Multigenerational tax strategies can be an advisor differentiator

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These days, clients — in particular, coveted millennial clients — want something more from their advisors than just consistent returns on investment.

Clients also want advisors to assist with family financial matters, according to industry studies. An Oppenheimer Funds and Camden Wealth study of ultrahigh-net-worth millennial clients shows 60% of respondents identified family goals as “very important.”

Advisors can provide such sought-after planning services by facilitating family meetings, and specifically introducing tax strategies that can help clients and their heirs.

“It can really differentiate you from the do-it-yourself firms. They can’t do it,” says Lisa Detanna, a senior vice president and managing director for Raymond James’ Global Wealth Group in Beverly Hills.

A Range of Complexities
Detanna and other veteran advisors have several productive ideas to offer clients seeking to prevent their family’s tax bill from becoming burdensome.

Those ideas include frontloading 529s; stretching IRAs; funding newly and poorly paid working family members’ Roth IRAs; gifting illiquid — and therefore discounted — assets; setting up defined pension plans at family companies; purchasing irrevocable life insurance trusts; and issuing low-interest loans to heirs.

Some of the tactics are relatively simple to execute — the stretch IRA or the irrevocable life insurance trust, for example.

“It can really differentiate you from the do-it-yourself firms. They can’t do it,” — Lisa Detanna, Raymond James’ Global Wealth Group

But other methods require tackling complexities and helping clients do the same. One such tricky tax-saving tactic — the gifting of discounted limited liability family company shares — might become even trickier, as the IRS in August announced its plan to significantly alter the rules that allow such discounting.

Such complications should make advisors wary of overstepping their expertise, Detanna warns.

Know What You Don’t Know
“You have to know what you know and what you don’t know,” Detanna says. Because she works for Raymond James, Detanna can tap accountants and lawyers who also work with the firm — an advantage she is thankful for.

But before checking with experts or even beginning to share intricate tax-saving strategies with clients, advisors need to secure their buy-in, Detanna and others say.

That requires a lot more handholding and a deeper understanding of clients’ lives than robo advisors could ever acquire, Detanna stresses.

Her well-heeled clients often need a surprising amount of reassurance about their own wealth outlasting them before they can even envision effective and legal tax-reduction strategies that will affect future generations.

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There can also be a significant resistance to the family transparency necessary to execute many of these strategies.

“It is a very difficult subject, because we were all taught, ‘don’t ask, don’t tell.’ Grandma is gonna give what she is going to give,” Detanna says.

Unlike a robo advisor, Detanna can ask enough questions to fully understand the logic behind clients’ hesitation, and help them work through any concerns.

Ultimately, clients have the final say in devising the particular planning they want. “I don’t get a vote,” Detanna says.

When $50 Million Isn’t Enough
Mike Geri concurs that it takes many clients time to warm up to the value of tax planning to benefit future generations.

“Nobody thinks that they have enough money, even with $50 million, to meet their lifetime income needs,” says Geri, a managing director for RBC Wealth Management’s Three Points Group in Seattle.

After convincing wealthy clients that they’ll have enough for themselves, Geri asks them to consider a question: “When is the money beyond that amount going to be spent?”

If the answer is that it will probably be spent in the next generation, Geri encourages clients to evaluate their portfolios’ likely returns by factoring in the long-term tax consequences.

“Nobody thinks that they have enough money, even with $50 million to meet their lifetime income needs,” — Mike Geri, RBC’s Wealth Management’s Three Points Group in Seattle.

In Washington State, Geri says, clients with wealth that exceeds $11 million must consider what amounts to a 52% blended inheritance tax imposed by the federal and state governments.

With his hypothetical example, if clients have an equities-based portfolio with $20 million and it achieves 10% in annual gains, by the time heirs inherit the assets, any gains shrink, post-estate tax, to 6% per year. And those calculations conservatively omit inflation adjustments.

Given such considerations, lower but estate-tax–protected returns for assets become more palatable for any portion of clients’ wealth expected to go to heirs, Geri says.

“Think Completely Differently”
Before they take steps to make tax-saving plans, clients must understand and subscribe to the strategy of considering estate-tax consequences when choosing investments, Geri says.

Some clients simply don’t care about the tax bite for their heirs. Or they don’t want to add any additional complexity to their investments. Many tax-saving strategies require initial and annual evaluations by lawyers and accountants. These are expensive and time-consuming events.

For clients who want to achieve tax savings for their heirs but prefer to avoid complexity, irrevocable life insurance trusts rank as one of the simplest possible options, Geri says. The trust owns insurance policies, so those assets aren’t included as part of the estate, which reduces the prospective inheritance.

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Clients may buy the irrevocable life insurance trust and reduce their other assets so they fall below the $10.9 million federal law, thereby allowing a couple to pass on to heirs without triggering estate taxes.

Some clients, particularly entrepreneurial ones who own family-operated companies, have a bit more appetite for complexity. Historically, such clients have often opted to reduce their heirs’ estate taxes by giving them discounted limited liability shares.

Proposed Changes
But the IRS’s proposed changes in regulations would eliminate or substantially limit the discounts for such transfers. Even before the IRS began considering the changes, the strategy required a level of intricacy beyond many clients’ tolerance levels, says Michael Repak.

“Discounting illiquid assets is a very effective strategy. But you have to do it with a very good attorney, because the IRS takes a very challenging view,” Repak, a vice president and senior estate planner at Janney Montgomery Scott’s wealth management department in Philadelphia, says.

Many lawyers propose taking an aggressive discount, as they always expect the IRS to object. Starting out with an aggressive strategy means a settlement in the middle may lead to a significant enough discount for the client’s purposes, Repak says.

The tactic makes sense when the assets are sizable enough to address the expense of the lawyering, he adds. “This is a strategy that is geared toward the ultra-rich.”

Repak agrees that before clients consider such complexities, advisors must help them reckon with giving up control over assets to help shrink their heirs’ tax bill.

“It is difficult to persuade the older generation to engage in multigenerational tax planning,” he says. “It is going to involve some loss of control. People are very reluctant. People are concerned with giving away something, and that it may mean they are making an irrevocable decision.”

He starts by assuring wealthy clients that their future income needs are covered. He then shows them what the losses due to inheritance taxes will be if they do nothing. This often inspires clients to take action, he says.

Disinheriting the Government
“Most people have an aversion to taxes,” Repak says. “Every once in a while, someone comes along and says, ‘I don’t care what goes to taxes.’ But most want to disinherit the government.”

Because many clients remain unaware of the federal estate tax bite, “it can be a real eye-opener” when he calculates the cost of a do-nothing scenario, Repak says.

“An estate tax is basically a voluntary tax, and you volunteer for it by ignoring,” Repak tells clients.

Clients’ resistance to focusing on what their heirs will pay in estate taxes shouldn’t stop advisors from broaching the subject, says Chad Smith, a wealth management strategist in national sales for HD Vest Financial Services in Irving, Texas.

“These are the most sensitive conversations that any financial advisor can engage in,” Smith says. “Clients are resistant until they understand where they are in terms of outliving their money,” he says.

“What we are doing more and more with affluent clients [is] leaving the money in trusts and allowing professional trustees to work with the financial advisor and manage the assets,” Smith says. “By having a corporate trustee, it brings an impartial third party into the family fights, and it can force tax discipline on the heirs.”

Detanna also helps clients set up trusts to limit tax exposure and pace heirs’ spending. “We design them so they don’t get all the money at once,” she says. “We tell clients, ‘It’s our job to help teach your family with you.’”

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Tax planning Estate planning Roth IRAs IRS Raymond James Financial RBC RBC Wealth Management Janney