17 minutes | Jun 5, 2019

The Danger of Direct Distributions

Death is a major taboo. No wonder that most people want to be quick and to the point when dealing with who gets what when they die. In this episode, you’ll learn three key insights that are critical to doubling the lifetime value of your accounts and dramatically increasing the value of your practice. Lean in as Paul shares a story about how a direct distribution (which sounds simple on the surface) can actually turn into a fiasco in real life. Make this information work for you so you can double the lifetime value of your accounts and increase the value of your practice.     The Danger of Direct Distributions This is the show devoted to financial advisors, fee-based investment advisors, and wealth managers who want to increase the value of their practice by attracting more premium clients and reducing client attrition. Now if this sounds like you, all you need to do is lean forward and listen carefully. Family Dynasty Planning is central to our discussions, and you and I will also explore other fascinating and important topics such as attracting wealthy clients, dealing with increasing competition, continuity planning and succession planning, growing and building your business, understanding the true worth of your business, and leveraging technology, just to name a few. In this episode, you’ll learn three key insights that I believe are critical to doubling the lifetime value of your accounts and dramatically increasing the value of your practice. First, you’ll learn what an outright distribution in a trust or will is. You’ll learn how to spot this in a client’s estate plan document. Next, you’ll find out why outright distributions don’t work, especially when dealing with significant wealth. Finally, you’ll learn how talk to your clients who have Wills or Trusts that give everything outright to their heirs. Please read carefully. Because this episode could have a significant impact on your future success.   Squabbling over $30 million I’m in Probate Court in Phoenix, Arizona. “Objection!” I said, as I stood up to break the opposing attorney’s rambling opening argument. “None of what the opposing counsel is saying is relevant to today’s hearing,” I said. The opposing attorney was an overweight man who loved to hear himself talk. Our clients were the two beneficiaries of their parents’ trusts. The opposing attorney represented the son and I represented the daughter. My client –let’s call her Clarissa -- had flown in from New York to attend this hearing. Clarissa was wearing a nice dress that looked like it was new. The hearing on this occasion concerned Clarissa and her brother’s dispute over division of their parents’ $30 million worth of investment properties. They were arguing over who should receive a particularly lucrative strip mall. I had tried to convince my client and the other attorney that it didn’t really matter who received what asset, as long as they each received roughly 50%. After all, whoever received the less lucrative commercial property could simply sell it and purchase a more profitable one. But they each had a story about how their father had promised that strip mall to them. Never mind that this was complete hearsay and is not admissible in court. This case dragged on for over THREE YEARS. Clarissa eventually fired me and hired two subsequent lawyers. The brother did the same, but I think he went through three more lawyers. During this entire time, the commercial properties had no clear owner. Tenants started to leave because the properties were not being properly maintained. Also, during this time, both the daughter and the son were anxiously requesting partial distributions from the trusts. They each went on vacations (though not together, I’m sure). They were spending the money as fast as they could get it. But because the properties were tied up in litigation, they were angry at each other for not allowing the properties to get sold faster. This story highlights a number of issues involved when a successful business owner doesn’t think through how the businesses will be transferred upon his or her death. In this case, $30 million of commercial properties were held in a limited partnership in order to save on estate taxes. Over the years, the estate attorney had focused solely on the estate tax issue, without any thought to the other details of what would happen when he client eventually passed away.   What’s a “direct distribution,” and why it matters … There were MANY bad results from this poor planning. However, we’re going to focus on what happened as a result of the trust and other documents providing for an immediate, outright distribution to the two beneficiaries. What do I mean by “outright distribution” or “direct distribution?” I mean that the trust documents simply say who is to receive what. PERIOD. There is no provision that the assets continue to be held in trust. There was no way of resolving conflicts outside of court. The drafting attorney, and the parents, ASSUMED that their kids would simply be able to work together and then receive $15 million of properties and be happy. Who wouldn’t be happy with a $15 million inheritance, right? What’s wrong with this? Most heirs go crazy when they know they are inheriting money. They figure out how to spend the money way before they actually receive it. There’s nothing wrong with this, per se. Spending money isn’t inherently evil. But these heirs usually don’t think about the second and third order consequences. Sure, they get to buy a nice house and go on some great vacations. But they also often end up getting to their later years without adequate retirement savings.   Clarissa was no different. She spent the money as fast as she could get her hands on it. She would now be retirement age. I haven’t spoken to her for years, do I don’t know her current financial situation. But I do know at the rate she was spending, she probably has only a small fraction of the $15 million that she inherited. So, again, an outright distribution is when the trust or will simply says that the assets are to be distributed immediately to the named recipients. If you’re talking about less than $500,000 that may be the best approach. Because it’s simply not cost-effective to hold less than $500,000 in trust indefinitely. The trustee fees start eating into the principal. Outright distributions simply don’t work when dealing with large amounts of money due to a psychological condition known as Sudden Wealth Syndrome. This isn’t a formal diagnosis; at least not yet.  But few people would deny that it exists. You can hardly go through a checkout line at a grocery store without seeing a tabloid about someone who won the lottery and lost the money. Or a successful celebrity who got into financial troubles or went nuts for no apparent reason. The reality is that coming into a sudden financial windfall changes a person’s reality. The financial windfall is usually occasioned by some sort of loss. It could be loss of a loved one. It could also be a divorce. Either way, all of a sudden, expenses that previously seemed impossible are now affordable. And people come out of the woodwork asking for money. Life is more complicated, with more to manage. It’s hard to know if the people around you care about you as a person or as a deep pocket. Also, when a trust or will provides for an outright distribution, it creates a sense of entitlement. And this is technically correct. The person is legally entitled to the inheritance. But, as the famous economist Adam Smith said, “Entitlement is such a cancer, because it is void of gratitude.” The person who is entitled to an outright distribution has no gratitude for what the money means. How hard did the parents work to build that wealth? What did the parents want to be done with the wealth? The child doesn’t care. She only cares that she’s named in the trust document and is entitled to the money. And she wants it NOW!   How to bring up this issue to your clients Finally, here’s how you can talk to your clients whose Wills or Trust provide for outright distributions to their heirs. The difficult thing here is that so most people have been indoctrinated to believe that if they have a Will, they have done more than most people to prepare for their eventual death – which is true. And they have been taught that Trusts avoid probate – which is usually true. We’re also living in an age when people distrust institutions – probably including representatives of financial institutions such as the ones you work with. People now tend to trust a total stranger to drive them somewhere (using Lyft or Uber), though they don’t trust government or religion. So, the solution is frankly to take a long-term team approach. First enlist the client’s estate attorney. But, many estate attorneys are cynical and don’t believe Family Dynasty Planning is possible. If that’s the case, bring me in or enlist another estate attorney who believes in Family Dynasty Planning. After you have an estate attorney on board, get a CPA on board as well. THEN, you’re ready to schedule a conference call with your client. And don’t attack the client. It may take time to raise the issue and have it marinade.   EPISODE REVIEW So, let’s do a quick review of the insights you and I discovered in this episode. First, you learned that an outright distribution is when the heirs are entitled to get their shares immediately. The shares are not held in trust on an ongoing basis. Second, you learned why outright distributions often don’t work. It has to do with psychology. Because the heirs are “entitled” to get their distributions, they have no gratitude or appreciation for what they are to receive. As a result, they are more prone to spend the inheritance quickly. Finally, you learned how to go about raising the issue of Dynasty Family Planning to
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