Managing Financial Ties to Your Kids

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Financial Responsibility

After making the initial contribution, the family has a menu of options similar to a 401(k) plan that allows it to choose between aggressive, conservative, or balanced investment vehicles. Collins likes the American Endowment Foundation, whose open architecture lets donors choose any investments they want, including individual stocks.

In addition to themselves, parents can give grown children control over making grants and can also name successors to take control after their deaths. Each year, the family would meet to decide how that year's contribution is used. The DAF cuts the check, sends it out, and files the required paperwork.

Family foundations can also serve as a tool for teaching children a sense of financial responsibility, laying the foundation for a healthy attitude about money matters throughout their lives, says Collins.

A Family Business

A parent who wants to transfer a portion of a business to a child can set up what's known as an intentionally defective grantor trust, which purchases an interest in the business. The income from the trust can either be distributed as it's generated or held until a grown son or daughter is ready to manage it, Chasen says. While it's a complete transfer for estate-tax purposes, the senior generation is still responsible for the income tax liability.

Setting up the trust doesn't have to entail transferring operational control of the business, Chasen points out. Once the parent dies, the trust is no longer treated as a grantor trust, but how it gets taxed by the government from that point on still isn't clear. The trustee the parent appoints to run the trust could be a sibling, a close friend, or a professional trustee. The costs to set up and run it are questions that each grantor needs to ask when talking with a prospective trustee.

There is no one-size-fits-all rule for setting up this kind of structure. "The question is what is appropriate for these people, given their values, their intentions, their risk comfort level, and the assets that are involved," he says. It's important that, he adds, that parents work with financial advisers who know what they're doing and who take the time to get to know their clients.

To bring down the taxable portion of an estate, parents can put life insurance policies into a trust, says Glenmede's Aulino.

Legacy Statements

There are also tricks to turning the $1 million lifetime gift limit into more money that's equally protected from the gift tax. One popular strategy is to set up a simple lifetime gift trust, to which both a husband and wife contribute their entire $1 million lifetime gift exclusion allowance, ideally well before they retire.

"If you live for 15 to 20 years from now, that $1 million can generate another $4 million to $5 million, which is also excluded [from your uniform credit]. People in their fifties can see that multiplied while they're alive, so they can have the satisfaction of knowing the government can't touch [it] with a 10-foot pole," says Aulino.

Beyond the purely financial issues, estate planning can also be used to pass down values and life lessons to successive generations.

Chasen routinely has his clients prepare a personal legacy statement. Though not strictly a legal document, it allows parents to stipulate certain conditions for an inheritance. One of his clients was a matriarch whose children had a lot of hostility toward each other. In her legacy statement, she said it would hurt her to know she had failed as a parent if her kids couldn't find a way to get along with each other after she died.

One point that Chasen never tires of making is that financial planning is about more than just the treatment of assets. It's not just about the money, he says. You have to take "into account the human beings that are involved."

Bogoslaw is a reporter for BusinessWeek's Investing channel.