A person who wishes to transfer wealth can either do so during her lifetime as a gift or after her death as part of her estate as a bequest.. The decision on whether to transfer wealth a
Trang 1Estate Planning in a Global Context
1 Introduction 2
2 Domestic Estate Planning: Some Basic Concepts 2
2.1 Estates, Wills, and Probate 2
2.2 Legal Systems, Forced Heirship, and Marital Property Regimes 2
2.3 Income, Wealth, and Wealth Transfer Taxes 3
3 Core Capital and Excess Capital 3
3.1 Estimating Core Capital with Mortality Tables 4
3.2 Estimating Core Capital with Monte Carlo Analysis 5
4 Transferring Excess Capital 5
4.1 Lifetime Gifts and Testamentary Bequests 6
4.2 Generation Skipping 7
4.3 Spousal Exemptions 7
4.4 Valuation Discounts 7
4.5 Deemed Dispositions 8
4.6 Charitable Gratuitous Transfers 8
5 Estate Planning Tools 8
5.1 Trusts 8
5.2 Foundations 9
5.3 Life Insurance 9
5.4 Companies and Controlled Foreign Corporations 10
6 Cross-Border Estate Planning 10
6.1 The Hague Conference 10
6.2 Tax System 10
6.3 Double Taxation 11
6.4 Transparency and Offshore Banking 14
Summary 14 This document should be read in conjunction with the corresponding reading in the 2018 Level III CFA® Program curriculum Some of the graphs, charts, tables, examples, and figures are copyright
2017, CFA Institute Reproduced and republished with permission from CFA Institute All rights reserved Required disclaimer: CFA Institute does not endorse, promote, or warrant the accuracy or quality of the products or services offered by IFT CFA Institute, CFA®, and Chartered Financial Analyst® are trademarks owned by CFA Institute
Trang 21 Introduction
This reading gives an overview of how assets can be transferred to others in the most efficient way
2 Domestic Estate Planning: Some Basic Concepts
2.1 Estates, Wills, and Probate
This section covers LO.a:
LO.a: Discuss the purpose of estate planning and explain the basic concepts of domestic estate planning, including estates, wills, and probate
An estate is all of an individual’s property or assets, which can include:
Financial assets
Real estate
Tangible assets
Intangible assets
Estate planning is the process of arranging for our assets to be transferred to others in the most
efficient way The transfer of assets to others can take place during an individual’s life or upon his/her death
The most basic method of arranging for the transfer of assets is to write a will (or testament), which is a
legal document containing an individual’s instructions for the distribution of his property after his death
The person transferring assets through a will is known as the testator If an individual dies without leaving valid will – a common occurrence - she is declared to have died intestate and the distribution of
her assets is determined by court
Probate is the legal process to confirm the validity of a will Individuals, particularly high net worth
investors, may wish to avoid the probate process, which can be expensive and time consuming One alternative method for transferring assets is to establish joint ownership of assets with rights of survivorship Upon one owner’s death, ownership of the asset will transfer to the surviving owner(s) and
is not subject to a probate challenge Other estate planning tools that avoid the probate process are discussed in section 5
2.2 Legal Systems, Forced Heirship, and Marital Property Regimes
This section addresses the “important non-tax issues” mentioned in LO.b:
LO.b: Explain the two principal forms of wealth transfer taxes and discuss the effects of important non-tax issues such as legal system, forced heirship, and marital property regime
Tax laws vary from country to country, many of these differences are due to the different law systems
Trang 3used by these countries
A Civil law system is derived from the Roman law This system uses deductive reasoning and rules or
concepts are applied to particular cases
A Common law system is derived from British law This system uses inductive reasoning and it draws
rules from specific cases
In forced heirship regimes, a certain portion of a parent’s estate must be distributed to his surviving
children In Example 1, the Berelli children are entitled to split one-third of their father’s total estate There may be an additional provision that all children are entitled to an equal share of assets Should a parent try to work around this provision by, for example, making lifetime gifts to a favored child, the other children may be able to claim a share of these transfers
In community property regimes, both spouses are typically entitled to an equal share of the assets that
are acquired during their marriage (common property) For example, if a couple’s combined net worth increased from $0 to $1,000,000 during the course of their marriage, the surviving spouse would automatically receive $500,000 and the remaining share could be freely distributed
