Diversification by Speculation

by Daniel Cross, ChFC

There is a naughty word whispered occasionally among investors. It has been heard in homes, jobs, and golf courses across America and equally met with fear and derision. A cold shiver runs down the spine of many an investor that hears it spoken aloud. The word is: speculation.

It has been demonized in the mainstream media, but speculation belongs in every investor’s portfolio whether you’re an aggressive day trader, decades away from retirement or a conservative, income-based retiree. The mere mention of speculating in a retiree’s portfolio is enough to send many financial planners sputtering in outrage and disbelief, but a fundamental understanding of what a truly diversified portfolio is and what it’s supposed to do should shed some light on this shadowy subject.

To understand speculation’s place in a portfolio, one must first define what diversification really means. To many investors, it means to have a mixture of equities and fixed income products to mitigate risk. This idea is an oversimplification that doesn’t take into account the various characteristics of a single investment such as beta, market cap, industry, and many other factors. The ideal portfolio would have a mixture of all of these from a basic savings account to an emerging markets fund. The point is that no single investment should carry a disproportioned weight that can swing a portfolio’s profits or losses solely by its performance.

While there is a negative stigma associated with the more speculative investments, most people overlook the possible defensive capabilities this can have. For the aggressive investor, speculating in atypical investments such as art, hedge funds, limited partnerships, and real estate can provide significant downside protection as many such investments are not directly related to stock market performance. Market fluctuations and even recessions can be effectively hedged using this strategy.

For the conservative investor, the benefits of speculation are not so readily apparent. The primary risk associated with these portfolios is underperformance. Fixed income based portfolios often struggle to keep up with inflation, especially during long bull market periods where it can rise dramatically like it did in the eighties. Keeping a portion of your portfolio in equities, emerging markets funds, and high-income corporate bonds (also known as junk bonds) can help you keep up with inflation much better.

Speculation also serves an ancillary role by keeping investors interested in their own accounts. Putting money into investments you believe in such as green energy, or pharmaceuticals will keep your attention on your money much better than just sticking it into a couple of random mutual funds and forgetting about it. Noted CNBC personality Jim Cramer is an advocate of this. He speaks of speculation as a way of “keeping you in the game” to help investors stay focused on their goals and monitor their overall portfolios and thus avoid the nasty surprises that afflict the unwary.

Used wisely, speculation serves an important purpose in any investment portfolio. By obeying the rules of diversification, you can use it to balance your investments and keeps you on the road to your ultimate goals. Keep all this in mind, and the next time you hear someone mention speculators, you can proudly say you’re one of them.

