ESTATE PLANNING TECHNIQUES

"There are very few ways of actually reducing the size of one's estate and thereby the liability for estate taxes without losing total control over the estate."  Unknown

Estate planning for many people connotes the way assets will be disposed of upon death. However, a large part of estate planning consists of the disposition of assets during one's lifetime. There are numerous benefits to making lifetime transfers rather than holding onto assets and transferring them upon death. Furthermore, there are several different methods and vehicles that may be used for making lifetime transfers depending on the desired result. Some of these methods and vehicles include outright gifts of property, transfers of property into trusts, and transfers of property to and interests in family limited partnerships.

In addition to the other estate planning devices described in more detail elsewhere in this web site, you may wish to consider the following:

 "Effective Planning can Keep the IRS Out of Your Heirs' Hair"

All serious planning involves "cause and effect" and is therefore akin to each other.  Therefore, before you can institute an effective estate plan; a short and succinct course in 'planning in general' is prudent and in order.  Please take the time to look at your estate planning process in the same light as if you were the CEO of a multi-billion dollar corporation ready to embark on a new product that can either revolutionize mankind's every day living or be the downfall of your company and the bankruptcy of your shareholders.  Below the author mentions the "KISS" process but we prefer the "3d" approach: Decide, Delegate and then Disappear.  Now that's good sense!

Detailed Planning

By the stage you start detailed planning, you should have a good picture of where you are, what you want to achieve and the range of options available to you. You may well have selected one of the options available to you as the most likely to yield the results required.

Detailed planning is the process of working out the most efficient and effective way of achieving the aim that you have defined. It is the process of determining who will do what, when, where, how and why, and at what cost.

Identifying Key Activities

The first stage in the process is to identify the key actions that need to be performed in order to achieve the Aim of the plan. If these actions are large and complex, reduce them down to a number of smaller key actions.

For each of these key actions, plan out how they will be achieved, working out the time that will need to be taken and the resources that will need to be allocated to achieve the action. This will allow you to calculate the cost of that action.

Prioritizing Activities

Once you have done this, prioritize the actions in order of importance so that you do not waste time on low priority tasks. It can also be helpful to set mock deadlines (allowing appropriate contingency time for overruns and unavoidable delays). This gives a target to work towards.

If some of the actions being carried out depend on the completion of other activities, it may be useful to carry out a Critical Path Analysis. This will show you the minimum length of time that will be needed to achieve the plan, and will help you to decide task priorities. It will also help you to identify the key activities to keep moving when your resource requirements conflict with other managers using the same resources.

Control Mechanisms

While you are concentrating on the actions that need to be performed, ensure that you are also considering the control mechanisms that will allow you to monitor the performance of the activity. These will include the activities such as reporting, quality assurance, cost control, etc. that are needed to spot and correct any deviations from the plan.

Elements of a Good Plan

A good plan will:

Making Effective Plans

The following points will help to make your plans effective:

Evaluation of the Plan and It's Impact

Once you have worked out the details of your plan, the next stage is to work out whether it will work and its impact: often you may find that a plan may have unexpected effects, either positive or negative.

You may also find that when you cost the plan, and compare this against the benefits achieved, that the plan is simply not worth carrying out. This can be frustrating after the hard work of detailed planning, however it is much better to find this out now than when you have invested time, resources and personal standing in the success of the plan. Evaluating the plan now gives you the opportunity to either investigate other options which might be more successful, or to accept that no plan is needed or should be carried out.

Plan Evaluation

There are a number of ways in which you can evaluate your plan:

Assessing Impact

It is important to ensure that you do not rely exclusively on the results of numeric analysis as the basis of your plan evaluation. Many factors which are important to the evaluation of your plans cannot practically be quantified.

These factors include:

Any analysis of your plan must be tempered by common sense. It is much better to change a beautifully crafted plan that analysis shows will not work than deal with the consequences after a failed attempt at implementation.

Decision Theory and Decision Trees

Decision trees are excellent tools not only for making financial or number based decisions where a lot of complex information needs to be taken into account but also in the estate planning arena. They provide an effective structure in which alternative decisions and the implications of taking those decisions can be laid down and evaluated. They also help you to form an accurate, balanced picture of the risks and rewards that can result from a particular choice.

How to Draw a Decision Tree

You start a decision tree with a decision that needs to be made. This decision is represented by a small square towards the left of a large piece of paper. From this box draw out lines towards the right for each possible solution, and write that solution along the line. Keep the lines apart as far as possible so that you can expand your thoughts.

