INDIVIDUAL AND TAXATION PORTFOLIOMANAGEMENTQUESTION HAS FIVE PARTS (A, B, C, D, E) FOR A TOTAL OF 23 MINUTES Sammy Kahn, a Level III candidate in the CFA program, works for World Financial Management (WFM) in New York Kahn has new clients, Anthony and Jennifer Parker, who are in their mid 50s Over the years, the Parkers built a successful residential construction company and recently sold their business by exchanging the equity in their business for shares of publicly traded stock of a national home builder The Parkers now work for the company who bought it They have two children who live on their own and are financially independent, and one grandchild The Parkers have no debt and a sizable net worth consisting of the stock of the company which bought them out, their primary residence, a rental property, a second home, and some other equity and fixed income assets Because of the sale of their business, Anthony and Jennifer now find themselves in a position to retire early They have sought Kahn’s advice regarding their assets in preparation for retirement Anthony Parker states, “We have too many taxable assets, including the high concentration of low basis stock from the sale of our business We need to reallocate our assets into a more diversified and tax efficient portfolio.” Jennifer Parker adds, “Another concern is to ensure the majority of our assets go to our children with the remainder being left to a few charities and the local hospital, university, and library When we retire I want to start taking less risk We took risk to build our business and I would not want to that again In retirement we want to start making annual tax-deductible donations of $16,000 to charitable non-profit organizations throughout our retirement adjusted for inflation.” The Parkers plan to retire in one year and would like to maintain their standard of living (maintain their current spendable income), taking into account an expected inflation rate of 3% The Parkers’ before-tax annual income consists of $161,000 salary from the company, $28,000 from rental property, and $4,000 from bonds The Parkers are taxed at a rate of 28% The following is a list of their assets and the expected value of the assets in one year: Asset Money market account Taxable bonds Common stock from sale of their business Other common stocks Primary residence Vacation home Rental property Total Expected $ Value in One Year 16,000 79,000 4,717,000 24,000 786,000 393,000 472,000 6,487,000 A State one factor that increases and one factor that decreases the Parkers’ ability to take risk Explain one factor that decreases their willingness to bear risk (3 minutes) B Calculate the after-tax nominal rate of return required to meet their living expenses during their first year of retirement based on their marketable investment assets Show your calculations (7 minutes) C Assuming the Parkers have just retired and all other facts are as expected, formulate the Parkers’ liquidity needs and time horizon (2 minutes) D Assuming the Parkers are able to sell their concentrated position of stock, have refined their required return as being 5.7%, and agreed that an average risk profile is most appropriate for their situation, identify which portfolio A, B, C, or D in Figure would best meet the Parkers’ needs when they retire in one year State one reason why the portfolio was selected and one reason why each of the other portfolios were not selected (5 minutes) Figure 1: Alternative Asset Allocations (Portfolios) for the Parkers Portfolios Asset Class A B C U.S Stocks 10% 20% 30% D 60% Non U.S Stocks U.S Corporate Bonds Cash and Equivalents Alternative Investments 0% 35% 35% 10% 10% 40% 10% 10% 20% 25% 5% 10% 20% 10% 0% 0% U.S Treasury Bonds 10% 10% 10% 10% 5.4% 5.6% 5.8% 6.2% 3.5% 3.1% 2.5% 1.5% After-Tax Expected Return After-Tax Income Yield E Regarding the Parker’s children, Jonathan and Tabitha, Tabitha is a nurse and feels she’ll always have steady employment in the nursing profession She is also a divorced single mother with one young child Jonathan is single and works as a pharmaceutical sales rep experiencing large fluctuations in pay based on commissioned sales Both are in the early years of their careers Discuss two factors that increase Tabitha’s and one that decreases Jonathan’s demand for life insurance based on their human capital (6 minutes) QUESTION HAS TWO PARTS (A, B) FOR A TOTAL OF MINUTES Kathy Saul, CFA, has recently accepted a position with Kim Jen Jen offers specialized investment advice to ultra-high net worth international investors Saul has substantial investment experience but has not worked with tax issues in the past and is reviewing some of the basics Assuming there is flexibility where to locate an asset for tax purposes, she wants to determine whether a deferred capital gains or annual wealth tax regime would be better The asset has a cost basis equal to 25% of its initial market value The assumed holding period is 15 years with a pretax return of 8% annually and a capital gains rate of 20% The annual wealth tax is 3% A Compute the after-tax ending value of an initial $100,000 investment and accrual equivalent return under both tax regimes Show your calculations Recommend the most tax-efficient location for the investor Do not assume any other taxes will be required in either location (6 minutes) B If the asset has a smaller initial unrealized capital gain, explain whether this would make locating the asset in an annual wealth tax location more or less attractive to the investor No computations are required (3 minutes) QUESTION HAS THREE PARTS (A, B, C) FOR A TOTAL OF 13 MINUTES Jane Russell, CFA, is meeting with a client who has asked her about protecting his assets from his wife The couple has been separated but divorce is not an option