One of President Ronald Reagan’s favorite expressions, which he often used in his negotiations with the old Soviet Union, was “Trust—But Verify.” Today, that expression may very well need to be turned on its head. Since World War II, general levels of trust—in each other, in business, and in government institutions—have steadily declined. Today, trust has reached a low ebb due to the near-collapse of the banking system, the self-interested behavior on the part of some corporate executives, and a host of other scandals such as the forced resignations of the governors of two major states.
A recent survey, the Edelman Trust Barometer, found that only 38% of Americans trust corporations to “do the right thing,” down from 58% last year. Lack of trust has in fact become pervasive. It used to be that you could trust personal recommendations from friends, but the Bernie Madoff Ponzi scheme, which was founded on recommendations from trusted friends and advisors, has put even that type of referral in doubt. The assurance of a friend who says a broker, lawyer, or doctor is outstanding may no longer be enough in the post-Madoff world. On a different level, a recent Wall Street Journal article about bank overdraft fees (which average $26/item) quoted one customer as saying, “I don’t trust my bank to resist the temptation to rip me off.”
Despite its vast transparency, the Internet presents its own trust-related issues. The New York Times, for example, recently highlighted a well-known health web site that asks visitors to fill out a personal health survey. Unknown to the participants, however, their personal information is then shared with pharmaceutical companies, who target them with tailored marketing pitches for drugs.
Finally, our ability to trust has also been undermined by puffery—by the equivalent of grade inflation in public life. Everyone is “the world’s leading authority,” a best selling author, or the inventor of a new product “based on a Nobel prize winner’s theories”—as touted by one recent TV advertisement.
Nothing is as it seems—or so it seems. The problem is that, as the 4th century monk and religious philosopher St. Augustine wrote in his essay On Lying, “When regard for the truth is even slightly weakened, all things remain in doubt.”
So how do you rebuild and strengthen trust in your professional relationships with colleagues, clients, and other constituencies? And as individuals, how can we know when to trust? Let’s look at these two separate but related issues that have been brought into relief by the calamitous events of the last 18 months.
The Heart of Trust
What is trust based on? Author Robert Shaw proposes that trust is “A belief that those on whom we depend will meet our expectations of them.” There are several core ingredients of trust:
1. Integrity: Is the person honest, reliable, and consistent? Can they discern between right and wrong? Is their behavior “integral” and consistently aligned with a set of core values and beliefs?
2. Competence: Is the other party competent to do the job at hand? I might trust my family doctor to treat the flu, for example, but certainly not to operate on my knee. In the business world, competence and credibility are important elements of our willingness to trust.
3. Agenda Orientation: Is the person focused on my agenda or on his agenda? Will they act consistently in my interests or in their own interests?
One of the CEOs I interviewed for my new book, All for One, expressed this to me in slightly different words. He said, “I wish all of my advisors were independently wealthy. Then, I would know that they would be objective, put my interests first, and always tell me what they honestly thought.
What enables us to judge integrity, competence, and agenda orientation is transparency. “What you see is what you get” summarizes this simple idea. When things are hidden (like bank overdraft fees that are only explained in too-small-to-read print), or only partially revealed (such as the intelligence about weapons of mass destruction before the US invasion of Iraq), it becomes difficult to trust. When vested interests and conflicts of interest are not properly disclosed—for example when a pharmaceutical company has paid a doctor for her research on the effectiveness of their drug—trust is undermined.
Increasing Trust in Your Relationships
To build trust in today’s environment, you have to exemplify behaviors that reinforce the foundations of trust. For example, you can:
· Do things that are clearly in the other person’s interest and not yours. You might turn down a piece of business with a customer, for example, because you are not the absolute best person for the job.
· Demonstrate your competence not through smooth proclamations (“trust us!”) but rather multiple testimonials from past clients and customers and specific examples of your successes. I call this showing rather than telling.
· Strengthen trust—or rebuild it if it has been damaged—through small, specific, confidence-building measures. Say you’re going to do something next week, do it, and then move on to the next step.
· Be available and present for your clients even when there aren’t a lot of fees coming in. Everyone talks about becoming a “trusted advisor”—real ones are not just mercenaries, they are helpful to others through thick and thin.
· Be extraordinarily transparent in your business relationships. Create a collaborative process to develop a proposal rather than writing it at your office and then “pitching” the client. Invite clients to see your operations and the processes your use to develop and deliver your solutions. Use collaboration technology and Web 2.0 platforms to create links with your clients and business partners and promote idea exchanges (this is what IBM does through its “Innovation Jams” which can involve over 100,000 employees, customers, and other partners).
Verifying Whom You Can Trust
Building trust in a low-trust environment is one challenge; verifying whom you can trust is also important. Because of hidden conflicts of interest, a lack of transparency, and the heightened risks of trusting in areas such as financial management, verification has taken on a heightened importance. “Trusting your gut” about someone is no longer the litmus test—and in any event, your gut can often be wrong because of the way some people (like sociopaths) can compartmentalize their personalities and appear credible.
Using the elements of trust described earlier, you need to ask a lot of hard questions before throwing your hat in the ring with someone. For example, you need to:
1. Verify Integrity. Do they have an unblemished track record of honesty and ethical behavior? These things can be verified using everything from multiple references (not one) to criminal background checks. Are their any inconsistencies in the information presented by this person and in their behavior? Even small things can be a tip-off—for example, an excellent job candidate once told me he had an MBA from a top Business School. However, it turned out it was an executive MBA, which was a very different kettle of fish from the school’s highly competitive two-year program (the executive MBA was far less competitive and took a fraction of the time to complete). Not a huge red flag, but a red flag nonetheless. In the case of Bernie Madoff, some investors turned down the opportunity to invest in his fund when very basic research showed that his trading system couldn’t possibly function the way he said it did.
2. Verify Competence. Can you objectively verify if the person or their company is really as good as they say they are? You could gain this insight by have in-depth discussions with at least several existing clients or customers. What is the quality of their business base? What level are they actually working at in the companies they list as references? People throw a lot of names around, but it’s one thing to work with a Senior Vice President at GE, and quite another to have a mid-level training manager at that company as your top client.
3. Verify their Agenda Orientation. Whose interests they are focused on? This is a judgment call you have to make based on having several in-depth conversations with the person. Are they sincerely focused on understanding your issues, or do they try to “close the sale” as fast as possible? Is their approach generic, or tailored based on having invested time to get to know you? Are they “pitching you” or trying to educate you about what they do and how they do it? You can also understand this by asking other clients or business associates about their relationship after the sale. Was the same level of enthusiasm present a year later? Did this person come through in a crisis or during a rough patch in the relationship?
Finally, how transparent are they? Is this person free and open with information about themselves and their organization? Do they advertise anonymous testimonials, or are their testimonials from real people with names and titles? Are they willing to give you three or four references? If you sense a cloak of secrecy, or an unwillingness to open up, then caveat emptor.
Another CEO that I interviewed for my research told me, “When someone says ‘trust me’ I usually reach for my wallet to make sure it is still there.” When it comes to trust, watch their feet, not their mouths. Look for inconsistencies, and carefully verify.

