The Giving Dilemma. Prepared by. In this white paper. Amir Mossanen SVP, Wealth Advisor, Wells Fargo Private Bank

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1 The Giving Dilemma Prepared by Amir Mossanen SVP, Wealth Advisor, Wells Fargo Private Bank In this white paper 1 Talk to your children about both the challenges and opportunities wealth presents 2 Help your children define their dreams 3 Make trades together 3 Build in some safeguards 4 In summary

2 The Giving Dilemma For the remainder of 2012, high net worth families have the exceptional opportunity of gifting just over $5 million per parent as part of their lifetime gift exemption. To put this gifting allowance in perspective, just three years ago, this limit was as low as $1 million. By all accounts, this increased exemption has been a rare tax relief to high net worth families. Gifts beyond the exemption amount are taxed at the unified transfer tax rate, which is currently 35 percent and will revert to 55 percent unless Congress is able to reach a new resolution prior to year end. So, why aren t more people taking advantage of the lifetime gift exemption? In the many discussions I have had with high net worth families, I realized that these families have considerations far greater than taxes as they think about gifting and wealth transfer. While very few families like the idea of paying transfer taxes, such tax considerations pale in comparison to the concerns that parents have over the effects the transfer of significant wealth would have on their children. Many parents are rightly worried that if their children knew they were to be recipients of fortunes, they would lose their motivation to work and would become reliant on family support. Some of the most common concerns that wealth parents share include the following: 1. Too much emphasis on material things 2. Naïve about the value of money 3. Spend beyond their means 4. Initiative ruined by affluence 5. Won t do as well financially 6. Hard time taking financial responsibility The Williams Group study of 3,250 high net worth families across the world revealed that approximately 70 percent of wealth is lost within one generation 1 of inheriting it, while The Wealth Counsel quotes the statistic that 90 percent is lost by the end of the third generation. 2 It is not surprising that faced with these odds, parents are conflicted when it comes to transferring significant wealth to their children. On the one hand, they would like to see the wealth they have generated and worked hard to protect to be put to good use and to benefit those whom they love the most. On the other hand, parents are worried about the destructive and negative effects such wealth can have on their heirs. We believe that doing nothing and hoping that the heirs will figure it out for themselves is definitely not the answer. The phenomenon known as Sudden Wealth Syndrome describes the potentially devastating effects of not being trained or skilled at managing a large and unexpected injection of wealth. This syndrome helps to explain why so many lottery winners end up broke, but can equally be applied to heirs who were otherwise ill-prepared to step into the shoes of their parents. What we advocate at Wells Fargo Private Bank is to incrementally but actively prepare your children for both the responsibilities and the opportunities that inheriting wealth can bring. The process of preparation may take several years and should include a combination of tailored formal education and practical hands-on experience. However, there are some basic steps that all families can follow on an ongoing basis. 1. Talk to your children about both the challenges and opportunities wealth presents You may hope that your children will remain unaware of the extent of your wealth, but it is not something you can sweep under the rug. Nonetheless, we often find that many families have a hard time bringing up the subject of money in a productive way. Often parents find that their children seem profoundly disinterested in the topic to begin with, thereby making the parents task that much harder. The task may be made harder by the fact that children may experience these talks as lectures, and if they are in their teens or older, may have no interest in being lectured to. One way to overcome this perception is to have your children actively participate in the discussions as opposed to having to passively listen. As an alternative, try asking more questions to engage your children in the conversation. Here are some that I have found useful: n What do you like best about the fact that we can afford to have so much? n What would you miss the most if we could no longer be this fortunate? n What would you do if you won the super lotto? n What do you know about how I earn my living? n What sacrifices do you think I had to make along the way to get us here? The Giving Dilemma 1