In separate property regimes, each spouse is able to own and control property as an individual
2.3 Income, Wealth, and Wealth Transfer Taxes
This section addresses the “two principal forms of wealth transfer taxes” mentioned is LO.b:
LO.b: Explain the two principal forms of wealth transfer taxes and discuss the effects of important non-tax issues such as legal system, forced heirship, and marital property regime
As discussed in section 2 of Taxes and Private Wealth Management in a Global Context, taxes are
typically applied on income, consumption, or wealth Wealth taxes can be imposed on assets that are held (such as a property tax on real estate) or when assets are transferred This section focuses on wealth transfer taxes
A person who wishes to transfer wealth can either do so during her lifetime (as a gift) or after her death
as part of her estate (as a bequest) Gits are referred to as lifetime gratuitous transfers or inter vivos transfers and can be subject to gift taxes Bequests are known as testamentary gratuitous transfers and can be subject to estate taxes Therefore, the two principal forms of wealth transfer taxes are gift taxes
and estate taxes The decision on whether to transfer wealth as a gift during life or as a bequest after death is heavily dependent on how such transfers are taxed, which will be discussed in section 4
3 Core Capital and Excess Capital
Refer to Exhibit 1 which shows a hypothetical life balance sheet of an individual The assets consist of financial and other assets currently held by the individual plus the present value of net employment income expected to be generated over the lifetime, referred to as net employment capital The liabilities consists of mortgage or other loan payments and present value of capital required to maintain the
Trang 4current lifestyle and fund retirement
Capital required to maintain your standard of living and fund essential objectives and meet unexpected
commitments- is called your “core capital” Any additional capital is called “excess capital” and, as will
be discussed in section 4, it this capital that is relevant in the context of estate planning
3.1 Estimating Core Capital with Mortality Tables
This section covers LO.c:
LO.c: Determine a family’s core capital and excess capital, based on mortality probabilities and Monte Carlo analysis
Mortality tables, also known as “life tables” and “actuarial tables”, provide an estimate of an individuals expected life For example, the mortality table in Exhibit 2 reveals that Ernest Webster (who is 79 years old) has a 93.55% probability of living to age 80, an 87.02% probability of living to age 81, and a 0.00% probability of living to age 101 or beyond These are referred to as “survival probabilities” Also in Exhibit 2, we see that Ernest’s wife, Beatrice Webster, is 69 years old and has a 98.31% probability of living to age 70
The one-year survival probabilities for Ernest and Beatrice Webster are 93.55% and 98.31%, respectively The probability that at least one them survives another year – their joint survival probability - can be calculated using the following formula:
𝑝(𝑆𝑢𝑟𝑣𝑖𝑣𝑎𝑙) = 𝑝(𝐻𝑢𝑠𝑏𝑎𝑛𝑑 𝑠𝑢𝑟𝑣𝑖𝑣𝑒𝑠) + 𝑝(𝑊𝑖𝑓𝑒 𝑠𝑢𝑟𝑣𝑖𝑣𝑒𝑠) − 𝑝(𝐻𝑢𝑠𝑏𝑎𝑛𝑑 𝑠𝑢𝑟𝑣𝑖𝑣𝑒𝑠)
× 𝑝(𝑊𝑖𝑓𝑒 𝑠𝑢𝑟𝑣𝑖𝑣𝑒𝑠)
.9355 + 9831 – (.9355 x 9831) = 9989
The joint survival probability for the Websters is 99.89% Put differently, there is just a 0.11% chance that both Ernest and Beatrice will die within the next year Living expenses over the next year are projected to be €500,000 over the next year, which puts their expected spending at €500,000 x 9989 =
€499,457 This amount is then discounted back to today using the real risk free rate The couple’s total core capital need can be calculated as the sum of each year’s discounted expected spending:
As shown at the bottom of column 9 in Exhibit 2, the Webster’s core capital need – based on their life expectancy and discounted annual spending – is €9,176, 955
Discounting at the risk-free rate
One important considerations with this method is the use of the risk-free rate for discounting cash flows While there is definitely risk associated with expected spending, this risk is unrelated to the
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Nominal versus real cash flows
When projecting and discounting cash flows, it is critically important to be aware of whether the figures being used are stated in nominal or real terms and to remain consistent Note that in Exhibit 2, the Webster’s annual spending (column 7) increases each year As we learn just below Exhibit 2, “The Webster’s inflation-adjusted annual spending needs are calculated based on their current spending of
€500,000 per year and are increased annually using a 3 percent real growth rate (that is, 3 percent annual spending growth after inflation).” Therefore, the expected spending figures listed in column 8 are discounted by the real discount rate of 2%
3.1.1 Safety Reserve
Determining our core capital requirement could be an exact science if we knew exactly how long we will