**************
Andrew Sobel is a leading authority on client relationships and the skills and strategies required to earn enduring client loyalty. Andrew is the author of the newly published All for One: 10 Strategies for Building Trusted Client Partnerships (John Wiley & Sons) as well as the business bestsellers Clients for Life and Making Rain. He has also written over 75 articles on building long-term relationships, and contributed chapters to four books on leadership, strategy, and marketing. He spent 15 years at Gemini Consulting, where he was a Senior Vice President and Country Head, and for 13 years he has headed his own consulting firm, Andrew Sobel Advisors. He can be reached at www.andrewsobel.com.

Favorable Interest Rates

Interest rates are at historic lows and all indications are that they will be this way for a while. These low rates make some loan-based estate planning practices extremely advantageous.

Sales to Intentionally Defective Irrevocable Trusts (IDITs)

When assets are sold to an IDIT in exchange for an installment note, the interest rate on the note is based upon the appropriate AFR (Applicable Federal Rate) in effect at the time the note is created. The lower the AFR used, the greater the likelihood that rate of return on the assets owned by the IDIT will outperform the interest rate charged. In other words, if assets sold to the IDIT appreciate at a rate greater than the interest rate charged, there will be more assets left in the IDIT after the note is repaid.

Intra-Family Loan Arrangements

When funds are loaned by one family member to another, the adequacy of the interest rate charged on the loan is determined by the appropriate AFR. The lower the AFR used, the greater the chance that loaned money (assuming it is invested) will outperform the interest rate on the loan.

Life Insurance Loan Arrangements

When money is loaned by an insured to an Irrevocable Life Insurance Trust (ILIT) to enable the ILIT to pay life insurance premiums, the adequacy of the interest rate charged is again determined by the appropriate AFR. The lower the AFR used, the lower the gift tax cost of loaning money to an ILIT to make life insurance premiums payments (assuming the interest is imputed or gifted directly to the ILIT).

The favorable interest rate environment also benefits the Internal Revenue Code Section 7520 rate (7520 Rate) which is used in certain estate freeze techniques (i.e. freezing the value of your estate). The 7520 Rate is 2.4% for May, 2009, which is considerably less than the average 7520 Rate of 6.4% over the past 18 year period starting January, 1991.

A low 7520 Rate also makes estate tax freeze techniques, such as grantor retained annuity trusts (GRATs) and charitable lead annuity and unitrusts (CLATs & CLUTs) more attractive. Just like the techniques discussed above, the lower the 7520 Rate, the easier it is for a GRAT, CLAT or CLUT to outperform the expected return and therefore pass more money to younger family members estate and gift tax free.

Depressed Asset Values

In a recent post to my estate planning blog, Altman Speaks, I discussed the importance of reviewing your estate plan in light of declining asset values. Generally speaking, no one likes to see their assets lose value. However, the upside to such an occurrence is that gifting assets of lesser value lowers the amount of taxes that will be paid on the gift. In the future, the value of the gift may increase (outside of the client’s estate) and benefit the heirs.

Potential Legislation Eliminating Valuation Discounts

If planning is done properly, current law generally permits as much as a 35% to 50% discount when clients transfer certain types of assets. These discounts are generally applicable to transfers of interests in Family Limited Partnerships (FLPs), Limited Liability Companies (LLCs), etc., due to the lack of control and/or lack of marketability.

There is a looming threat to the ability to take sizable valuation discounts. House bill H.R. 436, introduced in early 2009 by Congressman Earl Pomeroy (D-ND), would eliminate the minority discount for transfers to family members, when family members, as a group, control the entity.

This bill also eliminates discounts for transfers of entities that hold non-business assets, such as bonds, stocks or cash.

Assuming H.R. 436 (or similar legislation) is enacted, the loss of the ability to take a discount for lack of control or lack of marketability will, in most cases, lead to higher valuation of assets, and thus higher estate and gift tax consequences. Clients who do not want to risk losing the benefit of higher valuation discounts might consider transferring their FLP interests, LLC interests, etc. prior to the potential enactment of any legislation.

The Triple Opportunity

In combination, these three occurrences (lower interest rates, depressed asset values and possibly legislation limiting valuation discounts) can create great opportunities for wealthy individuals to make the most of estate planning techniques and maximize the potential of gifts.

Possibilities include:

· Contribute depressed assets to an FLP;

· Gift an interest in the FLP to a family member or trust for a family member; and

· Give the FLP interest to a long-term GRAT or sell the FLP interest in an IDIT

Bottom Line:

The opportunity for clients to take advantage of this “estate planning triple witching hour” may be short-lived.

