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CFA Level 3 - Private Wealth Management > Estate Planning > Flashcards

Estate Planning Flashcards

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CFA flashcards
1
Q

What are the **two primary objectives **of estate planning?

A
  1. minimize taxes
  2. facilitate tax efficient transfer of assets
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2
Q

What are the four levels of taxation an individual faces?

A
  1. income
  2. spending
  3. wealth
  4. transfer
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3
Q

What are the four targets of taxation?

A
  1. income
  2. assets held
  3. assets transferred
  4. expenditures
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4
Q

What are the two methodologies for improving after-tax returns?

A
  1. realize income and capital agains in the most advantageous way
  2. defer taxes as long as possible
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5
Q

What is a general provision of the tax code that benefits married couples?

A

When one spouse dies, the taxes are deferred until the death of the surviving spouse.

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6
Q

Why are investments in privately held companies tax-efficient from an estate planning perspective?

A

They can be transferred after taking a valuation discount.

Valuation discount relates to:

  • uncertainty of the true value
  • lack of liquidity
  • lack of control (sometimes)
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7
Q

How do you calculate the joint probability of survival for a couple?

A

The joint probability over some time period is the probability that one or both survive that period.

PH+P<span>W</span>- PH*PW

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8
Q

How do you calculate the capitalized value of core spendings needs for a couple over some period n?

A

core capital = SUMi->n [P(survivalt) * (spendingt)] / (1+r)t

If given real rate, discount by real rate

If given nominal rate, discount by nominal rate

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9
Q

How can you calculate the real risk free rate given the nominal risk free rate and expected inflation?

A

Exact:

real = (1+nominal) / (1+infl) - 1

Approx:

real = nominal - infl

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10
Q

What are the two types of legal systems?

A
  1. Civil Law
    • “top down”
    • laws come from legistlative body
  2. Common Law
    • “bottom up”
    • law comes from judges and precedent
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11
Q

How would Monte Carlo simulation be used in the estate planning process before retirement?

A

Client determines desired level of spending and any desired gifts/bequests

  1. analyst detemines size of portfolio needed on day individual retires.
    • ​Uses
      • uses distributions of reinvestment rates
      • inflation rates
      • tax rates
      • asset class returns
    • Gets:
      • distribution of portfolio sizes along with probabilities
  2. Analyst uses Monte Carlo to determine the expected value and distribution of portfolio values at retriement.
    • Uses:
      • different asset allocations
      • macro variables
      • retirement date
    • Gets:
      • portfolio values with probability of portfolio growing to that value by retirement
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12
Q

How would Monte Carlo simulation be used in the estate planning process at retirement?

A
  1. Analyst inputs various spending rates and other inputs.
  2. Gets for each spending rate, probability of outliving assets
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13
Q

What does **relative after-tax value **tell you?

A

Relative after-tax value can tell us if a recipient would be better off getting a gift now or when we die.

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14
Q

How is the relative value of a tax-free gift given during one’s lifetime calculated?

A

RVtax-free gift= FV_taxfree/FV_bequest

RV = [1+rg(1+tig)]n/ [1+re(1-tie)]n*(1-Te)

r_g: pre-tax return on asset

t_ig: annual income tax rate for gift receiver

r_e: pre-tax return on asset

t_ie: annual income tax rate for giver

T_e: estate tax

T_g: gift tax

Hint:

  • numerator: FV if given to receiver
  • denominator: FV if held and hen taxed at death
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15
Q

How is the relative value of a taxable gift given during one’s lifetime calculated?

A

RVtax-free gift= FV_taxfree/FV_bequest

RV = [(1-Tg)] * [1+rg(1+tig)]n / [1+re(1-tie)]n*(1-Te)

r_g: pre-tax return on asset

t_ig: annual income tax rate for gift receiver

r_e: pre-tax return on asset

t_ie: annual income tax rate for giver

T_e: estate tax

T_g: gift tax

Hint:

numerator: FV if given to receiver
denominator: FV if held and hen taxed at death

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16
Q

How is the relative value of a taxable gift given during one’s lifetime **when taxes are paid by the donor **calculated?

A

RVtax-free gift= FV_taxfree/FV_bequest

RV = [(1-Tg+TgTe)] * [1+rg(1+tig)]n / [1+re(1-tie)]n*(1-Te)

r_g: pre-tax return on asset

t_ig: annual income tax rate for gift receiver

r_e: pre-tax return on asset

t_ie: annual income tax rate for giver

T_e: estate tax

T_g: gift tax

17
Q
A
18
Q

Under generation skipping, the value to the third generation is what?

A

1 / (1 - t)

where t is the gift/inheritance tax rate

19
Q

Why can making a charitable gift be advantageous?

A

Most jurisdictions do not tax assets transferred to non-profits and charities. Also, the donor can take a tax deduction in the amount of the value of the gift.

20
Q

How can you calculate the relative value of donating to charity vs making a bequest?

A

FVcharitable= (1+rg)n + Toi[1+re(1-tie)]n(1-Te)

where

r_g: expected return on asset in charity portfolio

r_e: expected return on asset in donor portfolio

T_oi: tax on ordinary income

T_ie: donor’s tax rate on investment income

First term: no deduction in value of gift due to estate or gift taxes.

Second term: value added due to tax free nature of organization.

21
Q

Why are life insurance policies tax efficient?

A

In mos jurisdictions, life insurance proceeds pass to beneficiaries without tax consequences.

22
Q

What are the three types of tax conflicts?

A
  • residence-residence conflict
    • two countries claiming the same resident
  • source-source conflict
    • multinationals with business in multiple places
  • residence-source conflict
23
Q

Which two methods provide **complete **resolutions of the residence-source conflict?

A
  1. credit method
  2. exemption method
24
Q

Which method provides partial resolution to the residence-source conflict?

A
  1. deduction method
25
Q

What is the credit method?

A

residence country allows individual to take tax credit for taxes paid to source country.

resident pays the greater of domestic and source tax rates on the foreign source income.

26
Q

What is the exemption method?

A

residence country charges no income tax on income generated in a foreign country that enforces source jurisdiction.

27
Q

What is the deduction method?

A

Individual pays the full tax to the source country and is only allowed to deduct the amount of taxes paid to the source country in calculating total world-wide income.

Tdeduction=Tresidence +Tsource(1-Tresidence)

CFA Level 3 - Private Wealth Management (1 decks)

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