Balancing Act in Dividing Assets

April 21, 2021

When it comes to leaving assets to heirs, fair and equal may not always be the same thing. We provide some perspective, and ideas.

One of the most sensitive issues you may face in estate planning is how to divide assets among family members. Typically, assets are split equally among children; however, in some cases, for a variety of reasons, parents choose to treat children differently. In our view, there is no right or wrong way to handle dividing up assets. However, we believe it is important to understand the potential consequences of your decision and to maintain open lines of communication so that there are no misunderstandings or surprises after you are gone.

What Is Fair?

In theory, simply dividing assets equally among children would seem to be the fairest approach, but often parents feel that other considerations should be taken into account. For example, one child may have more extensive needs than the others. In that case, would you want to provide more for that child? Would you be concerned that your other children, who receive less because that one sibling receives more, would be resentful, and at some level believe that you value (or even love) the other child more?

Emotional issues are often at the core of estate litigation, where family members can spend more money on lawyers disputing an estate plan than the actual dollars at stake. One way to attempt to alleviate a contentious situation after you pass away is to have conversations with your children during your lifetime about your plans and the rationale for your decisions. Whether or not your children agree with your approach, they can let you know their feelings and won’t be surprised after your death.

Different Needs

When children are growing up, it’s rare for parents to divide up resources based on the cost of activities. For example, just because one child’s equestrian lessons are more expensive than another child’s cello lessons, the 10-year-old cellist rarely gets “compensated” for the difference in cost between her lessons and her sister’s. On the other hand, the calculus usually changes when the children become adults, and especially when parents are making decisions about permanent wealth transfers.

Issues of fairness can be subtle. If you have two children, and one is planning to go to medical school and the other isn’t going to get a graduate degree, should you leave more to the child who plans to go to medical school since she’ll have more educational expenses? Would that penalize the child who doesn’t continue his education? What if you paid for one child’s graduate school education and the other child didn’t go to graduate school? Should you make up the difference in your will or revocable trust? There are no easy—or “right”—answers in such situations. In our view, these are issues that each family should address based on their individual values and preferences. In another scenario, one child may have a disability and be unable to be self-sufficient. In those circumstances, other children usually understand the need to provide extra resources for the disabled sibling.

Life Choices

Another element involved is that of choice. Should your children be treated differently if one child doesn’t need the money because she chose a high-paying career, spending years working very long hours, and has significantly more wealth than another child, who has a less stressful and remunerative job? Should the first child’s hard work be “penalized” with a smaller inheritance if her sibling does not have as much money? Would it make a difference if the child with a lesser net worth needed the money? And is there always a choice? Maybe one child doesn’t have the aptitude to work in a high-paying job and is earning as much as he is capable of.

Possible Solution: If one child has significantly greater needs than another, a trust can be created for the wealthy sibling with her equal share of the inheritance, providing for distributions to the less wealthy child at the discretion of an independent trustee. In this way, wealthier children are not cut out of an inheritance and the trustee has the ability to make distributions to less affluent children as needed.

Family Makeup

Not all of your children will necessarily have the same expenses, such as providing for children of their own. Is it fair to leave a son without children less than his siblings who do have children, because he may have fewer expenses? Would providing him with less be seen as a penalty? Should it matter? This issue can become apparent in annual gifting situations, where it’s common for wealthy individuals to provide gifts of up to $15,000 (per donor, per recipient) to each of their children and grandchildren. For example, if you anticipate dividing assets equally among your adult children at death, giving an extra $30,000 in a particular year to a child who has two children (when another child doesn’t have any) isn’t consistent with that plan. The decision is often very personal, but there are ways to maintain reasonable equality in such situations.

Possible Solution: Rather than give annual exclusion gifts outright to each of your children and grandchildren, you can create a trust to receive those gifts. The assets in the trust can be invested and then split equally among the children at your death.

