Lifetime Gifting Strategy Part II: The Heart of Gifting

People make gifts for two primary reasons. One is “head” based; the gift lowers the giver’s tax burden. The second is “heart” based; the gift makes a positive and desired impact on people the giver cares about. When it comes to creating a lifetime giving strategy for clients, financial planners and estate planning attorneys can—and should—work as a team. Financial planners can help navigate the all-important “heart” of giving to ensure that clients can create the impact they envision.

Why, Who and When

Most of the expert analysis that is published on giving focuses on “what” and “how” questions. Issues commonly addressed are:

• What are the best assets to give away? 
• How do I determine the value of the gifted property? 
• What are techniques I should use to reduce the transfer tax burden of giving? 
• How do I transfer ownership? 
• What tax returns do I need to file? 
• How do I complete a 709? 

These are critically important questions that advisors need to work through in providing expert tax minimization advice to clients. But, in my experience, those what and how questions are secondary to three other, dare I say more important, types of questions:

• Why do I want to make a gift? 
• Who do I want to impact? 
• When do I want that desired impact to take place? 

Among these, while I believe why questions are the most important, I think clients benefit from addressing them after “who” and “when” questions have been first addressed and answered.

Answering “Who” Questions

When it comes to the “head” or logical reasons for giving, there is often math that compels making gifts as soon as possible. And that math is critical. But there is an assumption that must now be addressed. Lifetime gifts only make sense, regardless of the math, if the potential giver wants to impact people or causes other than him or herself and his or her spouse. People who do not care about, or want to impact, other people should not make gifts.

The first question of giving is who do you want to impact? There is a process to determining the answer to these who questions. First, the advisor should have a more “generic” conversation with the client. Those questions should focus on the client’s impact aspirations unconstrained by practicality. The types of questions that are helpful at this stage are:

• Who do you care about? 
• How do you currently use your assets to help those people? 
• If you could do more, would you? What would you do that you are not doing? 
• If money were no object, how would you change the lives of people and causes you care about? 

Once that impact wish list is captured, the second phase of “who” is to test the possibilities and practicalities. That is done through creating a financial plan that separates assets (and income) into two buckets. The lifetime bucket is comprised of the assets and income needed to purchase all the goals of the clients (the couple if the clients are married or the person if unmarried). The assets and income that exceed the lifetime bucket is the legacy bucket. The legacy bucket defines the potential impact the client(s) can make on those people and causes they care about. Presuming the plan provides a legacy bucket, the clients can begin to define, monetize and prioritize that impact wish list, determining what impact they want to make on the people they care about. Once that is established, the conversation needs to move onto the second set of critical questions: those of when.

Answering “When” Questions

Once the clients determine who they want to impact, how that impact works and how much it costs, they need to determine when they want that impact to take place. These when questions are some of the most subtly important and least addressed questions in preparing an impactful wealth strategy. For example, it is incredibly common to have an impact wish list that is in complete alignment with the clients’ “who” goals (they want the children to be impacted) but in utter misalignment with “when” goals (they have a plan that will leave the assets to the children when they die; at a time when the children will be too old to make the desired impact).

The most common reason for a plan that misses the mark on timing is fear. Clients don’t give away assets that could make the desired impact at the right time because they are scared that they will run out of money. Again, that’s why an analytical process around giving is critical; the division of assets into lifetime and legacy gives clients the emotional freedom to use the legacy assets solely for the benefit of others, knowing that the lifetime assets will provide for all their personal goals. And then the plan can allow the clients to determine which of their legacy goals can be met under the timing the client desires. So once the client has an in-depth legacy strategy that provides mathematical evidence that the clients can impact who they want, when they want, and clients therefore determine what they can do, it is important for the clients to take a step back and answer the most important question: should they make that impact through a gift?

Answering “Why” Questions

What we have done so far in the process is to collect all the impact possibilities and help the client determine which of those, under the assumptions in the plan, work. But there is a difference between what can be done and what should be done.

There are several historical lessons about the damage that unearned wealth can cause to its recipients. One such lesson is the statistics surrounding lottery winners. For example, one study shows that one-third of lottery winners file for bankruptcy between three to five years of winning. A second study finds that 70% of lottery winners lose all their winnings within 5-7 years. But it’s not only lottery winners that provide such dire financial failure numbers. It is estimated that 90% of wealth is lost by the third generation of inheritors (in fact, the saying “shirtsleeves to shirtsleeves in three generations” is so common among cultures, that it has been called a “universal truth” and a “global phenomenon”).

As numerous studies focus on the commonality of the problem, as many try to determine the root cause: why does so much wealth get wasted? While there are several theories, there tends to be two common themes: (1) failure to place meaning to money and lack of positive financial values; and (2) poor readiness to make intelligent financial decisions and weaknesses in financial governance.

Going back to our core question—do I make a gift—it is critically important for the giver to first determine what money means to him or her. What values does the client want furthered by money? For example, if a client believes money’s purpose is independence, that client would want money spent in a very different way than a client who believes money’s purpose is enjoyment. Or opulence. So before making any gift, clients must first define what they believe is the purpose of wealth. Once that is determined, clients must ask themselves how important it is to them that gifted money be used for that purpose.

For clients that either are not worried about their purpose or trust that their children’s purpose will be aligned with theirs, they can make a gift that allows the child to determine how the property is used. But for others that have deep concerns, they generally give the property in such a way that constrains the use of the property. The most common recipient of the property is a trust that provides standards that align with their purpose and names an independent trustee to ensure that such standards are followed.

The other, more common, concern in giving property away is readiness. A gift should only be made if the recipient has the expertise and skill to manage the transferred property. If the recipient lacks that skill, again, a trust can be created to ensure that an expert can make critical financial decisions in the best interests of the person who the donor wants to impact.

Conclusion

Making gifts requires an alchemic blend of head and heart analysis. Gifts should be considered when the math dictates that a failure to act will cause undue taxation. But then, regardless of the math, giving property away requires that “who,” “when” and “why” questions are uncovered and answered. Once clients define the impact they want to make, only then should gifts be made that align with that impact.