· There is no telling how long this favorable interest rate environment will last.

· Asset values hopefully will not remain depressed at their current level for too long, as a market upturn could be just around the corner.

· Legislation limiting valuation discounts may be passed before the end of 2009, though no one knows exactly what Congress will do.

· The “estate planning triple witching hour” is a reason to act now to transfer assets and wealth to younger family members.

Gary Altman, Esq. is founder of the DC Metro-area estate planning law firm, Altman & Associates, and the former President of the Financial Planning Association of the National Capital Area. He has been honored as a “Top 100 Attorney” in the country by Worth Magazine and has been recognized by Washingtonian Magazine as among the DC region’s “Best Estate Planners”. He can be reached on 301-468-3220 or via email at gary@altmanassociates.net. To learn more, visit www.altmanassociates.net.

face with his hands, the money still held tightly.
His crying continues until he finally says, “I don’t know what this is about. I don’t even know why I’m crying.”
At first I’m silent, but right there with him. I want to give him the space to see what comes to him.
Eventually I say back to him what he has said: “I want you. I need you. I can’t get enough of you. I’m starving for you. I’m desperate for you. I’ll never have enough of you. Never. There’s no way out.” I ask him other than money, who else could he say that to?
“My mother,” he replies. “I never had enough of her. Even if I begged. Even if I worked hard. Even if I was a good boy. Even if I did everything I could to make her happy. I learned very early that it was no use trying. And then I became even more desperate.”
“Do you see what you’re uncovering here?” I ask John.
“Not really,” he replies.
“You’re uncovering and we’re discovering that you have transferred your feelings toward mother – who was your first source of your resources – onto money, one of your resources in the world today. You have transferred your thoughts, feelings, perceptions, experiences, decisions, behavior, fantasies, body responses, and more from mom onto money.”
“So I’m raging like a little boy when I can’t have my mommy?” he asks with a glint of understanding in his eye.
“Exactly,” I respond. “Good for you, John. Want to take it a step further?”
“I don’t know how, Judith.”
“I’ll help. What are you feeling beneath the rage, John?”
“I’m terrified I won’t have enough. Terrified. Terrified.”
“And what do you do when you’re terrified, John, other than rage?”
“I want more and more and more, Judith, and manipulate to get it and take it. I grab and hoard.”
“You’re getting the hang of this, John. How are you feeling about what you’re doing?”
“This is amazing, Judith. How did we get here?”
“We followed you, John. The clues that came from within you. Shall we go even further?”
“I don’t know if I can? Will you show me?”
“Of course I will, John. Next step . . . What is the effect on you of your raging?”
“Uh. I feel out of control and scared. I scare people around me. People don’t want to get close to me. I feel like I’m a monster. And that scares me.”
“Wonderful, John. It takes you right back to feeling scared. And what is the effect on those around you – you’ve just said it – I want to be sure it’s clear.”
“What did I say, Judith? That I scare them and they don’t want to get close to me?”
“Yes, John. In addition to that, may I share what I see with you?”
“Yes, please, don’t hold back from me now, Judith.”
“Your raging scares other people, and probably triggers fear in them from when they were children. That’s why they cringe and hide and withdraw from you instead of telling you to stop it.”
“I seeeee. So here we are in an international corporation and we’re in these big bodies but we’re children inside – all of us?”
“Right! John. That’s the heart of it. So if they do their jobs like children, without even realizing it, they impact all the customers you serve all over the world. And when those customers are affected, the child in each of them gets scared and angry and reacts in ways that aren’t grown up. And that affects the next people and so on. You see, John, the effect of your childhood deprivation – the feelings you’ve buried inside you, the childhood decisions you made about never having enough, the actions you’ve taken and will take as a result – acts like a line of dominoes causing everything to tumble into a regression.”
“That’s mind-blowing, Judith. Why don’t we all know that? Why aren’t we taught that?”
“A story for another time, John. In essence, people are afraid of their memories and their feelings, and because of the fear, they try to keep it all buried. But as with you, John, when we try to keep it buried, it somehow explodes out into the world and affects everyone.
“I’ve wondered a lot, John, if the recession we’re in is really the consequence of many, many ‘lines of dominoes tumbling into a regression – a recession regression.’ I know that’s an unusual way to put it, but I’m serious.”
“I can barely understand what you’re saying, Judith. I’m filled with all I’ve learned with you today, both in my head and my feelings. I have to go think about it. Can I come back and talk with you again, when I’m ready?”
“Of course, John. Just give me a call any time.”

And as John stands at the door on his way out, I add, “By the way, John, you did great work today. And just like your feelings, decisions, and behaviors have an impact on the world, so also does the work you do to heal yourself.”
John smiles, waves goodbye, and walks to his car with his step a bit lighter than it was on the way in.