The client wants all of his assets to go to his children and is considering making gifts to the children to avoid marital and forced heirship rules The couple has marital assets of GBP 25M Total estate assets are estimated at GBP 35M reflecting GBP 7M owned personally by the husband and 3M by the wife Community property rules specify either spouse is entitled to 40% of the marital assets, and forced heirship rules specify entitlement to 30% of the total estate A If the client gifts his GBP 7M of personal assets to his children now and leaves his wife GBP 10M in his will, determine and justify whether the wife would have a claim under claw-back provisions (4 minutes) B Russell has a different client with excess capital of EUR 5M that is not subject to claw-back restrictions The client is considering a gift or bequest to an advocacy group, the group is not considered a charitable entity for tax purposes Russell is using a 10-year holding period for analysis The assumed after-tax return if the client holds the funds is 7.5% The estate tax rate is 35% The advocacy group is assumed to earn a 9.5% pretax return and pay an accrual equivalent tax rate of 25% Gift taxes are 40% and paid by the receiver of the gift Calculate the relative value ratio of gifting versus bequest and state which is more favorable State two reasons not reflected in the relative value analysis why gifting may not be desirable for the client (5 minutes) C If the gift receiver where a charitable entity, state two reasons making a gift now instead of a bequest would become more valuable No calculations are necessary (4 minutes) QUESTION HAS THREE PARTS (A, B, C) FOR A TOTAL OF 12 MINUTES Josh Wells has been asked to research appropriate methods of retirement planning for individuals One of his clients is 55 years old and would like to retire in years Wells is considering using Monte Carlo instead of the traditional deterministic approaches his firm has used The firm has and will continue to use an asset liability perspective with either method A State whether Monte Carlo or a deterministic approach will be the preferred method for this client’s situation, and support your decision with two reasons relevant to this situation (6 minutes) After reviewing Wells’ analysis, the client realizes he will need to increase his rate of savings The client is approaching his annual contribution limits for tax-exempt and tax-deferred locations In spite of this, he will increase his annual savings, placing as much as he can in the tax-sheltered locations and the rest in a taxable account each year He will be splitting the new funds between equity and bonds Wells suggests he also delay retirement for a few years, beyond the planned three-year horizon B Discuss how the equity and bond holdings purchased with the new savings should be allocated between the tax- sheltered and taxable locations Assume all the equity could go in the sheltered or taxable location with bonds in the other location, or the equity bond allocation could be the same in the two locations Explain the tax reason for the decision (3 minutes) C If the client accepts Wells’s recommendation to delay retirement, explain why this will make the equity and bond location decision in the previous question more or less important, or have no effect on its importance (3 minutes) QUESTION HAS THREE PARTS (A, B, C) FOR A TOTAL OF 10 MINUTES Samantha Keys has a client who invests in multiple countries The client is interested in legal ways to avoid double taxation The client is considering two investments, Able and Bravo They are equivalent on a pretax basis but located in different countries These two foreign countries have the same 35% tax rate, and both have tax treaties with the client’s residence country Able is located in a country with an exemption tax treaty, and Bravo in a country with a credit tax treaty The client plans to make only one of the investments The client is quite wealthy and also has a large real estate position and a private business Both are owned personally by the client The two assets are of roughly equal value, and both have similar, large unrealized taxable gains The client wants to gift one to a charity (a deductible gift) and the other to his children The client uses the real estate as a key asset in his business and will need access to the property for several more years Ultimately, he wants the children to take over the business Wells prepares a presentation outlining how a charitable contribution with leaseback and an estate tax freeze using a limited partnership could meet the client’s goals and reduce taxes Wells assumes either the business or real estate will be used for the charitable contribution, and the other asset will be used with the estate tax freeze A Explain from a tax perspective a situation under which Able will be the preferred investment and a situation where there is not a preference between the two investments (4 minutes) B Explain whether the estate tax freeze or charitable gift will best reduce taxes for the client (3 minutes) C State whether the business or real estate should be used for the charitable contribution, and support the decision (3 minutes) ... Allocations (Portfolios) for the Parkers Portfolios Asset Class A B C U.S Stocks 10% 20% 30 % D 60% Non U.S Stocks U.S Corporate Bonds Cash and Equivalents Alternative Investments 0% 35 % 35 % 10% 10%... attractive to the investor No computations are required (3 minutes) QUESTION HAS THREE PARTS (A, B, C) FOR A TOTAL OF 13 MINUTES Jane Russell, CFA, is meeting with a client who has asked her about... which portfolio A, B, C, or D in Figure would best meet the Parkers’ needs when they retire in one year State one reason why the portfolio was selected and one reason why each of the other portfolios