Generation is commonly known as the generation that grew up during the Great Depression and subsequently

went on to fight in World War II.

2 Yo Man, Nobel prize winner and Chinese author.

3 Depending on the state, different names will be used to describe the person who is appointed a health care decision maker.

Common names include health care attorney in fact, health care appointee, health care surrogate, and health care representative.

4 Often many families will utilize a combination of techniques to help protect family assets.

5 In addition, in community property states, another agreement that is commonly used is a separate property agreement that keeps

property between married individuals separate.

6 Inheritance here is being used broadly to include gift taxes, estate taxes, and generation-skipping transfer taxes,

as well as inheritance taxes (generally only assessed in a handful of states).

M C M L L C . C O M

educating and informing the next generation · two common traits among families successful at...

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