live, our exact spending needs, and the returns that our investments would generate with absolute certainty In reality, such certainty is difficult to achieve In order to protect against the uncertainties of capital market returns and spending requirements, it is advisable to augment estimated core capital with a safety reserve allocated to cash or highly-liquid, ultra-low risk securities
3.2 Estimating Core Capital with Monte Carlo Analysis
Monte Carlo simulation is a very useful tool the process of planning for retirement and the distribution
of one’s estate Like the mortality table approach, the Monte Carlo method assumes an average expected rate of return However, unlike the mortality table approach, which assumes a constant (ie riskless) rate of return, the Monte Carlo method assumes a certain level of volatility among returns, which captures the risk that returns will not be sufficient to meet spending needs over a given period of time
The output of a Monte Carlo simulation will look like Exhibit 3, which shows the “probability of ruin” for
a given level of spending For example, a person who retires at age 60 and has a life expectancy of 83.4 years, has a 1.5% probability of outliving his assets if his annual spending rate starts a 2% of his initial core capital The probability of ruin increases with higher annual spending rates It is therefore important to be able to determine the acceptable spending rate given an investor’s stated risk tolerance
In Example 5, we see that Sophie Zang, who is 55 and – based on the data Exhibit 3 – can expect to live
to age 83 (i.e., she has a 28-year time horizon) is able to spend SGD 40,000 (or 2%) of her SGD 2,000,000 portfolio if she wants a 98% probability of avoiding financial ruin (in other words, she accepts a 2% probability of ruin), but can increase this spending rate to 3% if she is willing to be accept a 6.3% probability of ruin
4 Transferring Excess Capital
Section 3 addressed the calculation of core capital required to meet essential needs during an investor’s lifetime If investors have assets that are greater than their core capital requirement, they have excess
Trang 6capital that can be transferred to others such as family members or charitable organizations For example, if the Websters from section 3.1 have total assets worth €20,000,000 and a core capital requirement of €9.200.000, their excess capital is €10,800,000
4.1 Lifetime Gifts and Testamentary Bequests
As mentioned in section 2.3, individuals who wishes to transfer assets can either do so during her lifetime as a gift, or after her death as a bequest Sections 4.1.1 and 4.1.2 address LO.d:
LO.d: Evaluate the relative after-tax value of lifetime gifts and testamentary bequests
4.1.1 Tax-Free Gifts
Certain countries allow for the tax-free transfer of wealth as a gift The exact amounts and applicable periods vary by jurisdiction, but the ability to transfer an asset without incurring an immediate gift tax liability can create significant after-tax value compared to the alternative of transferring the same assets
as a bequest that is subject to an estate tax The relative value of a tax-free lifetime gift is captured in Equation 5:
The top half of the formula above shows the future value of an asset if it is transferred from the donor’s estate to a recipient (“donee”) such as a child The bottom half of the formula shows the future value of the same asset if it is held until after the donor’s death and transferred to the donee as a bequest Note
that the returns (r g ) are still taxed at a rate of t ig after the asset is transferred to the donee, just as the
returns (r e ) would have been taxed at a rate of t ie if the asset had remained in the donor’s estate
4.1.2 Taxable Gifts
The relative advantage of a gift versus a bequest is clear when no gift tax is applied However, the
advantage can persist even when a tax is applied on lifetime gifts (T g) The relative value of a taxable gift
is shown in the formula below:
4.1.3 Location of the Gift Tax Liability
The following section addresses LO.e:
LO.e: Explain the estate planning benefit of making lifetime gifts when gift taxes are paid by the donor, rather than the recipient
Trang 7Even when the gift tax rate is equal to the estate tax rate (T g = T e), and returns are taxed at the same
rate whether the asset is held by the recipient or the donor (t ig = t ie), there can still be an advantage to gifting an asset if the gift tax is paid by the donor By paying the gift tax directly from the donor’s estate, the size of the estate is reduced and will incur a lower tax liability when the remainder of the estate is transferred as a bequest The value of such a strategy is calculated as the size of the gift multiplied by
the gift tax rate multiplied by the estate tax rate (or Gift x T g x T e)
To summarize section 4.1, transferring an asset as a lifetime gift is preferable to transferring the same asset as a bequest when:
