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    January 2013
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    Stewardship As An Element of Estate Planning

    Don Shaughnessy

    Money has value only in use. Dynamic rather than static money. In terms of advancing the wellbeing of a family, taken as a whole, some assets that the parents own are sterile.

    Good estate planning recognizes that.

    If a parent owns financial assets that exceed the amount needed to fulfill their life plan, there is an opportunity for beneficial planning on a multi-generational basis. The excess, once defined, is a portfolio that the parent holds as “a steward.” The parent has title to assets but will spend neither the income nor the capital in their lifetime.

    Stewardship is complicated. Wikipedia offers 12 different ideas relating to it. We only need to know about the idea of a steward. There are at least five definitions. None quite suit. A simplified amalgam of the definitions serves our purpose.

    “A steward is a person who owns and manages assets on behalf of others.”

    If the parent invests according to a risk profile appropriate for their age, they will tend to own fixed income assets. For the part of the portfolio they need for their security and lifestyle, that is reasonable. But when the portfolio is larger than the one needed to guarantee lifestyle, the asset mix in the excess portfolio is flawed.

    This observation leads to an interesting place. You can deal with the excess asset creatively and beneficially once you can quantify it. You do that by building a model to show future income, future taxes, future expenditures, future inflation, future capital transactions, and as a result, future assets.

    The advantage to do so is that the parent can see how their future financial well-being and security will evolve over time. Typically the client is concerned about the ratio of financial assets to the annual spending that these assets must develop.

    The model should deal with important non-recurring events and some probabilistic ones:

    • Sale of assets “owned to be used” rather than to produce income, (cottage, ski chalet, collectibles)
    • Inheritances
    • Negative events like home care or special medical expenses.
    • Unusual expenditures. In 1990 I had a client who wanted to build in the purchase of a Dior gown for the New Year’s celebration at the turn of the millennium. She did it too.

    Building such a model serves several useful purposes:

    1. The client can observe the effect on assets as cost of living changes with inflation. The inflation step is crucial and is not as easy as inflating today’s values by some arbitrary or even well supported number. Expenditures are layered and each layer behaves differently with age. In addition, inflation is not one-way. Cost may inflate, but the ability to spend deflates.
    2. Modelling requires understanding. Involve the client. For example, care is required in projecting some expenditures. One difficult condition involves currency exchange rates if a meaningful share of expenditures is in non-Canadian currency.
    3. The client can test the impact of an adverse medical event.
    4. The client can test the cost/benefit of insuring life, long-term care and critical illness.
    5. The client can quantify the financial effect of disposing of “use” assets.
    6. The client’s stress level reduces in respect to safety/security. They can see the relationship between financial assets, near-financial assets, yield, taxes and cost of living, and they can test under variable conditions.
    7. They can see what assets are redundant

    This method makes the estate a living thing. A dynamic estate allows people to use better judgement in managing investments. They can test and eventually build a web of assumptions around time, yield, tax, inflation and change within which they are comfortable.

    The epiphany occurs when the client realizes that he holds title to all his money but, in reality, he cannot reasonably use some or even most of it. He is “a steward.”

    The discussion becomes two part.

    1. How much of the estate is required to provide for living expenses up to and including the result from some outrageously conservative variables?
    2. How much can the client do without and never notice its absence?

    One client found a set of variables that busted his estate prior to age 100. The assumptions included taxes at one third more than now, inflation at 10% and investment yield at 5%, fully exposed to taxation. By using more realistic variables, principally that investment yields would be at least as much as inflation, an apparent asset surplus arose. It ranged from around $500,000 to more than $2,000,000 depending on the level of inflation. High inflation has a tax penalty.

    The talking points became:

    1. Most people who inherit money are over 50 and often over 60.
    2. By the time children inherit, they don’t need the money. About the only thing they notice is that their tax bill goes up. By doing nothing, sterile assets become a chronic family problem.
    3. In the early years, children give up a great deal of potential to pay non-deductible interest and to pay off debts. Capital for business startups is difficult to come by.
    4. Money injected into their care early can provide years of advancement and many options. A few hundred thousand dollars at 30 is worth far more than a million dollars at 65. Some people see it as insurance against divorce.
    5. Would it not be prudent to use assets as effectively as possible on a family wide basis?

    If you have dynamic information, you make better decisions. This client made several modifications to the “during life” part of his estate plan. None of them benefited him, but then, none of them cost him anything either.

    1. He gave his daughter $150,000 to pay off the balance of a mortgage on a cottage.
    2. He created two trusts, totaling $100,000, for the education of two grandchildren. These supplement RESPs which he funds. The trust assets are tax-efficient.
    3. He loaned his daughter $500,000 to invest. The loan is interest free, is repayable on demand and is well secured. She may spend the income if she wishes. The ability to retract the debt forms part of his emergency fund.
    4. Over the next 10 to 12 years, he will invest in a permanent life insurance policy on his own life. The transferred amount will be $500,000 currently held in fixed income assets. Depending on his longevity, and assuming interest rates remain low, he expects to do better than 4% after taxes as an estate investment. Better than that if rates go up. This also provides him the option to buy life annuities in the future should he want unconditional guarantees on his cash flow.
    5. He will allocate $750,000 of his remaining assets to investments that do not necessarily suit his risk profile but do suit the daughter’s risk profile. These investments are more equity oriented and more tax efficient than the ones he has held in the past.
    6. He will revisit the program at least every two years and, while living, will gradually move the $750,000 tranche to his daughter. Potentially as a gift but more probably by secured loan. (At least in the early years. That decision will depend on his age and health.) If investment yield is adverse, or inflation is high, some or all of this may go back into his income producing asset portfolio.
    7. All other assets are manged to be tax efficient and to provide income that matches his cost of living projection. You do not want to pay tax on income before you spend the after tax amount. If you do receive it then taxes compound.

    Many estates hold sterile assets. These should be managed differently than common practice dictates. Inter generational estate planning is more beneficial for the family than holding everything to the end and investing on the parent’s risk profile.

    The stewardship idea is the key to starting the discussion.

    Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. don.s@protectorsgroup.com

    The MONEY® Network