Avoiding estate planning traps

Advisors can steer clear of estate planning pitfalls by using the will drafting process to avoid a collision of competing objectives between beneficiaries of the testator (the individual whose estate will be divided after decease).

For the advisor, this means working with the client-testator to anticipate and prevent potential problems that could occur after death, according to financial commentator, author and lecturer Tim Cestnick, who spoke on Tuesday at the IFB’s fall summit in Toronto.

In what Cestnick calls “one of the biggest pitfalls,” problems can result from bequeathing a specific asset to more than one heir. Where the asset is a family business, for instance, an heir working there on a daily basis may want a good salary, company car and status while an heir not involved would be more focused on dividends and appreciation in share value.

Moreover, the heir working in the business may see dividends as a drain on resources and a threat to his or her own estate. This conflict can be sidestepped by leaving the business to the actively-involved heir and cash or other assets to the other heir or heirs, he suggested.

Leaving real estate to more than one beneficiary leads to problems when one feels willing and able to contribute to upkeep while another feels unable to contribute, or where one wants to sell the property and take cash while another wants to retain the property. The solution again is to bequeath the property to one heir and cash or other assets to the other heirs.

A second marriage in which either or both spouses have children from previous marriages can also create an estate planning trap, Cestnick pointed out. A popular solution involves setting up a spousal trust providing for assets to pass first to the second spouse and to the testator’s children by the first marriage after the second spouse’s decease.

That leads to competing objectives, Cestnick said. The surviving spouse will likely want income from the trust and feel entitled to encroach on the capital. Meanwhile the testator’s children will want growth in the assets with no encroachment in capital and view the second spouse’s expenditures as threatening their future inheritance. The solution may be a life insurance policy or life annuity for the surviving spouse. This could trigger tax liabilities, he acknowledged, adding that “sometimes it makes more sense to do that and pay the tax than to cause family problems.”

Problem children and their demands can be another issue when the client passes away. In this scenario, the problem child exerts undue pressure for money on the surviving spouse who finds it difficult to say ‘No’ to demands for extra money, Cestnick said. Meanwhile, other offspring may see this as eroding their eventual inheritances. This trap can be avoided by arranging a trust administered by the surviving spouse and an independent trustee who has the power to veto extra payments to the problem child.

As with sex and drugs, failure to talk as a family about estate planning can lead to problems that crystallize after the client-testator’s death. Kids hesitate to approach parents about inheritances for fear of looking greedy and parents are uncomfortable discussing death with children. However, when parents give children an estimate of their inheritances and the opportunity to request specific assets, they can do some advance financial planning of their own.

Art Melo is a Toronto-based freelance writer

(11/02/05)