There is no gift tax
The gift tax is lower than the estate tax
Returns are taxed at a lower rate when the asset is held by the donee rather than the donor
The gift tax is paid by the donor, which reduces the value of assets subject to an estate tax
Sections 4.2 to 4.6 address LO.f:
LO.f: Evaluate the after-tax benefits of basic estate planning strategies, including generation skipping, spousal exemptions, valuation discounts, and charitable gifts
4.2 Generation Skipping
When the first generation transfers assets to the second generation, the assets are taxed Then when the second generation transfers assets to the third generation, the assets are taxed again If a grandparent has sufficient excess capital that his children’s needs are already met, he can avoid this extra layer of taxation by transferring assets directly to his grandchildren This is known as generation skipping
4.3 Spousal Exemptions
Many jurisdictions allow for the tax-free transfer of assets (either as a gift or a bequest) from one spouse
to another However, it may be unwise to make such transfers if doing so eliminates the opportunity to make a tax-free (or tax-advantaged) transfer to other recipients such as children or grandchildren The specific rules vary by jurisdiction, but the point is that the opportunity to use a spousal exemption to transfer assets should be considered as just one option in the context of a broader estate planning strategy
4.4 Valuation Discounts
An estate that is entirely composed of highly liquid assets such as exchange-traded stocks and government bonds will be taxed based on an easily-determined market value Assessing the tax liability for an estate that includes a significant proportion of illiquid assets is a more complicated matter and the owner of such an estate may qualify for a valuation discount For example, imagine that rather than
selling IngerMarine, Peter and Hilda Inger (from Managing Individual Investor Portfolios) wished to
transfer ownership of the company to their children The intrinsic value of their position is estimated at
€61,200,000, but their shares do not trade on a public exchange and the relevant tax authority may
Trang 8apply a liquidity discount in the range of 20 to 25 percent when valuing this asset for the purpose of determining the tax liability that is triggered by this transfer Obviously, no such discount would be applied if the Ingers sold their shares for cash and transferred the proceeds to their children
4.5 Deemed Dispositions
Certain tax jurisdictions treat (or deem) assets that are transferred as a bequest to have been sold (or disposed) for tax purposed and a tax liability is incurred on any capital gains In countries that apply deemed disposition status to assets transferred after death, but do not apply a gift tax, there is a strong incentive to transfer highly-appreciated assets as gifts during the donor’s lifetime
4.6 Charitable Gratuitous Transfers
Transferring assets to a charitable organization during the donor’s lifetime can offer several advantages First, charitable donations reduce the size of a donor’s taxable estate and very few countries impose a gift tax on such transfers Second, in almost all jurisdictions, donors are allowed to claim charitable donations as a deduction for income tax purposes Finally, the returns on assets that have been transferred to a charitable organization are allowed to accumulate tax-free
5 Estate Planning Tools
As mentioned in section 2, the most basic method of arranging for assets to be transferred is to write a will, which provides for the distribution of assets after the owner’s death However, the process of affirming the validity of a will – known as probate – can be time-consuming and expensive This section considers four alternative estate planning tools
5.1 Trusts
This section addresses LO.g:
LO.g: Explain the basic structure of a trust and discuss the differences between revocable and irrevocable trusts
A trust is a legal arrangement in which a settlor (or grantor) transfers assets into the care of a trustee, who manages these assets on behalf of a beneficiary A common trust arrangement is for a parent to transfer assets into a trust where they are then managed for the benefit of her children
Trusts can be customized and it is important to distinguish between various trust structures In a revocable trust, the grantor to allowed to rescind the arrangement (ie reclaim control of its assets) at any time By contrast, the grantor of an irrevocable trust permanently relinquishes her right to take back control of any assets that she has transferred into it This is an important consideration with respect to asset protection (see section 5.1.2 below)
A second important consideration when establishing a trust is whether to use a fixed or discretionary structure A fixed trust makes distributions to its beneficiaries according to the specific terms that have been established by the grantor For example, a parent may established a fixed trust that automatically
