CFA 2018 r10 estate planning in a global context

Level III Estate Planning in a Global Context www.ift.world Graphs, charts, tables, examples, and figures are copyright 2014, CFA Institute Reproduced and republished with permission from CFA Institute All rights reserved Contents Introduction Domestic Estate Planning: Some Basic Concepts Core Capital and Excess Capital Transferring Excess Capital Estate Planning Tools Cross Border Estate Planning www.ift.world Introduction • Estate planning is an important component of wealth management – Inheritance planning – Business succession – Charity – Wills – Tax planning www.ift.world Domestic Estate Planning: Basic Concepts Estate: A property a person owns or controls Estate Planning: Process of preparing for disposition of one’s estate Will (testament): Rights others will have over one’s property after death Testator: Person who authors the will and whose property is disposed according to the will Probate: Legal process to confirm validity of the will A person without a valid will dies intestate www.ift.world 2.2 Legal Systems, Forced Heirship and Marital Property Regimes Civil Law: Derived from Roman Law Apply rules or concepts to particular cases Deductive reasoning Common Law: Derived from British Law: Draw rules from specific cases Inductive reasoning Legal concept of trust is unique to common law Shari’a Law: More like civil law Forced Heirship: Children have a right to fixed share of parent’s estate Community Property Regime: Each spouse has indivisible one-half interest in income earned during marriage On death half property goes to spouse Other half divided according to will Separate Property Regimes: Each spouse is able to own and control property as an individual Read Example www.ift.world 2.3 Income, Wealth and Wealth Transfer Taxes Taxes levied in four ways: 1) Tax on income 2) Tax on spending 3) Tax on wealth and 4) Tax on wealth transfer Understand how assets are taxed when their ownership is transferred at or before death Lifetime gratuitous (inter vivos) transfer: transfer made during life-time of the donor Tax depends on jurisdiction Testamentary gratuitous transfer: transfer made upon one’s death Tax on wealth transfer may be applied to transferor or recipient depending on jurisdiction Example Example www.ift.world Core Capital and Excess Capital Exhibit 1: Hypothetical Life Balance Sheet Assets Liabilities and Equities House Equity Investments Fixed Investments Other Investments Mortgage College Net Employment Capital (Human Capital) Current Lifestyle Retirement Excess Capital Core Capital: Capital required to 1) maintain lifestyle 2) fund primary goals and 3) meet unexpected commitments Excess Capital www.ift.world 3.1 Estimating Core Capital with Mortality Tables Simplest approach: Calculate PV of anticipated spending over remaining life expectancy What is the problem with this approach? Another approach: multiply each future cash flow by survival probability If husband/wife are relying on the same core capital… P (S) = P(H) + P(W) – P(HW) www.ift.world www.ift.world Embedded example: Ernest, 79 and Beatrice, 68 Probability of survival in year 1: P(E) = 0.936 P(B) = 0.983 What is the probability that either or both survive in year 1? Refer to Exhibit Annual spending in year = 500,000 What is the expected spending in year 1? What is the present value using a real risk free discount rate of 2%? Assume real growth rate of expected spending is 3% What is the expected spending in year 2? Core capital requirement = €9.2 million Why should we discount at risk free rate rather than expected rate of return on investments? www.ift.world 10 Taxable Gifts Relative Value of Taxable Gifts www.ift.world 16 Location of the Gift Tax Liability Preceding section assumes tax is paid by recipient In some countries donor pays tax Tax benefit of lifetime gift vs bequest increases Exhibit Example www.ift.world 17 4.2 Generation Skipping If wealth transfer goals extend beyond second generation… 200,000,000 allocated for third generation 5% growth 35 years 50% gift tax Scenario 1: Transferred to second generation after 10 years Transferred to third generation after 25 more years Scenario 2: Transferred to third generation after 35 years www.ift.world 18 4.3 Spousal Exemptions UK: Estate less than GBP 312,000 can be transferred to spouse without inheritance tax 4.4 Valuation Discounts Gift and estate taxes can be mitigated by transferring assets that qualify for valuation discounts Privately held family business  Discount for lack of liquidity www.ift.world 19 4.5 Deemed Dispositions Treat bequest as if the property were sold 4.6 Charitable Gratuitous Transfers Most charitable donations are not subject to a gift transfer tax Charitable organizations exempt from paying tax on investment returns Gifts to charitable organizations are tax deductible Relative Value: Example www.ift.world 20 Estate Planning Tools Gratuitous transfers are often implemented through structures that: 1) Maximize tax benefit and/or 2) Produce a non-tax benefit Common estate planning tools: 1) Trusts (common law concept) 2) Foundations (civil law concept) 3) Life insurance 4) Companies www.ift.world 21 Trusts Settlor (or grantor) transfers assets to trustee Trustee holds and manages assets for benefit of beneficiary Irrevocable trust Trustee responsible for tax payments Less vulnerable to creditor claims Revocable trust: Settlor retains right to rescind Settlor responsible for tax payments Vulnerable to creditor claims Discretionary trust Trustee decides whether and how much to pay Fixed trust Fixed payment Fixed periods Benefits: 1) Avoid probate 2) Make resources available to beneficiaries without yielding control 3) Protection from creditors 4) Tax reduction www.ift.world 22 Foundations Foundations are set up to hold assets for a particular purpose Example: promote education Like trusts, foundations survive settlor Life Insurance Policy holder transfers assets (premium) to insurer Insurer has obligation to pay death benefit to beneficiary Benefits: 1) Lower taxes 2) Avoid probate 3) Protection from creditors www.ift.world 23 Companies and Controlled Foreign Corporations (CFC) Place income generating assets in CFC Benefits: 1) Tax deferred until income is distributed 2) Establish in country with no taxes Many countries have CFC rules designed to prevent tax payers from avoiding taxation www.ift.world 24 Cross-Border Estate Planning 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 The Hague Conference: Intergovernmental organization that works toward the convergence of private international laws www.ift.world 25 Tax System Source jurisdiction = territorial tax system  tax income as a source within borders Residence jurisdiction  all income, domestic and foreign is subject to taxation Wealth and wealth transfers may be subject to tax based on source or residence principles Double Taxation Two countries might claim to have taxing authority over the same income or assets Residence-residence conflict Source-source conflict Residence-source conflict Ex: US citizen owning real estate in Singapore subject to US and Singapore tax www.ift.world 26 Foreign Tax Credit Provisions Residence country may provide tax-payers relief from residence-source conflicts using: 1) Credit method 2) Exemption method 3) Deduction method Credit Method: residence country reduces tax payers’ domestic tax liability for taxes paid to foreign country Exemption method: residence country imposes no tax on foreign sourced income Deduction method: residence country allows taxpayers to reduce taxable income by amount of taxes paid to foreign government Double Taxation Treaties www.ift.world 27 Example www.ift.world 28 Transparency and Offshore Banking Tax avoidance vs tax evasion Trend towards increase in information exchange and transparency across countries This makes tax evasion more difficult What is needed: Compliant, tailored and tax-efficient strategies www.ift.world 29 Review learning objectives Examples Practice Problems www.ift.world 30 ...Contents Introduction Domestic Estate Planning: Some Basic Concepts Core Capital and Excess Capital Transferring Excess Capital Estate Planning Tools Cross Border Estate Planning www.ift.world Introduction... Introduction • Estate planning is an important component of wealth management – Inheritance planning – Business succession – Charity – Wills – Tax planning www.ift.world Domestic Estate Planning: Basic... Gratuitous Transfers Most charitable donations are not subject to a gift transfer tax Charitable organizations exempt from paying tax on investment returns Gifts to charitable organizations are