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The Other Facts of Life

That birds-and-bees talk you're bound to have with the kids may be easy compared to the delicate matter of wealth and how to handle it.
Chuck Jaffe, CFO Magazine
February 1, 2007

Jim McConnell had a dilemma: He wanted to share his wealth with his children, but he didn't want the money to lead them astray or sap their will to succeed on their own.

He's far from alone. Currently, about 2.7 million Americans have at least $1 million in financial assets, according to the World Wealth Report from Capgemini and Merrill Lynch. Between 2004 and 2005, the number of U.S. millionaires rose 6.8 percent. They represent about $10.2 trillion worth of financial assets, and 92 percent of them will eventually transfer most of their assets to their families, with three-quarters of that wealth expected to be given directly to their children.

In other words, over the next decade an awful lot of parents must answer the question: How should we tell our kids that we're rich?

Approaches vary. McConnell started talking about money with his two daughters when they were young, and transferred money to them as teenagers while offering financial advice as they grew into adulthood (they are now in their 30s). "As I became more successful, it was clear that teaching the children about money — and about our values — was something we had to start early," says the retired CEO of Instron Corp., who now lives in Bonita Springs, Florida.

Some parents keep the size of their fortunes to themselves. One entrepreneur living in Massachusetts, who asked not to be identified, has not told his children the extent of his success. "Frankly, our kids will never have to work," says his wife. "But we don't want them to know that." Indeed, these suburban parents have encouraged their children to develop their own entrepreneurial ventures to earn spending money.

Most experts recommend that parents discuss money in broad terms rather than specific dollar amounts, then gradually introduce their kids to the idea that the family has money. "You don't want to suddenly spring it on a child," says Michael Steiner of Regent Atlantic Capital in Chatham, New Jersey. "If you're a successful executive, your kid has kind of won the genetic lottery. Now think of all the lottery winners who have gone broke because they were unprepared for what happened next. You don't want that to happen to your kids."

Most successful people want their offspring to share their values, including the "hard work, discipline, [and] ambition that factored into their success," says Judy Barber of Family Money Consultants in San Francisco. "But you walk a really fine line here, because either too much or too little information can be a problem."

The dangers of providing too much information run the gamut from the merely embarrassing — your son brags about your bonus on the playground — to the injurious — gossip rags are littered with the foibles and failures of the overprivileged children of the rich.

Saving & Loans
One of the simplest ways to introduce the subject of fiscal responsibility is to demonstrate the power of savings to younger children by setting up a matching account for them. For every dollar of allowance a child deposits into a bank account, the parents match the deposit by an agreed-upon ratio; some parents do a 1-for-1 match, others more. Either way, children are often surprised at the rate at which their personal savings grow, and in the meantime develop good saving habits.

Some families set up a family bank from which the children can take loans. Other families rely on trusts to enforce fiscal discipline, although most experts suggest that the administrative expense makes these appropriate only for families looking to move sums of $1 million or more. "You might set up a trust to protect the money, or use it to distribute part of the money to the kids and see what happens before you give them more," says Stephen Ziobrowski, a partner in Boston law firm Day Pitney LLP.

Ziobrowski suggests that wealthy parents who want to help children learn the true value of money might consider establishing a family foundation and putting the kids on the board. Discussions held at foundation meetings may give parents insight into their children's financial sophistication and level of fiscal responsibility, says Ziobrowski. A child may become very active in the foundation and take a thoughtful, mature approach to financial matters. Or a child may not show up for meetings and take little interest in the foundation's financial matters, he adds.

Parents may also want to investigate how a Crummey Trust can solve tax and fiscal-discipline issues simultaneously. A Crummey Trust, says Mark Paluzzi, senior vice president at Bank of America Private Bank and a certified trust and financial adviser, limits the children's access to the money while giving a tax break to parents and grandparents (see "Making the Best of a Crummey Situation" at the end of this article).

McConnell, who acknowledges that he didn't want to pay the freight for setting up trusts, devised a simpler solution. "The kids know I can't do anything about the money they've already got, but I can do something about what they don't have yet," he says. "Knowing that they have to be responsible in order to get more money makes them interested in what they have to do to prove that they can handle it."


Chuck Jaffe is senior columnist for MarketWatch.


Making the Best of a Crummey Situation

There are many ways to transfer wealth to your children, including gifts. The Internal Revenue Service allows individuals to "gift" up to $12,000 per year to anyone, tax free. That means that two parents and four grandparents could load a child's bank account with $72,000 a year, with each gift giver subtracting $12,000 from his or her estate annually.

But there's a rub: the gift exclusion is available only if the money can be spent by the recipient immediately. In tax parlance, that's called having a "present interest" in the gift. Here's why the concept of present interest creates a problem for children of affluent parents.

No matter how well Junior does at the science fair, most kids are not mature enough to handle the kind of wealth that will accumulate, so many families set up a custodial trust under the Uniform Transfer to Minors Act (UTMA). While the trust does pay taxes on gains, it also uses a trustee (which can be the parent) to invest and manage the funds and essentially keep the money under legal lock and key until the child becomes an adult in the eyes of the state — either age 18 or 21.

But most parents know their kids better than the state, and many would rather keep the money out of their children's reach for a longer period of time. That's not possible under the UTMA, but it can be accomplished by setting up a general irrevocable trust. In this type of trust, however, the child lacks a present interest in the money, which in most circumstances negates the giver's tax break.

In 1969, the Crummey family tested a new, complicated trust structure and challenged the present-interest rule in court. The Crummeys won, beating the IRS and setting in motion a new structure to rein in the childish spending habits of spoiled trust-fund babies.

In a nutshell, a Crummey Trust gives the child rights to access the gift for only a very limited amount of time — typically 30 days a year, says certified trust and financial adviser Mark Paluzzi. But that's long enough to qualify the gift as a present interest, explains Paluzzi, and thereby win the tax exclusion for the gift giver.

The child usually has 30 days after receiving the gift to withdraw all or part of the most recent gift before the money is returned to the trust for safekeeping. Once the money is back in the trust, it may not be withdrawn until the child reaches the predetermined distribution age. Even if the child insists on withdrawing money within the monthlong, present-interest period, he can access only the current year's gift, not the total trust assets. — Marie Leone




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