“By failing to prepare, you are preparing to fail.” Benjamin Franklin
"There are very few ways of actually reducing the size of one's estate and thereby the liability for estate taxes without losing total control over the estate."
Estate planning for many people connotes the way assets will be disposed of upon death. However, a large part of estate planning consists of the disposition of assets during one's lifetime. There are numerous benefits to making lifetime transfers rather than holding onto assets and transferring them upon death. Furthermore, there are several different methods and vehicles that may be used for making lifetime transfers depending on the desired result. Some of these methods and vehicles include outright gifts of property, transfers of property into trusts, and transfers of property to and interests in family limited partnerships.
In addition to the other estate planning devices described in more detail elsewhere in this web site, you may wish to consider the following:
GRATs and GRUTs: Grantor Retained Annuity Trusts and Grantor Retained Unitrusts are forms of trust whereby the trust creator (grantor) gifts the remainder interest in the trust property to a donee (such as a child) after receiving income from it for a fixed term of years. The value of the gift is reduced by the value of the grantor's retained income interest as determined by IRS tables. If the grantor survives the GRAT's or GRUT's term, the value of the remaining property for gift tax purposes may be significantly less than its actual value.
QPRTs: A Qualified Personal Residence Trust is a form of Grantor Retained Income Trust (GRIT) for a residence owned by the grantor. The remainder interest for gift tax purposes may be considerably less than the actual value of the residence. This could be an effective method of gifting a residence such as a vacation home with a reduced gift tax value after retaining an ownership interest in it for a term of years.
CHARITABLE LEAD TRUSTS: This trust is similar to the Charitable Remainder Trust but works in reverse. With the Charitable Lead Trust the trust creator gives an income interest in the trust property to charity for a term of years with the remainder going to, for example, children. The transfer tax value of the remainder will be reduced by the value of the income interest to the charity.
BUSINESS PLANNING: If you have an ownership interest in a business, you may wish to consider issues such as:
selection of entity (e.g., business trust, partnership, C or S corporation, Limited Liability Company (LLC), etc.)
"Effective Planning can Keep the IRS Out of Your Heirs' Hair"
All serious planning involves "cause and effect" and is therefore akin to each other. Therefore, before you can institute an effective estate plan; a short and succinct course in 'planning in general' is prudent and in order. Please take the time to look at your estate planning process in the same light as if you were the CEO of a multi-billion dollar corporation ready to embark on a new product that can either revolutionize mankind's every day living or be the downfall of your company and the bankruptcy of your shareholders. Below the author mentions the "KISS" process but we prefer the "3d" approach: Decide, Delegate and then Disappear. Now that's good sense!
By the stage you start detailed planning, you should have a good picture of where you are, what you want to achieve and the range of options available to you. You may well have selected one of the options available to you as the most likely to yield the results required.
Detailed planning is the process of working out the most efficient and effective way of achieving the aim that you have defined. It is the process of determining who will do what, when, where, how and why, and at what cost.
Identifying Key Activities
The first stage in the process is to identify the key actions that need to be performed in order to achieve the Aim of the plan. If these actions are large and complex, reduce them down to a number of smaller key actions.
For each of these key actions, plan out how they will be achieved, working out the time that will need to be taken and the resources that will need to be allocated to achieve the action. This will allow you to calculate the cost of that action.
Once you have done this, prioritize the actions in order of importance so that you do not waste time on low priority tasks. It can also be helpful to set mock deadlines (allowing appropriate contingency time for overruns and unavoidable delays). This gives a target to work towards.
If some of the actions being carried out depend on the completion of other activities, it may be useful to carry out a Critical Path Analysis. This will show you the minimum length of time that will be needed to achieve the plan, and will help you to decide task priorities. It will also help you to identify the key activities to keep moving when your resource requirements conflict with other managers using the same resources.
While you are concentrating on the actions that need to be performed, ensure that you are also considering the control mechanisms that will allow you to monitor the performance of the activity. These will include the activities such as reporting, quality assurance, cost control, etc. that are needed to spot and correct any deviations from the plan.
Elements of a Good Plan
A good plan will:
Have a clear statement of the current situation
Have a clear aim
Reflect the resources available
Detail the tasks to be carried out, whose responsibility they are, their priorities and deadlines.
Explain control mechanisms that will alert the manager to difficulties in achieving the plan.
Plan for contingencies, so that a rapid and effective response may be made to crises, perhaps at a time when you are at a low ebb or are confused following a set-back.