*******

Imagine: Each one of us has our own version of young relationship with money needing to be healed. Each one of us affects our world with the current relationship we have with money. And each one of us can help heal our world by doing our own inner work with our relationship with money. Imagine the effect on you. Imagine the effect on your family, friends, business associates. Imagine the effect on our nation’s economy. Imagine the effect on our world!

********

*This is not something to be done with people if you are not a healing professional who has been trained to work with someone’s psyche. You don’t know what will be opened up for the person. It can be dangerous if you aren’t trained to help them.

© 2008, Judith Barr

Judith Barr has been a depth psychotherapist in private practice since 1975, now practices in Brookfield, CT, and has earned an M.S. in Counseling and licensure as a Mental Health Counselor in Florida, New York, and Connecticut. She is an affiliate member of NAPFA (The National Association of Personal Financial Advisors), and has written for the NAPFA professional journal. In addition to sessions, consultations, and workshops, Judith informs, inspires, and invites people into their own awareness and healing through her book, Power Abused, Power Healed , her speaking engagements, media interviews, and many articles in print online and off. She can be contacted at judithbarr@powerabusedpowerhealed.com.

by Richard Kohan
Partner, Private Company Services/Personal Financial Services

The use of trusts offers asset protection for children as well as many other ways to reduce taxes while providing for and protecting your family members or others and, at the same time, allowing you to set initial parameters regarding the management of those assets.

There are several types of trusts. For effective gift planning purposes in the current low value/low interest environment, we will focus here on two types of irrevocable trusts—grantor trusts and non-grantor trusts. This can be confusing, since both are funded by a grantor (the person establishing the trust) and both are irrevocable, meaning the terms cannot be changed and any assets held by the trust should be excluded from the estate of the person funding the trust (assuming the terms are drafted correctly). Both are subject to gift tax upon funding (although the planning techniques discussed below are designed to reduce or eliminate actual gift tax). The difference is that a grantor trust is set up so that the person funding the trust is responsible for income taxes on the earnings of the trust (a benefit for wealth transfer planning) and a non-grantor trust is responsible for income taxes on its earnings.

Sophisticated versions of these trusts can generate impressive wealth tax savings, particularly when values and interest rates are low. Some of these include:

Grantor retained annuity trust (GRAT)s. With a GRAT, the grantor transfers highly appreciating property into a trust while retaining an annuity stream for a stated period of years. At the expiration of the term, the property remaining in the trust is transferred to the beneficiaries. Because the grantor retains an annuity stream GRATs particularly appeal to people who are cautious about giving away wealth now.

The transfer of assets to the GRAT creates a taxable gift equal to the fair market value of the assets less the actuarially determined present value of the retained annuity stream. To the extent that the amount actually transferred as the remainder interest exceeds the value calculated for gift tax purposes, the excess is transferred gift tax-free. At the end of the GRAT term, the remainder interest that passes to heirs is completely out of the grantor’s estate. Because the present value of the remainder interest is calculated based on the interest rate at the time the trust is established, GRATs can be especially effective during periods of low interest rates.

Intentionally defective irrevocable trust (IDIT)s. Because an IDIT is considered a grantor trust for income tax purposes, the grantor pays the tax on income within the IDIT, increasing the after-tax trust value to the ultimate beneficiaries (as with a GRAT). However, an IDIT is structured so that its assets will not be included in the grantors estate for federal estate tax purposes. This split feature gives rise to various planning opportunities, such as a sale to an IDIT, which are particularly attractive when values and interest rates are low.

With a sale to an IDIT, the grantor makes a cash gift to the trust and also sells assets (e.g., closely-held stock) at fair market value to the trust in return for a promissory note bearing interest at the Applicable Federal Rate. (A cash gift to a new trust can be avoided if the family structure already includes a grantor trust with assets that can support the required promissory note.) As with a GRAT, appreciation (and cash flow) of the property sold, in excess of the interest rate charged on the note (or the GRAT Internal Revenue Code section 7520 rate), passes to heirs free of transfer tax. The grantor does not recognize gain or loss in connection with the sale of property to the trust in exchange for a note (or funding of GRAT). The grantor is not taxed on the interest the grantor receives on the note (or the GRAT annuity payments). The grantor indirectly retains an element of cash flow from assets sold to the trust. And, the grantor’s payment of the trust’s income tax liability is not considered to be an additional gift to the trust beneficiaries.

Dynasty trust. These are irrevocable trusts designed to pass assets through multiple generations at a reduced transfer tax cost. They have a perpetual existence and assets owned by the trust should not be includible in anyone’s estate until the trust is terminated. Grantor trust rules allow the settlor to pay the income taxes on behalf of the trust during his/her life, which further benefits future generations by allowing trust assets to grow tax-free. Further, dynasty trusts may provide creditor protection and may not be subject to marital claims. Kohan points out that an IDIT is a great trust to set up as a dynasty trust.