Advance Payments

It’s also possible that one child will need a significant outlay during your lifetime. Whether it should count against the child’s share of the estate is a judgment call. You may decide that a large medical expense should not reduce the child’s inheritance, but that money given to a child to purchase a home should. In some instances, it may make sense to loan the money to the child instead of making an outright gift. A parent can give a child a low interest rate loan (a certain amount of interest needs to be charged to ensure that the loan is not treated as a gift), which can be forgiven at death as a portion of that child’s inheritance. That seems fair on its face; however, such a loan creates an opportunity cost since you can’t invest the money that was loaned out. Should that be taken into account when dividing the estate? Again, it’s something worth discussing with your children to explain your rationale, regardless of the decision you make. This communication doesn’t mean that you need their approval—it’s just important to have transparency so that everyone understands that you are aware of the ramifications of making the low interest loan to the sibling.

Hard-to-Divide Assets

It may not be feasible to divide certain assets, such as a home, a parcel of land or a family business. With a business, it becomes more complicated if one child is involved and the others are not. That child may want to continue to run the business while the others may wish to sell it and divide the proceeds. One possible solution is for the child who is involved in the business to buy out his siblings. However, if he can’t afford to do so, how do you resolve this issue? Set out a payment plan over several years? Give each child an equitable share of the business and put in a structure where the child who runs the business has day-to-day control and receives a salary in addition to an equal share in the profits, which the other siblings receive as well? No one answer will work for every situation. Again, it is important to discuss these issues with your children and to come up with a plan for resolution.

Personal items can be another source of conflict. While it may be easy to value a marketable security, it is much more difficult to assess the value of a family painting, a music box or a piece of jewelry, to name a few. Some objects don’t have monetary significance, just sentimental value, and they may be “priceless” to more than one child. While many people leave it to their heirs to ”duke it out” over personal property, we believe it’s useful to set up some kind of framework to avoid conflict and to reach sensible results.

Possible Solution: Provide that if more than one child wants a personal item, one child will get the item and the others will receive an equal value in cash so that they can buy, or have made, one of their own. Of course, some items are “priceless” in that they have sentimental value, while others can’t be replicated. To help alleviate dissension among your children, another option is to direct the sale of any item that they can’t agree on.

Blended Families

When a divorced or surviving spouse remarries, the allocation among family members can be particularly challenging. Wills or revocable trusts of couples often specify that everything be left to the surviving spouse. However, where there are children from a first marriage, it’s important to consider whether you want to ensure that some or all of your assets pass to your children upon your death or upon your second spouse’s death.

An example of such a situation was recently brought to my attention. A husband and wife each had a child from a prior marriage. There was an understanding between the spouses, which they articulated to the children, that on the death of the first spouse to die, all of that spouse’s property would pass to the surviving spouse, and upon the surviving spouse’s death, the property would be split equally between the children from their prior marriages. The wife died first and, as agreed upon, left all of her assets to her husband. When he died several years later, the wife’s child discovered that the husband had changed his will, contrary to the previously stated intentions, and left his entire estate to his child—leaving out his stepson, who had no viable legal recourse.

Possible Solution: A marital trust can help alleviate this issue. Upon the death of the first spouse to die, the first spouse’s assets can be held in trust for the surviving spouse’s benefit. Upon the death of the surviving spouse, the children from the first marriage (or from both marriages, as the case may be) can be provided for. Because of the inherent conflict of interest between the surviving spouse and the children who will receive the property upon the second spouse’s death, it is important to choose an independent trustee who will take into account the respective interests of the spouse and children. In this situation, it may be beneficial to name a corporate trustee who will look out for the interests of both the surviving spouse and the children from a prior marriage.

Control Issues

Beyond actual monetary divisions, a source of conflict may be the power one sibling exercises over an estate or trust by virtue of being named as an executor and/or trustee. In some cases, parents select all of their children as executors out of “fairness”—which can make the administration of the estate and/or trusts complicated and unwieldy. If a parent chooses one child over the others to be a fiduciary, it may create conflict among the siblings. Moreover, while being chosen as an executor or trustee may be considered an honor, these roles involve a lot of work, can take an inordinate amount of time and energy, and may ultimately be considered thankless tasks. And not only do these positions come with considerable duties, but they can create potential liability for the fiduciary as well.