Making Effective Plans
The following points will help to make your plans effective:
Involve people affected by the plan to gain their support
Explain why the plan is being carried out
Sell & resell the benefits to everyone involved
Ensure that the required resources are available and remain available
As far as possible keep to existing ways of doing things. This avoids unnecessary disruption.
Build in milestones and review progress. This helps to keep a sense of movement in the plan, and allows achievement to be rewarded
Use KISS (Keep It Simple and Straightforward)
Keep the plan flexible
Consider transitional arrangements - how will you keep things going while you implement the plan?
Evaluation of the Plan and It's Impact
Once you have worked out the details of your plan, the next stage is to work out whether it will work and its impact: often you may find that a plan may have unexpected effects, either positive or negative.
You may also find that when you cost the plan, and compare this against the benefits achieved, that the plan is simply not worth carrying out. This can be frustrating after the hard work of detailed planning, however it is much better to find this out now than when you have invested time, resources and personal standing in the success of the plan. Evaluating the plan now gives you the opportunity to either investigate other options which might be more successful, or to accept that no plan is needed or should be carried out.
There are a number of ways in which you can evaluate your plan:
This is probably one of the simplest ways of evaluating a plan. During the process above you should have carried out an analysis of the costs involved with each activity within the plan. Simply add up these costs, and compare them with the expected benefits.
Once you have carried out a cost/benefit analysis, you may find it useful to mix its financial information with an assessment of the intangible or non-financial aspects of the decision. An effective way of doing this is with a PMI analysis. This is an advanced form of 'weighing the pros and cons', and involves listing the positive points in the plan in one column, the negative points in a second column, and the interesting indirect implications of the plan in a third column. Each point can be allocated a subjective positive or negative score.
Force Field Analysis
Similar to PMI, Force Field Analysis helps you to get a good overall view of all the forces for and against the change that you want to implement. This allows you to see where you can make adjustments that will make the plan more likely to succeed.
Cash Flow Forecasts and Break Even Analysis
Where a decision is has mainly financial implications, such as in business and marketing planning, preparation of a Cash Flow Forecast (article to follow) can be extremely useful. Not only does it allow you to assess the effect of time on costs and revenue, it helps in assessing the size of the greatest negative and positive cash flows associated with a plan, and provides the basis for accurate break-even analysis. When it is set up on a spreadsheet package, a good Cash Flow Forecast also functions as an extremely effective model of the plan, allowing the effect of variance in assumptions to be examined.
Risk Analysis & Contingency Planning
All of the above analyses broadly assume that the plan functions correctly. None of them assess the risks associated with carrying the plan out and the potential costs should those risks damage the plan. These risks can be assessed effectively by preparing a variant of a Decision Tree which allows you to show the major uncertainties associated with different stages of the plan, analyzed by probability and outcome. Wherever an outcome is unfavorable, this will help you to assess and plan the contingency actions needed and the cost of getting the plan back on course.
It is important to ensure that you do not rely exclusively on the results of numeric analysis as the basis of your plan evaluation. Many factors which are important to the evaluation of your plans cannot practically be quantified.
These factors include:
This should include an assessment of likely changes in public ethics over the lifetime of the plan.
How will the shareholders, owners, or trustees of the organization view the plan?
What effects will the plan have on the organization's members or employees? Should these effects stand in the way of improving efficiency?
Will the plan change the way in which your organization's customers view it? Will this affect their likelihood of reordering?
How will your plan affect relations with suppliers?
Will the plan have a positive or negative effect on your organizations relations with the public, press and politicians?
Will it enhance or damage the environment?
Any analysis of your plan must be tempered by common sense. It is much better to change a beautifully crafted plan that analysis shows will not work than deal with the consequences after a failed attempt at implementation.
Decision Theory and Decision Trees
Decision trees are excellent tools not only for making financial or number based decisions where a lot of complex information needs to be taken into account but also in the estate planning arena. They provide an effective structure in which alternative decisions and the implications of taking those decisions can be laid down and evaluated. They also help you to form an accurate, balanced picture of the risks and rewards that can result from a particular choice.
How to Draw a Decision Tree
You start a decision tree with a decision that needs to be made. This decision is represented by a small square towards the left of a large piece of paper. From this box draw out lines towards the right for each possible solution, and write that solution along the line. Keep the lines apart as far as possible so that you can expand your thoughts.
