Rich kid/poor kid

Rich kid/poor kid

By: Martin M. Shenkman, CPA, MBA, JD

Estate planning when you have heirs of significantly different means can be quite a challenge. When your kids are the financial version of Danny DeVito and Arnold Schwarzenegger in the movie Twins, do you bequeath assets equally? If equal is not equitable, do you use a different non-equal approach?

* Rich Kid; Poor Kid: What to do when your children have very different financial situations? Most parents still leave everything equally. "They're both our children", "We love them the same".... are all common refrains. So perhaps the most common approach is to simply ignore the disparities between the children. This ostrich approach to a tough issue has one major benefit, it is simple.

* Leave the child in greater financial need a larger bequest in your will. For example, bequeath 40% to the rich kid and 60% to the poor kid. A problem with this approach is that if there is a major change in the size of your estate, the percentages may be more or less of a differential than you intend. Alternative approach: Make a fixed dollar bequest to poor kid, and then leave the remainder of the estate in equal (or other percentages). Depending on the circumstances, you might feel this approach takes the sting out of the difference, because the residuary (what is left after the dollar bequest) is divided equally between the children.

* Use Bactine! Remember, unlike hydrogen peroxide, it does not sting. Add a statement to the will to the effect that: "I have made a larger bequest to my son Sam, out of consideration for his greater financial needs, and not in any way to indicate greater lover or affection for him than for my other children." May sound corny, but the reality is that most heirs equate love and money, and saying it "ain't so", even if you think it is obvious, can take the sting out of unequal bequests. Just be careful how you word such "fuzzy" provisions; you do not want to create a condition that could affect the distribution, or raise the likelihood of one of the children challenging the will.

Leave the child in greater financial need more assets, but endeavor to minimize offending the wealthy child by making the disparate transfers less obvious. Avoid an "in your face" bigger bequest in your will.

* Set up 529 plans for the poor child's children to alleviate the college cost burden. These gifts are made outside your will, and if under the annual exclusion amount ($12,000 in 2008), they will not appear on a gift tax return. You might wish to avoid the front loading of 529 plan gifts (you're allowed to make 5 years worth of gifts at once) to avoid a gift tax return that would advertise it. Another plus is that if the child in greater need has more children, there is a sense of fairness to defraying college costs. These gifts, while they directly benefit the grandchildren, can defray substantial costs for the child/parent. Importantly, if the financial tides shift, you can reclaim some or all of the 529 plan funds as the account owner for the plan. This is a key point many people planning for heirs of disparate wealth overlook: financial tides can be fickle. The kid worth mega-bucks today could be holding a pay telephone empire, or a patent for rotary dial phones. They may not be Richie Rich tomorrow.

* Buy a life insurance policy naming the poor child as the owner and beneficiary. This can minimize the tax costs of disparate gifts, avoid an obvious affront to the wealthy child, and accomplish your goals.

* Buy an annuity in the name of the poor kid using annual exclusion gifts. This can be a way to assure a cash flow overtime. If the poor kid is irresponsible use a trust or a non-cancellable annuity.

* Set up a joint bank or brokerage account with the poor kid that transfers on death automatically and leave everything under the will equally. You can always change the account if circumstances change. But if your estate is over the state or federal estate tax filing threshold, this asset, and its disposition will appear on an estate tax return.

* Use a "pot" or "sprinkle" trust to distribute based on need. If the "rich" kid stays rich. an independent trustee can distribute more to the poor kid. If the rich kid develops a health problem or business set back, the independent trustee can easily modify the distributions. A variant of this is to say leave 40% to rich kid, 40% to poor kid, and 20% to a trust for all heirs with an independent trustee able to address circumstances over time

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