Possible Solution: It may be feasible to divide control in constructive ways. For example, you might name a child with a medical background as the agent under a health care proxy, another child who has a financial background as the agent under a power of attorney, and another child who is an accountant/lawyer as an executor and/or trustee. While your children may have close relationships, often administering a will or trust can lead to conflict, so it may make sense to appoint an independent party who is not a family member to serve as a fiduciary in order to help maintain family harmony.

Communication Is Essential

One of my most rewarding client experiences resulted from encouraging a parent to communicate with her children about her plans for the distribution of her estate. She had two grown daughters who were best friends, one with considerable assets and the other struggling to get by. The client assumed that her wealthy daughter would understand if she left all of her assets to her sister, since the wealthy daughter was well provided for.

At my urging, the client and I met with her daughters so that she could explain her plans. The client was very surprised by how upset the wealthier daughter became. It wasn’t a function of money, but purely a reaction tied to emotions around being “disinherited.” Ultimately, they agreed upon a solution, which was to create a trust using the wealthier daughter’s share of the inheritance for the benefit of both sisters. I cringe to think about what the result would have been had the mother not spoken with her daughters.

In some ways, this was an unusual situation, but the lesson around communication has broad applicability. Uneven division of assets can often foster resentment. Even where siblings generally get along, it’s remarkable how family relationships can deteriorate when money is involved—especially when parents are no longer around to serve as referees.

Ultimately, we believe there is no right way to divide assets among your children—that’s up to you. But proceeding in a thoughtful way, and discussing your plans with your children in advance, can help your family avoid conflict and work through the estate process with feelings and relationships intact.

Planning Idea: Loans in a Low Interest-Rate Environment

With interest rates still at exceptionally low levels, loans to family members can be an effective way to transfer future appreciation out of an estate and/or to provide funds when your children need them.

Let’s assume, for example, that you loaned your daughter $1,000,000 at 1.98% annual interest with the loan to come due in 10 years. Assuming that she invested the proceeds to potentially generate a 6% annualized return,¹ at the end of 10 years the amount loaned to her would grow to $1,790,848—netting proceeds to her of $592,848 after the payment to you of $198,000 in interest and the repayment to you of the $1,000,000 principal amount. If the term of the note exceeded your life expectancy, the value of the note upon your death would be includible in your estate, but the net proceeds of $592,848 would not be. It’s possible to combine a trust with the loan to mitigate the income tax liability on the interest paid to you.

Loans can be an especially effective strategy when made to a grantor trust. The grantor is responsible for paying the income taxes on the assets held in the trust, effectively providing for additional wealth transfer without it being deemed a taxable gift. A loan by a grantor to his grantor trust is considered a loan to himself; thus, in contrast to a typical loan, the grantor does not need to pay tax on the interest received. Certain best practices may apply; generally, the trust should be funded with a minimum of 10% of the anticipated loan amount, and all formalities should be observed to avoid gift-tax treatment.

Various other strategies can also be used to capitalize on low interest rates. Be sure to talk to your advisors before proceeding.

1 Roughly our expected return for a moderate-risk portfolio of stocks and bonds.

Taking Action Prior to Tax Reform

As the country anticipates legislation on infrastructure spending and tax increases, it may still be possible to take steps to benefit from the favorable tax environment that has been in place since the 2017 tax reform. This includes:

  • Using the $15,000 annual gifting exclusion to transfer assets to an unlimited number of recipients
  • Paying educational and medical expenses for others to the service providers. There is no cap on these payments
  • Making gifts outright or in trust that count against the $11.7 million lifetime gift, estate and generation-skipping tax exemption, which many believe could be reduced²
  • Where assets are tied up, borrowing money at low rates to make these gifts
  • Converting your traditional IRA to a Roth IRA, to pay taxes on their value now rather than upon withdrawal, when income tax rates presumably could be higher

2 This assumes that any reduction in the amount of the exemption is not implemented retroactively.

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