At the end of each solution line, consider the results. If the result of taking that decision is uncertain, draw a small circle. If the result is another decision that needs to be made, draw another square. Squares represent decisions, circles represent uncertainty or random factors. Write the decision or factor to be considered above the square or circle. If you have completed the solution at the end of the line, just leave it blank.

Starting from the new decision squares on your diagram, draw out lines representing the options that could be taken. From the circles draw out lines representing possible outcomes. Again mark a brief note on the line saying what it means. Keep on doing this until you have drawn down as many of the possible outcomes and decisions as you can see leading on from your original decision.

An example of the sort of thing you will end up with is shown below:

Once you have done this, review your tree diagram. Challenge each square and circle to see if there are any solutions or outcomes you have not considered. If there are, draw them in. If necessary, redraft your tree if parts of it are too congested or untidy.

You should now have a good understanding of the range of possible outcomes.

Starting to Evaluate Your Decision Tree

Now you are ready to evaluate the decision tree. This is where you can calculate the decision that has the greatest worth to you. Start by assigning a cash or numeric value to each possible outcome - how much you think it would be worth to you.

Next look at each circle (representing an uncertainty point) and estimate the probability of each outcome. If you use percentages, the total must come to 100% at each circle. If you use fractions, these must add up to 1. If you have data on past events you may be able to make rigorous estimates of the probabilities. Otherwise write down your best guess.

This will give you a tree like the one below:

Note that the tree looks less confused when different colors are used for numbers than for the structure of the tree.

Calculating Tree Values

Once you have worked out the value of the outcomes, and have assessed the probability of the outcomes of uncertainty, it is time to start calculating the values that will help you make your decision.

We start on the right hand side of the decision tree, and work back towards the left. As we complete a set of calculations on a node (decision square or uncertainty circle), all we need to do is to record the result. All the calculations that lead to that result can be ignored from now on - effectively that branch of the tree can be discarded. This is called 'pruning the tree'.

Calculating The Value of Uncertain Outcome Nodes

Where we are assessing the value of an uncertain outcomes (circles on the diagram), we do this by multiplying the value of the outcomes by their probability, and noting the result. The total value of that node of the tree is gained by adding these together.

In the example above, the value for 'new product, thorough development' is:

     0.4 (probability good outcome)     x $500,000 (value) = $200,000
     0.4 (probability moderate outcome) x  $25,000 (value) =  $10,000
     0.2 (probability poor outcome)     x   $1,000 (value) =     $200
                                                             --------
                                                             $210,200
This is shown across our example tree in the diagram below: 

Note that the values calculated for each node are shown in the boxes.

Calculating The Value of Decision Nodes

When you are evaluating a decision node, write down the cost of each option along each decision line. Then subtract the cost from the value of that outcome that you have already calculated. This will give you a value which represents the benefit of that decision.

Sunk costs, amounts already spent, do not count for this analysis.

When you have calculated the benefit of each decision, select the decision which has the largest benefit, and take that as the decision made and the value of that node.

Calculation of decision nodes in our example is shown below:

In this example, the benefit we previously calculated for 'new product, thorough development' was $210,000. This example shows that we calculate the cost of this approach as $75,000. This gives a net benefit of $135,000. The benefit of 'new product, rapid development' was $15,700. On this branch we therefore choose the most valuable option, 'new product, thorough development', and allocate this value to the decision node.

Result

By applying this technique we can see that the best option for us may be to develop a new product. What the analysis shows which we might not have appreciated, is that it is worth much more to us to take our time and get the product right than to rush the product to market. In fact, it is better just to improve our existing products than to botch a new product, even though it costs us less.

Summary

Decision trees provide an effective method of decision making because they:

As with all decision making methods, though, decision tree analysis should be used in conjunction with common sense. They are just one important part of your decision-making tool kit.

 

      An excellent example of "cause and effect" in motion:

Open window (A) and fly kite (B). String (C) lifts small door (D) allowing moths (E) to escape and eat red flannel shirt (F). As weight of shirt becomes less, shoe (G) steps on switch (H) which heats electric iron (I) and burns hole in pants (J). Smoke (K) enters hole in tree (L), smoking out opossum (M) which jumps into basket (N), pulling rope (O) and lifting cage (P), allowing woodpecker (Q) to chew wood from pencil (R), exposing lead. Emergency knife (S) is always handy in case opossum or the woodpecker gets sick and can't work.

 


 

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C. Francis Baldwin
BTGrp2015@gmail.com
Updated Sunday, August 28, 2016