Want to know more about current wealth transfer opportunities?
Please contact:

Richard Kohan
Partner, Private Company Services/Personal Financial Services
617-530-7461
richard.kohan@us.pwc.com

Or visit www.pwc.com/pcs to locate the PricewaterhouseCoopers contact nearest you.

By Richard Kohan, national partner-in-charge of PricewaterhouseCoopers’ Private Company Services High Net Worth Individual practice

Although every day lately seems to bring yet another morsel of negative economic news, wealth planning is one area in which you can benefit from the economic downturn. Today’s depressed values and low interest rates provide significant opportunities for private business owners to reduce gift and estate taxes by formulating or rethinking gifting strategies. In an otherwise difficult economic environment, this is one opportunity worth exploring.

The primary purpose of estate planning is to be sure that you, not the state, direct how your assets are distributed. Estate planning allows you to provide for family security, business succession, the liquidity of your assets and the capable management of those assets. Another—but secondary—goal of estate planning is to eliminate or reduce federal and state income and transfer taxes. The real tax savings for high net worth individuals comes from lifetime giving, by giving away assets before they appreciate further. Thus, gift planning is the key to optimal wealth transfer planning. Done properly, wealth transfer planning ensures that assets pass to family, charities and other intended beneficiaries at the lowest transfer tax cost possible. Overlooked, it can leave an inheritance largely lost to taxation and legal fees.

Because privately-held companies are valued differently than public ones, different transfer planning opportunities exist. Various valuation discounts may be available, as well as unique treatment of the value of the business upon the death of the owner. There are also unique liquidity issues that arise when a significant portion of the total value of an estate is considered an illiquid asset.

Consider your own lifetime needs, as well as your giving philosophy
An appropriate wealth transfer plan for private company owners blends personal, financial and tax considerations into a comprehensive family wealth transfer plan and business succession plan that preserves a family’s wealth for the individual and his or heir heirs. An effective plan will meet your objectives, whether those objectives are to increase the benefits of ownership and assets, distribute assets to family members or charities, appoint capable estate managers as executors and trustees, reducing taxes, probate and administrative costs, and/or ensure the estate’s liquidity and stability.

Before taking advantage of today’s opportunities, private company owners should take certain essential preliminary steps. The first step is to assess your own personal lifetime needs. Before giving away assets, you need to set aside enough income and assets to meet your expected needs over your life expectancy. Then add a meaningful cushion to that figure. Given all the uncertainties in today’s economic environment, it’s not clear how long or deep the current slump will be. Moreover, there are longer-term concerns about housing and job security, not to mention issues such as the effect of energy policy. Thus, uncertainty needs to take a primary role in planning. What if there is another market collapse in the future? Consider also that an individual’s future medical needs are highly unpredictable—what if health care benefits are lost or there is a catastrophic illness?

Once you are comfortable that your own lifetime needs have been met, excess assets can be considered fertile ground for transfer planning. There may be good tax reasons to gift assets. But don’t let taxes drive your wealth transfer plan. First, consider your life philosophy and family system. How much control over assets do you want to retain? How much flexibility? Do you want to define specific terms? Will the trustee have a high or low level of flexibility?

Also, do you want creditor—and “predator”—protection for designated beneficiaries? Particularly if you will be giving away significant wealth, you will want to consider, for example, the consequences of a gift to a child or other beneficiary who may face a bad marriage, has money management or other difficulties, or who might be talked into a bad investment idea.

You will also want to consider your charitable giving philosophy and desires. “For example, what is your desired balance between gifts to children and charities? Also, remember that if you give money away now, you have lost the ability to drive charitable giving from that asset. While you control assets, you direct how your family uses or enjoy them. If you give assets away during your life to a specific charity, the asset is gone and in the charity’s control. This is not necessarily a bad thing. The real question may be whether you want to make direct gifts to charity year by year, or if you would be better off setting up a private foundation or a donor-advised fund that would dole out money to charity over time, allowing children or other family members to participate in timing and distribution decisions.

Part two of this series discusses the types of trusts that may be used in the current economy as part of an effective wealth transfer plan.

Want to know more about current wealth transfer opportunities?
Please contact:

Richard Kohan
Partner, Private Company Services/Personal Financial Services
617-530-7461
richard.kohan@us.pwc.com

Or visit www.pwc.com/pcs to locate the PricewaterhouseCoopers contact nearest you.

The folks in Kalamazoo, Michigan have it right … the key to an economically viable community and society can be found in education. Struggling with rust belt blight they came up with a plan that is innovative in the annals of redevelopment … a free college education for graduates of their public school system.