At the end of each solution line, consider the results. If the result of taking that decision is uncertain, draw a small circle. If the result is another decision that needs to be made, draw another square. Squares represent decisions, circles represent uncertainty or random factors. Write the decision or factor to be considered above the square or circle. If you have completed the solution at the end of the line, just leave it blank.
Starting from the new decision squares on your diagram, draw out lines representing the options that could be taken. From the circles draw out lines representing possible outcomes. Again mark a brief note on the line saying what it means. Keep on doing this until you have drawn down as many of the possible outcomes and decisions as you can see leading on from your original decision.
An example of the sort of thing you will end up with is shown below:
Once you have done this, review your tree diagram. Challenge each square and circle to see if there are any solutions or outcomes you have not considered. If there are, draw them in. If necessary, redraft your tree if parts of it are too congested or untidy.
You should now have a good understanding of the range of possible outcomes.
Starting to Evaluate Your Decision Tree
Now you are ready to evaluate the decision tree. This is where you can calculate the decision that has the greatest worth to you. Start by assigning a cash or numeric value to each possible outcome - how much you think it would be worth to you.
Next look at each circle (representing an uncertainty point) and estimate the probability of each outcome. If you use percentages, the total must come to 100% at each circle. If you use fractions, these must add up to 1. If you have data on past events you may be able to make rigorous estimates of the probabilities. Otherwise write down your best guess.
This will give you a tree like the one below:
Note that the tree looks less confused when different colors are used for numbers than for the structure of the tree.
Calculating Tree Values
Once you have worked out the value of the outcomes, and have assessed the probability of the outcomes of uncertainty, it is time to start calculating the values that will help you make your decision.
We start on the right hand side of the decision tree, and work back towards the left. As we complete a set of calculations on a node (decision square or uncertainty circle), all we need to do is to record the result. All the calculations that lead to that result can be ignored from now on - effectively that branch of the tree can be discarded. This is called 'pruning the tree'.
Calculating The Value of Uncertain Outcome Nodes
Where we are assessing the value of an uncertain outcomes (circles on the diagram), we do this by multiplying the value of the outcomes by their probability, and noting the result. The total value of that node of the tree is gained by adding these together.
In the example above, the value for 'new product, thorough development' is:
0.4 (probability good outcome) x $500,000 (value) = $200,000 0.4 (probability moderate outcome) x $25,000 (value) = $10,000 0.2 (probability poor outcome) x $1,000 (value) = $200 -------- $210,200
This is shown across our example tree in the diagram below:
Note that the values calculated for each node are shown in the boxes.
Calculating The Value of Decision Nodes
When you are evaluating a decision node, write down the cost of each option along each decision line. Then subtract the cost from the value of that outcome that you have already calculated. This will give you a value which represents the benefit of that decision.
Sunk costs, amounts already spent, do not count for this analysis.
When you have calculated the benefit of each decision, select the decision which has the largest benefit, and take that as the decision made and the value of that node.
Calculation of decision nodes in our example is shown below:
In this example, the benefit we previously calculated for 'new product, thorough development' was $210,000. This example shows that we calculate the cost of this approach as $75,000. This gives a net benefit of $135,000. The benefit of 'new product, rapid development' was $15,700. On this branch we therefore choose the most valuable option, 'new product, thorough development', and allocate this value to the decision node.
By applying this technique we can see that the best option for us may be to develop a new product. What the analysis shows which we might not have appreciated, is that it is worth much more to us to take our time and get the product right than to rush the product to market. In fact, it is better just to improve our existing products than to botch a new product, even though it costs us less.
Decision trees provide an effective method of decision making because they:
clearly lay out the problem so that all choices can be viewed, discussed and challenged
provide a framework to quantify of the values of outcomes and the probabilities of achieving them
help us to make the best decisions on the basis of our existing information and best guesses.
As with all decision making methods, though, decision tree analysis should be used in conjunction with common sense. They are just one important part of your decision-making tool kit.
An excellent example of "cause and effect" in motion:
Open window (A) and fly kite (B). String (C) lifts small door (D) allowing moths (E) to escape and eat red flannel shirt (F). As weight of shirt becomes less, shoe (G) steps on switch (H) which heats electric iron (I) and burns hole in pants (J). Smoke (K) enters hole in tree (L), smoking out opossum (M) which jumps into basket (N), pulling rope (O) and lifting cage (P), allowing woodpecker (Q) to chew wood from pencil (R), exposing lead. Emergency knife (S) is always handy in case opossum or the woodpecker gets sick and can't work.