High net-worth individuals and families have more to lose – and more to gain – from planning how assets will flow from one generation to the next.
Without careful planning, federal estate taxes can eat up as much 50 percent of an estate’s net worth. If a businesses or real estate is involved, they may need to be sold.
David Hokanson, a certified family wealth counselor with Prairie Village, Kan.-based Family Wealth Counselors LLC, has helped families pass wealth to the next generation for more than 30 years. Hokanson was the keynote speaker at the Small Business Times Wealth Management Strategies: “Misconceptions That Shackle CEOs” seminar on March 2. In advance of Hokanson’s Milwaukee appearance, SBT reporter Eric Decker, interviewed him about his wealth management techniques. The following are excerpts from that conversation.
SBT: Is it your experience that most business owners and top-level executives don’t have a plan in place to pass their wealth to their families or the charities of their choice?
Hokanson: “Most of them have been busy trying to grow their business and trying to grow their practices, and we just don’t have enough time to think about these other issues a lot of times.”
SBT: What are some of the consequences for not planning to transfer wealth to the next generation or charity before death?
Hokanson: “Take the extreme – accidents happen and without a plan in place, some of your worst nightmares take place. If you’ve got a closely held family business and you have non-active shareholders, one of the worst things you can have is one of the children that’s active in the family should be running it and should be in control of it, but you have a lot of non-active shareholders who inherit stock because there was never a plan in place. And what you have is a scenario for potential disaster because you have conflicting goals. If you’ve got non-active shareholders, they want cash. If you’ve got active shareholders, they want to reinvest in the business and grow it.”
SBT: How do you begin a dialog with a business owner about the potential consequences about not planning a wealth transfer? Do you lay out the nightmare scenario for them?
Hokanson: “The reality is, most of these people are brilliant. They’re just busy. And so, really, all you have to do is catch their ear and say, ‘Here are some of the things you ought to think about.’ It doesn’t take much for them to get excited about it, because they know intuitively they should be doing something. It’s sort of like basic financial planning. We all know we should be doing something about retirement, but there’s just a lot of other stuff going on.”
SBT: What are some of those misconceptions about wealth transfer planning?
Hokanson: “For example, if I said you knew that tomorrow you weren’t going to be around and I gave you two options – you can either send money to Washington, D.C., to support this wonderful country of ours or you could give those taxes to charity – which one would you pick? I think a lot of people would like to know that that’s an option, and they’d like to know how that option works.”
SBT: Tell me about the misconceptions about annual and lifetime maximum gifts – is there an annual or lifetime maximum amount you can give as a gift?
Hokanson: “The misconception is the maximum I can give my children or my grandchildren is $12,000 a year or the $1 million lifetime amount. And that’s not the correct number at all. There is no limit. What those numbers are is the amount I can give without paying the gift tax.
“Once I have gifted the $12,000, and let’s say I am a grandparent and my grandchildren are grown and I’d like to give them more, if I’m not saddled with this misconception, the real issue is do I want to subject my estate to estate taxes, which start at 50 percent at the lowest and can be higher than that. Do I want to pay 50 percent, or do I want to think about giving my kids something now that starts at a tax of 36 percent? Personally, if that’s my choice, I’d rather pay 36, especially if since now I get to hand them the check now that I’m alive, I get to see them enjoy it and I get to see them do something with it. There are lots of good families out there that if they weren’t saddled with that misconception, they’d do that.”
SBT: Tell me more about family foundations. When I hear that phrase, it makes me think of ultra-wealthy families. Is that not the case? What role can a family foundation play?
Hokanson: “I’m a big believer, and I’ve set up maybe 1,000 family foundations because I think everybody out there should have a family foundation. Just about everybody that you and I know makes a charitable gift every year – why not put it through a family foundation? The misconception is that they’re very expensive and they’re very cumbersome.
“It’s a fun way to give. One of the challenges you have as your kids grow up is how do I find a venue where we can have meaningful conversations? And I think a family foundation meeting is the perfect place. It’s just an excuse to talk about someone other than us, i.e. how do we help the community grow? How do we help this charity grow? How do we help make a difference? And I kind of think that’s our legacy to our children, is helping them understand that and maybe pass that legacy on.”
SBT: From a tax and wealth preservation standpoint, what role can a family foundation play? How can it help protect your current assets?
Hokanson: “If you’re an advisor and you’re asking your clients, ‘When you’re gone, would you and your wife like to give to charity?’ You would say sure, but then your wife would probably say, ‘Yeah, but you just told me you’re going to have to pay a lot of taxes to the government.’ So what you’re really asking is ‘Do I want to disinherit my children to give to charity?’ So what’s your answer now?
“What if I said to you, ‘Let’s make sure your kids get everything you want them to get, whatever you deem is the appropriate number.’ Once you’ve thought that, you ask the question, ‘Would you like to give your taxes away to charity?’ That’s the process you help families get through, what they want for the kids, how they want them to get it, when they want them to get it, and once I made sure they’re OK, I make a conscious decision to give my taxes away to charity.
“These are not the get-rich schemes. These have all been in the code since 1969, and the government encourages them because this releases them from having to worry about all those social programs. We’re taking the handle and you get to decide which social areas you want to specialize in. And that’s a great family discussion. That’s how you build family unity, is you talk about those things as a family ahead of time and you don’t just let it happen.”
SBT: What are some of the other big misconceptions about wealth management and financial planning for families?
Hokanson: “I work with people that have built net worth of $10 million or more. They’ve worked hard, they’ve strived to make it, but they’ve always been told by their advisors that they’re going to have to pay some estate taxes. And I think that’s improper. They don’t have to. They do have to make conscious decisions on how to avoid the estate taxes, but it can be done.”
“It takes a lot of work, a lot of planning, but the bottom line is if I do the planning, here’s the result. My kids get more, charity gets more and I have more financial security for the rest of my life. Those are pretty strong positives.”
SBT: What role can and should life insurance play in a wealth management plan for a high net-worth individual or family?
Hokanson: “Probably one of the misconceptions that people have is that ‘I’ve built all this wealth and I no longer need life insurance.’ What I would tell you is that not every plan, probably only 40 percent of the plans, need life insurance. I would say that if an insurance solution is appropriate, and it is 40 percent of the time, it is very, very appropriate. It can make a huge difference.
“One example is, if I have a family business and I’m going to give my family business to the only active family member that I have in the business. I want to treat all of my kids equally. Notice that I didn’t say fairly, I said equally. Some families do it differently. If my net worth is X and my business is 52 percent of X and I give that to one son, how do I treat the other four siblings equally? It’s not going to happen without (life) insurance. And I can buy that with discounted dollars, tax and estate tax free. If I can get that money to my children income and estate tax free and equalize the estate, that’s one appropriate example. And I only use that because I just had that example last week.
“And I will tell you another misconception sometimes brought about by well-intentioned people. They’ll say life insurance should be purchased to pay the estate tax. I will tell you I bought a policy for that 20-plus years ago and I put the life insurance in a trust. And that was good traditional planning. I still own that policy and trust. However, I will tell you that the purpose for that life insurance has shifted. It’s no longer to pay estate taxes. I’ve done planning to avoid the estate tax. So, if I bought a life insurance policy that was going to be in a trust in the name of my kids and they were going to use that money to pay the estate taxes, and I’ve done planning to avoid estate taxes, what will the children do with that money they got income and estate and tax free? They’ll probably use it themselves. Now, if I’m writing a check into the trust every year to give it to my kids and now they get to keep it income and estate tax free, how do you think I feel about writing that check? A lot better than if I were writing a check just to pay the estate tax.”
