According to P.J. DiNuzzo, founder and lead consultant of DiNuzzo Middle-Market Family Office and author of the Wall Street Journal bestselling book, The DiNuzzo Middle-Market Family Office Breakthrough: Creating Strategic Tax, Risk Cash-Flow and Lifestyle Options for Successful Privately-Held Business Owners and Affluent Families, “Wealth planning uses legal strategies and financial products that are readily recognized and generally applicable for most individuals and families. The very wealthy regularly use wealth planning solutions to legally mitigate taxes and protect their assets from unfounded lawsuits. Some of the tools of wealth planning include trusts, partnerships and life insurance.”

Trusts: In many ways, trusts are often cornerstone solutions for many successful individuals and families. A trust is a way to transfer property using a third party that is the trust. Specifically, a trust lets you transfer the title of your assets to trustees for the benefit of the people you want to take care of—your designated beneficiaries. The trustee will carry out your wishes on behalf of your beneficiaries.

“Trusts are ingenious. People can use them in all sorts of ways to transfer wealth between parties and determine how those assets can be used,” says Homer Smith, Founder of Konvergent Wealth Partners, and co-author of Optimizing the Financial Lives of Clients: Harness the Power of an Accounting Firm’s Elite Wealth Management Practice. “Trusts are also very useful in shielding a person’s assets from plaintiffs and creditors. Different types of trusts come with different tax consequences. For example, one kind of trust enables you to sell appreciated assets without paying any taxes on the increase in the value of those assets from the time you acquired them.”

In crafting trusts, the limitations tend to the ingenuity of the wealth planner and the law. As long as trusts are not set up for illegal purposes, wealth planners have a great deal of leeway.

Partnerships: As with trusts, there are various types of partnerships. They can determine how the partners address ownership issues and have varying tax benefits. For example, within the business world, disharmony among family members or unrelated business partners can mean a higher tax bill if the owners are forced to divide assets among their members. Through the use of sophisticated partnership structures, business owners can divide their companies, eliminating taxes. 

Consider two partners each owning 50% of a manufacturing business and 50% of a trucking company. Infighting and friction led to unresolvable discord between them that impaired their ability to run the companies.   

They decided that the only answer is for each of them to take over one of the businesses so that they would no longer have to work together. Both businesses were very successful, were roughly equivalent in value, and their respective values were in excess of their tax basis. If each partner had sold his business interests to the other, there would have been a sizable taxable gain for both.   

To avoid having to pay the taxes, a specialized partnership was formed that gave one partner 100% control of the manufacturing company and the other partner 100% control of the trucking company, thus achieving the desired separation between the two. The partnership could be liquidated at a future time without triggering a gain or a need to pay any taxes by either partner.  

Life insurance: Death and taxes are certainties for everyone. The very wealthy, for instance, face hefty taxes on their estates when they pass away. While there are ways to mitigate estate taxes through wealth planning, most are underutilized. 

Life insurance is commonly used by the wealthy to pay estate taxes. Options such as extensions and loans to pay estate taxes can be very useful. However, these approaches can be problematic, especially when dealing with extensive family businesses and significant non-liquid assets.

“For many of the affluent, life insurance is a significant component of their overall approach to paying estate taxes,” says Frank Seneco, president of the advanced life insurance planning boutique, Seneco Global Advisors, “Even though leading lawyers and accountants are capable of helping the wealthy tackle many legal and financial challenges, you still cannot take it with you. By using life insurance in estate planning, however, they can more effectively orchestrate the transfer of assets thereby protecting the family’s wealth and their legacy for future generations.”

In many situations, life insurance can work for most successful and affluent individuals. However, it is important to only get what you really need. It is also essential to recognize that life insurance is only part of the solution in managing estate tax obligations. All viable legal strategies need to be considered before life insurance should be purchased. 

Russ Alan Prince is the executive director of Private Wealth magazine and chief content officer for High-Net-Worth Genius. He consults with family offices, the wealthy, fast-tracking entrepreneurs, and select professionals.