Trang 9pays $10,000 to each of his children on the first day of January every year By contrast, the grantor of a discretionary trust provides instructions in general terms and allows the trustee to exercise his judgment (or discretion) when make distributions For example, the beneficiaries of a discretionary trust may receive distributions of different amounts at different times as their needs change
5.1.1 Control
Transferring assets into a trust allows a grantor to retain a measure of control over his assets even after they have been transferred For example, by established a fixed or discretionary trust, a grantor can ensure that his assets are used according to his wishes, such as to fund his children’s post-secondary education This allows the grantor to maintain control of his assets during his lifetime and avoid the disadvantages of the probate process
5.1.2 Asset Protection
Assets that have been transferred into an irrevocable trust are generally considered to be beyond the reach of any creditor’s claims against the grantor
5.1.3 Tax Reduction
Depending on applicable tax laws, trusts may provide a tax-efficient method of transferring wealth For example, returns on assets that have transferred into a trust may be taxed at a lower rate than if they continued to be held by the grantor Furthermore, transferring assets into a trust can reduce the size of
a grantor’s taxable estate
5.2 Foundations
Many civil law jurisdictions do not recognize the existence of trusts Investors in these countries can obtain the benefits discussed in sections 5.1 by establishing a foundation
5.3 Life Insurance
This section addresses LO.h:
LO.h: Explain how life insurance can be a tax-efficient means of wealth transfer
The holder of a life insurance policy pays premium periodically (often monthly) to an insurance company, which promises to pay a lump sum to a beneficiary in the event of the policy holder’s death This structure is similar to a trust in the sense that a policy holder transfers wealth in the form of premiums that is subsequently paid out to a beneficiary A life insurance policy also offers many of the same advantages of a trust
Control
The holder of a life insurance policy is able to transfer wealth (in the form of a death benefit) to a designated beneficiary outside the probate process By naming a discretionary trust as the designated
Trang 10beneficiary in the event of his death, a life insurance policy holder can assert additional control over the distribution of his assets Additionally, a life insurance policy can be used to transfer wealth without the need to sell illiquid assets at a deep discount
Asset Protection
As with assets that have been placed in trust, the benefits paid from a life insurance policy are generally considered to be beyond the reach of the policy holder’s creditors Additionally, life insurance policies can also allow for the transfer of wealth beyond the reach of forced heirship rules
Tax Reduction
Most tax jurisdictions do not apply taxes on death benefit payments from a life insurance policy Additionally, the policy holder can effectively transfer assets in the form of premiums in a designated beneficiary without having to pay a gift tax Such payments also reduce the size of the policy holder’s taxable estate
5.4 Companies and Controlled Foreign Corporations
The owner of a controlled foreign corporation (CFC) may use this structure as an estate planning tool The tax liability on returns from assets transferred into a CFC is reduced or at least deferred However, many tax authorities take measures to eliminate the tax benefits offered by CFCs
6 Cross-Border Estate Planning
Taxation issues are a challenge to understand at the best of times and they become even more complex when more than one jurisdiction is involved Income generated outside home country may be taxed in both countries Passing ownership of overseas assets on death might be difficult Transferring assets to heirs located outside home country might be difficult
6.1 The Hague Conference
The Hague Conference on Private International Law is a forum where various countries attempt to establish common standards for laws governing private matters, such as estate planning This initiative
is increasingly important as investors continue to take advantage of opportunities beyond the borders of their home country One specific treaty signed under the auspices of this forum allows for a will drafted
in one signatory nation to be recognized as valid in all signatory nation
6.2 Tax System
This section addresses LO.i:
LO.i: Discuss the two principal systems (source jurisdiction and residence jurisdiction) for establishing a country’s tax jurisdiction
A source jurisdiction (or territorial tax system) only taxes income that is generated within its borders