3 n How would you have done things differently if you were in my shoes? n What sacrifices are you not willing to make in order to create your own wealth? n What do you think are some of the challenges you ll face in preserving your standard of living? n How would you like me to support you? In thinking about what questions to ask, be mindful not to ask questions that might appear to be loaded or critical. For example, a common question for a parent to ask is: How do you think you are going to be able to pay for your lifestyle if you become a.? While phrased as a question, it is not really an offer to help but a judgment on the chosen profession or career. An alternative would be to help break the issue down through a series of questions: n Have you thought about what kind of lifestyle you would like to have when you are independent? n Do you have an estimate of how much it is going to cost you to maintain that lifestyle? n Have you had a chance to find out what a. earns per year? n Are you comfortable making some potential sacrifices in your lifestyle if necessary because of your choice of profession? At this point, a parent has the ability to offer guidance and advice without taking over the process. It is not uncommon for successful parents to have take charge personalities this might be, in fact, a reason for their success. However, it could leave children with a lack of desire to take responsibility for their own future as they have been accustomed to someone else taking charge for them. This is why it is often helpful to ask a neutral third party to help facilitate such discussions until there is a good working relationship between generations. The role of the facilitator is to set the stage so that there can open, free and productive communication and a sense of respect, commonality and unity. As much as you can, try not to tell your adult children what they should be doing unless they ask for your advice. This may be very challenging as a parent, but for wealth transfer to work effectively it is important for there to be a partnership between generations. Partnerships need to be born out of respect for one another and a commonality of visions and goals. Adult children often want to assert their independence and generate their own sense of self and, thus, may view a parent s advice as an imposition of their will. A consequence may be that they resent the money and engage in potentially destructive behavior. 2. Help your children define their dreams Once you have created a healthy rapport with your children regarding money, wealth and finances, you can begin to support them in creating their dreams and defining their goals. Ultimately, these are what motivate people. Conversely, a lack of dreams and goals results in a loss of motivation. Parents drive to create family wealth may have been as a result of a dream for a better life. Alternatively the desire to cease living pay check to pay check may have motivated them to work hard, take risks, be entrepreneurial and create wealth. Financially successful parents need to understand that their children may not have had the same experience growing up as they did, and are therefore unlikely to have the same motivations. An example is the successful entrepreneur who was complaining that his children don t have the hunger he did when he was their age and how he found this to be disappointing. I reminded him that he worked very hard so that his children would not have the same hunger and hardship that he had suffered and so it was unfair to blame his children for the environment that he created. Some parents try to artificially create that sense of hunger in their children by rationing their allowance and making them work through school in an attempt to make them live more normal lives. While this strategy may sound appealing, in our experience it is an inherently flawed approach for many high net worth families who are not normal by intent and may be putting a great deal of effort into wanting to preserve their wealth so that they do not become normal. A return to normalcy would in effect mark the failure of the wealth preservation strategy. Furthermore, it does not address the need to fight the negative effects of Sudden Wealth Syndrome. In our view, dreaming big ambitious dreams and then working hard to turn dreams into realities is a more reliable way of generating motivated and productive members of society. The parent s role in dream creation is very important, as money given to a child without a dream can create an illusion that money is a goal in itself. With their goals clearly defined, guide your children toward what they need to learn, how they need to behave, and who they need to partner with in order to make their dreams come true. 2 The Giving Dilemma

