My 500-year estate plan » PRINT

By Paul Merriman
September, 2005

Paul Merriman's estate plan is the topic of Chapter 16 in his book, "Live It Up without Outliving Your Money," published in 2005 by John Wiley & Sons. In this article, Paul summarizes that discussion and adds some new material.

Most successful investors will end their lives with surplus assets they did not need. The remaining sums will range from perhaps a few thousand dollars to many millions. Over the next few decades, these surplus funds will amount to trillions of dollars. What happens to this wealth will have a potentially enormous effect on our economy and our society as well as our children and grandchildren.

It's easy to leave our left-over assets to the succeeding generations in our families. For many decades the "default" core estate plan for many people has followed a formula: Pay your debts, support a few favorite causes and then divide the rest equally among your offspring.

But attitudes are gradually evolving about the best way to leave money to our heirs. I must admit that my own views have changed over the years.

In my investment workshops I have begun asking the audience, which typically includes many retired people, whether or not they have a pension and whether those pensions make them feel financial secure. Almost always the answer is yes. I then ask how many of them would have preferred to receive a lump sum check when they retired - but no pension. That concept doesn't win a lot of enthusiasm.

Yet I have found that it takes only a few more questions to ascertain that the majority of parents in the room have made wills designed to essentially give their children big lump-sum checks when the parents are gone. Few of these parents seem to have thought about the fact that their wills provide for a future transfer of wealth in a form that the parents themselves find wanting.

In my own case, after considerable thought I have decided I don't want my estate to simply write large checks to my children and grandchildren, as much as I love them.

My top priority is to see that my wife has adequate capital to live well for the rest of her life. My will provides for that, and she is in full agreement with the rest of my estate plan, which is the substance of this article.

I believe my plan will let me leave money so that my intended results are virtually guaranteed long after I am gone.

I devised the first part of this plan in the mid 1990s, when my grandson Aaron was a few months old. I had five ambitious goals. First, I wanted to make a one-time investment that would "buy" Aaron a comfortable retirement starting when he reaches age 65. Second, I wanted to make sure that the money will be there for him no matter what. Third, I wanted no taxes on the growth of this money or the income it generates for 65 years. Fourth, I wanted at least $20 million from this investment to go to charity someday. And fifth, I wanted to do all this with a one-time investment of only $10,000.

That sounds like a tall order, but with the help of some good professional advisors I found a way. (I did pay about $1,000 in legal fees in addition to the $10,000 investment, so to that extent I might have fudged on my original goals.)

I learned that with the help of a trust and a variable annuity, Aaron and I could accomplish together what neither of us could do alone. He has the time that I don't have. I had the financial resources that he didn't.

What I did was make a one-time gift of $10,000 to Aaron. Legally the money was his to spend if he wanted to. But as he was only a few months old, there was not much danger of that! After the money remained in his possession for 31 days, the money went into an irrevocable trust for Aaron's benefit. It is invested in a variable annuity, compounding with taxes deferred. Under the terms of the trust, Aaron cannot touch the money for any purpose until he is 65. His father, Jeff Merriman-Cohen, is the trustee and chose to invest the money 100 percent in equities, half in U.S. funds and in half international funds.

In the past, similar investments have grown at a rate of more than 11 percent a year. If this does the same, by the year 2059 when Aaron is 65, the annuity account will be worth around $10 million. At that time he will begin receiving annual payments equal to 7 percent of the trust's value. The payments will continue - and presumably grow - for the rest of his life.

At the end of Aaron's life the remaining trust assets will be given to tax-exempt organizations to be chosen by the trustees, which could be his children or even his grandchildren. If Aaron lives 20 years beyond the point that he begins collecting and if the investments continue to earn 11 percent or more while paying out 7 percent, the trust should grow to be worth more than $20 million by the time he is 85.

That is an awesome result from a one-time investment of $10,000.

The projected payment to Aaron of $700,000 in the first year sounds impressive. However, assuming an inflation rate of 3 percent, that would be worth about $135,000 in 2005 dollars. While that won't make Aaron wealthy, it's certainly a very comfortable supplement to whatever he can set aside for himself.

When I put this plan together, friends and some professional advisors told me I was making a big mistake. They didn't think I should lock up money that Aaron might need urgently before he is 65. Some people couldn't believe I would fail to provide for Aaron's own children and that I'd make a plan that would give him nothing at all if he lived to be only 64.

While those are valid criticisms, I believe anybody who won a lottery to be paid out at the rate of $700,000 for 20 years would consider that a stroke of excellent fortune. I have essentially given my grandson that winning Lotto ticket, with two bonus features: The payments will never run out and they are likely to get bigger over time.