These smart, and generous, civic leaders of Kalamazoo put their heads together, realizing that there was a link between jobs and education, and began working with the Superintendent of Schools, Janice Brown. Together, they came up with the Kalamazoo Promise.

The Promise, as Ms. Brown announced to Kalamazoo parents and students in November, states: “All students who graduate from Kalamazoo Public Schools, and are residing in the district, and have been students there for four years or more will be given funding for college tuition and mandatory fees. The amount of available dollars depends on years of residency and the number of grades attended in KPS, up to 100% of tuition and mandatory fees. The funds will be available to use at any public university or community college in the State of Michigan
A recent article in the Wall Street Journal by Neal Boudette noted that the impact on Kalamazoo was quick in coming. Developers who struggled to sell homes suddenly found a demand for their new homes. Land that went begging is being snapped up by builders. People are moving into the community from other parts of the country and finding more house for less money … and an unusual opportunity for their children.

The jury is still out on how this will spur growth and economic development. But John Austin, a nonresident fellow at the Brookings Institution is quoted by Boudette: “The places that produce and attract talented people are going to be the places that participate in today’s economy. Your economic future is linked to how many people get to post-secondary higher education and how many you can keep in the community.”

The problems facing Kalamazoo are typical of a community or region with a manufacturing base to their economy. Those matriculating through the school system found it easy to take a high school diploma to the nearest factory, get a well paying job, raise a family in comfortable style and ultimately retire with a livable pension. Those days are gone.

Technology is replacing humans on the assembly line. Jobs are going to those educated and skilled in a knowledge-based economy. A high school diploma no longer guarantees a decent living.

The anonymous donors see The Promise as a way to revitalize their city. “They understand that equal access to higher education for all creates a powerful incentive that will bring people and employers back to Kalamazoo,” states Superintendent Brown.

On a personal note, a service club in our community began challenging selected 10th grade students to graduate from high school. These students were identified as being in considerable risk of not finishing school. If they accepted the challenge and successfully completed high school, the club pays for the first two years of college tuition.

The results have been remarkable. In one case, the club challenged the oldest of a family of 10 whose parents were migrant workers. He accepted the challenge, went on to four years of college and inspired others in his family to do the same. The family boasts one PhD, two master’s degrees, one BS degree and several currently enrolled.

Education does make a difference. The best investment we can make in the futures of our community and nation is to support our schools and encourage our students to strive for a higher education.

Flipping the switch from work to retirement mode is not quite like flipping a switch to light a room. It is not a black and white transition. And neither is handling your investment accounts during the change.

Ask anyone recently retired about the adjustment process … according to a poll done by American Demographics®, 41% of retired workers said they were having a difficult time adjusting to retirement … compared to 12% of the recently married having a difficult time adjusting to marriage!

I suspect that many of those disenchanted follow a similar pattern … hit the local coffee shop in the morning, hang out with the other retirees, drink too much coffee, listen to the same stories over and over … and, finally, one morning saying to themselves, “Is this all there is to life?”

Our way of thinking about retirement needs an overhaul. We are geared to think of retirement in terms of the way it was defined 100 years ago: Work to age 65 (never mind that life expectancies were 46). If lucky enough to live to retire, we wouldn’t have to worry about a long line at the coffee shop. We persist in asking our retirees to make what author Mitch Anthony (The New Retirementality) calls “age-justments” or simply turn off who they are and the activities that drive their pulse … simply because they reached age 62.

Retirement is really a three-phase process.

The first phase occurs between 50 and 61 when the kids leave and our focus becomes wealth accumulation. At this time we concentrate on building the nest egg, paying off education bills, and thinking about where and how we wish to live the last third of our life. Our investment focus is growth-oriented and the larger portion of our portfolio will be in equities.

The next phase extends from age 62 to 75. Real change begins, as we leave the work life behind, but not necessarily abandoned. At this point we begin to trade leisure time for human capital … the latter defined as the present value of future earnings.

This is probably the most misunderstood phase of retirement … because to retire does not simply mean quitting work. It is more about the choices we make for the use of our time.

A study done by the Gallup® organization found that 60% of retirees want to become entrepreneurs or to seek a new job to fulfill their dreams, 10% are seeking a new work-life balance, 15% hope to enjoy a traditional retirement and the remaining 15% do not want to retire. Clearly this phase is not about quitting work … more like having the freedom to do what we want, without having the economics of the endeavor as the chief motivating factor.

From an investment perspective, those who continue to work and earn, at whatever they choose to do, are continuing to build human capital and can afford to take more risk with their investments. Their portfolios should reflect a bias toward equity or growth investments, consistent with their willingness to accept investment risk. As their production of human capital tapers off, and the need to depend upon investments for support or other retirement goals increases, this more risky strategy should begin to give way to less risky investments.