4 3. Make trades together As the partnership between generations is being formed, it is a good idea for there to be clear understanding of what each party expects of the other. While parents may love their children unconditionally, not all would say that they would unconditionally support their children. In truth, we all have expectations of one another and, in the confines of a family system, these expectations are often poorly expressed and this can lead to disappointment and frustration. Making a trade can help clarify expectations. Making a trade is no different than making a promise, where each party agrees to fulfill their obligation. For very young children, it might be something as simple as I will get you dessert once you have finished your dinner. For there to be integrity in your family system, you have to keep your word. As children get older, the conditions may change but the principle holds true. While this may appear to be a cold way to deal with loved ones, transparency and honesty actually lead to the best relationships, and clarity provides a good environment for there to be trust and respect among family members. I often encourage siblings to make trades with one another, teaching them to share responsibilities and work together, practices that will be useful when it becomes their turn to be stewards of their family s wealth. However, be mindful of the kind of trades you make with your children. The best trades are ones where there is a clear and visible link between what is being asked and what is being given. Going back to our earlier example, the parent agrees to give dessert to the child if the child finishes his or her dinner. For young children, the link has to be obvious and close in time, like dessert being offered immediately after the dinner is done. The same trade would fail if you were to say to a young child If you finish your dinner tonight, I will buy you dessert tomorrow night. As your children mature, trades naturally become more complex and can be more subtle. It is important to remember that for relationships to work over the long term, the format of a trade should be preserved. A trade takes place when both parties willingly make an exchange, in contrast to a reward, where one party judges the behavior of another and then decides whether to give something as an expression of their approval. Rewards work effectively with small children, but in the context of adult children, they can be construed as manipulative and disempowering. To a child, a trade signals that what the child is doing has value to the parent and so, in exchange, the parent is willing to do something for the child. This approach can help empower the child and give a sense of fulfillment and confidence. It also may create a greater sense of independence in the child as the relationship between parent and child is no longer one of a giver and a taker. There are many simple trades that a parent can make to empower their child. For example, consider having your ten-year old research where he or she would like to spend the family vacation, and present it to you in a comprehensive and detailed way, with cost estimates, travel schedules, photographs, etc. With this type of trade, your child can learn useful life skills about how to effectively gather information, present ideas and make informed choices. In exchange for doing quality research and making your life easier, you, as the parents, can agree to pay for the vacation. In this simple example, a load has been lifted from the parent, the child has learned to take responsibility and be motivated while being useful to the rest of the family, and everyone can be excited about the family vacation. An added advantage may be that the child will have had to take into consideration the distance to the destination and has a vested interest in making sure the vacation is good for the entire family, eliminating the much dreaded question, are we there yet?. This same process can be applied to more serious family decisions as children mature and become more capable of forming hypotheses and presenting their ideas. The process can provide a framework for children to be able to share opinions on what to do with the family business or other family assets, and for them to be rewarded for the contributions they are making. 4. Build in some safeguards Steps 1 to 3 are all about preparing your children to be able to make smart choices for themselves, but even if you have followed these steps and decide, as a result, that you should make a significant gift to your heirs, we recommend that you work with a good planner to establish some safeguards. Gifting does not necessarily mean handing over control to your children. A common concern that parents have about gifting is the loss of control coupled with the parents lack of confidence that their children will make the right decisions. One common safeguard is for the gift to be made to a trust for the benefit of your children, where neither you nor your children are the trustee. The trustee is tasked with the responsibility of managing the assets of the trust for The Giving Dilemma 3

5 the benefit of those to whom the gift was given, namely the beneficiaries. A trustee can be a family member, trusted friend or corporate fiduciary who should have the appropriate skills and knowledge to be able to both manage trust assets and coach the beneficiaries. Trusts can have provisions that allow for the trustee to be changed, thus giving the beneficiary the opportunity to assume the role of trustee at some point in the future. A good interim step is for your child to act as a co-trustee before being appointed sole trustee. This apprenticeship period is very important and allows your child to learn about important concepts such as investment management, real estate, operating a business, and taxes. End notes 1 Preparing Heirs: Five Steps to a Successful Transition of Family Wealth and Values, Vic Preisier and Roy Williams Why Most families Lose Their Wealth by the Third Generation, Tim Voorhees, wealthcounsel.com An alternative safeguard is for you to gift a portion of the assets and loan additional assets to a trust for the benefit of the child. While the gift is irrevocable, the loan could be drawn up to include certain conditions (known as loan covenants) that have to be satisfied or the loan would be called. For example, in order to ensure that the child makes investments that are prudent, the loan covenants would require investments to be welldiversified, for bonds to be of a certain quality and assets to be held at a reputable firm. If any of these covenants were breached by the trustee, you could call the loan and thus claw back assets from the trust and the child. In summary Ultimately, gifting is about more than passing assets from one generation to the next. It is about giving future generations the opportunity to lead extraordinary, productive, meaningful and enriching lives. Minimizing the negative effects of Sudden Wealth Syndrome while preparing your children to make the most of the opportunity with which you are presenting them requires a team effort, commitment from all parties and probably a lot of patience. Fortunately, this is not an endeavor you have to undertake on your own. Wells Fargo has been working with high net worth families for many generations and has developed educational programs, processes and tools to help your family have a lasting legacy and achieve your multi-generational goals. 4 The Giving Dilemma

6 Disclosures Wells Fargo Private Bank provides products and services through Wells Fargo Bank, N.A., and its various subsidiaries and affiliates. The information and opinions in this report were prepared by Wells Fargo Private Bank. Information and opinions have been obtained or derived from sources we consider reliable, but we cannot guarantee their accuracy or completeness. Opinions represent Wells Fargo Private Bank s opinion as of the date of this report and are for general information purposes only. Wells Fargo Private Bank does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. This information is provided for education and illustration purposes only. Wells Fargo and company and its affiliates do not provide legal advice. Please consult your legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared Wells Fargo Bank, N.A. All rights reserved. Member FDIC. NMLSR ID TPB01074 ( /12)