I am confident that Aaron's father (my son, Jeff) will be able to help with any urgent needs while Aaron builds up his own financial strength. And I believe this arrangement gives Aaron an incentive to take care of himself and do his best to live a long, healthy life.

Any reader who would like to do something similar will find the copies of the trust document online. I don't offer this in order to give legal advice, and it should be used only as a starting point for discussion with your attorney and financial advisor. You can find a copy of the document as part of an article on irrevocable trusts here.

The principal in the trust I created for Aaron will be disbursed at the end of his life, and the trust will end. For my four children, I've devised what I call my 500-year plan. Here's how it goes:

At my death, my estate will create four charitable remainder trusts, one for each of my children. The money will be invested for moderate growth with only moderate risk, in a portfolio to be made up of 60 percent equity funds and 40 percent fixed-income funds. Each year, the trustee will pay 5 percent of each trust's assets to the beneficiary. I intend and hope that this moderate distribution rate will allow the portfolio (and thus the payments) to grow at a rate faster than inflation even after expenses.

As with Aaron, I have set up these trusts so that the principal is protected from lawsuits, divorces and spending sprees.

At the death of each beneficiary, the assets of the trust will go to the Seattle Foundation, which will continue with a similar investment plan and will distribute 5 percent of the trust's assets each year to charities that my wife and I have designated.

I chose the Seattle Foundation because it is a convenient and reasonable-cost way to provide charitable gifts long into the future. If any of the organizations we have designated cease to exist, the foundation is directed to substitute another organization of similar goals. In effect, I'm buying a team of people to do their best to make sure my wishes continue to do what I want them to do regardless of future developments that I cannot possibly anticipate.

This is a permanent arrangement without an ending time. I call it a 500-year plan because the projected numbers are so hard to believe after that.

Let's assume that I leave $1 million at my death to each of these four trusts and that each year after expenses and the 5 percent distribution, the assets grow by 2.5 percent, adjusted for inflation. The inflation adjustment lets me think about the projected results of this investment in constant dollars that I can understand. So, if the first payment to one of my children is $50,000, a later payment in these projections of $100,000 would represent twice as much real wealth.

By crunching a few numbers I can calculate that 25 years after my death, the projected constant-dollar payment would be $92,697, an increase in real terms of 85 percent.

I expect my two younger daughters to survive me by about 50 years, by which time they would each have a constant-dollar annual stipend of $171,855.

Sixty years after my death, my $4 million of initial bequests would be worth about $17.6 million and would be generating about $880,000 a year. By 122 years after my death the annual payment to charities would grow to $4 million, meaning every year charities would get the entire amount of real wealth that I left in my will. The numbers keep growing. By 250 years after my death, the annual payout would be $96 million. After 500 years, this money would annually generate $25 billion - or more than 6,000 times the value of the $4 million that I left to the four trusts.

Although my plan will give income to my children as long as they live, it won't come close to providing everything they will need. It's designed to be the frosting, not the cake. I hope this income will let them do things they might not otherwise be able to.

The two essential elements for a plan of this nature to work are good investments and a trust document. To learn what I consider good investments, I suggest you read three articles at FundAdvice.com: "The ultimate buy-and-hold strategy," "Retirement: When your portfolio starts paying you," both of which I wrote, and "The Perfect Portfolio" by my son, Jeff.

The trusts I used will be established by my will, and I have made the relevant part of that document available online for whatever help it might be to readers who wish to do something along these lines.

I chose the Seattle Foundation to administer this program, and I believe other community foundations can offer similar help to people who live within their service areas. Another organization that could play a part in such a plan is the Vanguard Charitable Endowment Program, a tax-exempt donor-advised fund that's affiliated with The Vanguard Group.

Using combinations of Vanguard's low-cost index funds, this program allows individuals and estates to open accounts for as little as $25,000 and to distribute the earnings and principal of the accounts to tax-exempt organizations chosen by the donor.

Full information is available online at vanguardcharitable.org. The Vanguard program can't be used to channel money to your children or to any other specific individuals, since its grants can be made only to recognized tax-exempt organizations. But the program can be the ultimate beneficiary of a charitable remainder trust. That would ensure that your investment and donation wishes were carried out.

I know that my estate planning ideas aren't suitable for everyone. But I hope they encourage you to think "outside the box" about the results you want from whatever assets are left after you're gone.

In my own case, although I can't ever know the ultimate outcome, this planning has given me an enormous amount of satisfaction. I am very pleased to know that the financial results of my lifetime of work will continue to benefit my children, my grandchildren and the world that I love for as far into the future as anybody can see.

Editor's note: Paul's 500-year plan described in the newsletter Bottom Line Personal in August 2005.

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