The third and final phase of retirement begins about age 75. Now health concerns manifest themselves and we cut down on expensive travel and recreation that we pursued with such abandon 10 years before. The option of generating human capital has all but disappeared, and with it so should the risk in our portfolio. This does not mean that we throw out all stocks in favor of bonds … rather, that we begin to take a more cautious approach to investing with preservation of capital key.

Man’s life, as with all things in nature, has seasons. His investment strategy should reflect seasons as well.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Unlike married partners, those who cohabit do not share legal rights to property, inheritance, income and debts. And, if children are involved, additional issues of custody and support arise.
As unromantic as it may seem, a clearly written partnership agreement at the beginning of a relationship becomes the proverbial ounce of protection worth more than a pound of cure. The time to make these decisions regarding property ownership, inheritance, and support is before any triggering events occur. To attempt to prove the existence of an agreement after the fact, and without a written contract, can be costly and time consuming.

Even without formal documents, traditionally married couples have certain rights to property, protected by law. Those rights, such as the right to inherit property upon the death of a partner, are not available to the unmarried couple, same-sex or otherwise. Executing an appropriate contract can protect these rights.

For a contract to be valid it must pass four basic tests. First, the parties to the contract must be capable of contracting. This rules out a contract involving a minor or someone deemed incompetent.

Second, there must be valid consent. To be valid, the parties must agree without coercion, duress, undue influence, or fraud.

Third, the contract must have a lawful object…not an illegal activity.

And fourth, after the precedent setting Marvin v. Marvin case of 1976, the contract between partners cannot be based primarily on the rendition of sexual favors. The Supreme Court of California in the Marvin case held that contracts between unmarried couples are not against public policy and are enforceable, as long as the contracts are not founded explicitly on the consideration of sexual services.

The major elements of a living-together agreement should include property ownership and property rights, inheritance rights and support.

Like a business agreement, property ownership should address the issues of title and division of ownership interests, credit toward future property interests created by contributions to property, the rights of the parties in the event they choose to dissolve the partnership, and, equally important, inheritance rights.

Inheritance rights are a particularly sticky issue, since state intestacy laws have been written to favor a blood family member, never an unmarried partner. Therefore, a valid will and/or living trust are a must if the partners intend to pass on property to each other at death.

Partners can agree to pool their earnings for mutual support. Or, they may choose to treat income earned by each as that person’s separate property. Or, as the Marvin case pointed out, one may be the breadwinner while the other provides non-income producing support.

Unmarried couples do have one advantage over traditional married couples, especially in community property states. They may transfer property between partners for the purpose of avoiding future creditor claims, something difficult to accomplish in community property jurisdictions.

Parents who were once able to make cash gifts to adult children are finding themselves thinking twice about handing out this largess, as they wonder about their own financial futures.

Many are finding themselves sandwiched between taking care of older parents who did not plan on living this long, and continuing to support a younger generation who grew up thinking a TV in every room, a credit card in every pocket, and a nifty new sports mobile was a right, and not a privilege.

Thomas Stanly, PhD, author of a seminal study of family wealth, The Millionaire Next Door, referred to parental support for adult children as Economic Outpatient Care.

Stanley noted that many of the older generation who provide Economic Outpatient Care showed uncommon skill at accumulating wealth earlier in their lives. Yet these same parents feel compelled, even obligated, to continue to provide support for adult children.

The net result is that the children, or those who receive such outpatient care, accumulate less on their own. They use the gifts to present a facade of a lifestyle. Worse, they become adept at manipulating their parents for more, rather than taking on responsibility for their financial situation.

Parents of younger children still have a chance to guide offspring along the road to financial responsibility.

There is a nifty piece of software on the Web for teaching younger children about money. Family Bank at www.ParentWare.org is a computer-based allowance manager that helps children learn money skills and management. According to the author it comes with a set of rules that, when agreed to by the parent and child, and adhered to by the parent, will help the child develop the habit of sound financial management.

According to Nellie Mae (college loan administrator) over 78% of college students are carrying loads of high-interest, unsecured, credit card debt. Not surprising, since credit cards solicitations are everywhere on today’s college campuses…“no income, no employment, no problem!”

Parents can do their kids a favor by teaching them a few simple rules about credit cards. First, explain to them the facts of life regarding their credit history. Without good credit, buying cars and renting apartments become more expensive at best…impossible at worst. Second, put training wheels on a credit card; start them with a prepaid or debit card that is simple to monitor. You can see if they are using it wisely while controlling the amount they spend.
Third, explain the cost of credit. Show them the math. They are smart enough to figure out what 18% interest means if added to the cost of a purchase. Explain late fees…even when only $10 might be owed. It still has to be paid on time!

Finally, monitor their purchases and teach them what is appropriate and necessary versus what is “nice to have” or an impulse.

Teaching children about money, in many respects, can be as valuable as any other aspect of their education!