Estate Planning Flashcards
What are the **two primary objectives **of estate planning?
- minimize taxes
- facilitate tax efficient transfer of assets
What are the four levels of taxation an individual faces?
- income
- spending
- wealth
- transfer
What are the four targets of taxation?
- income
- assets held
- assets transferred
- expenditures
What are the two methodologies for improving after-tax returns?
- realize income and capital agains in the most advantageous way
- defer taxes as long as possible
What is a general provision of the tax code that benefits married couples?
When one spouse dies, the taxes are deferred until the death of the surviving spouse.
Why are investments in privately held companies tax-efficient from an estate planning perspective?
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)
How do you calculate the joint probability of survival for a couple?
The joint probability over some time period is the probability that one or both survive that period.
PH+P<span>W</span>- PH*PW
How do you calculate the capitalized value of core spendings needs for a couple over some period n?
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
How can you calculate the real risk free rate given the nominal risk free rate and expected inflation?
Exact:
real = (1+nominal) / (1+infl) - 1
Approx:
real = nominal - infl
What are the two types of legal systems?
- Civil Law
- “top down”
- laws come from legistlative body
- Common Law
- “bottom up”
- law comes from judges and precedent
How would Monte Carlo simulation be used in the estate planning process before retirement?
Client determines desired level of spending and any desired gifts/bequests
- 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
- Uses
- 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
- Uses:
How would Monte Carlo simulation be used in the estate planning process at retirement?
- Analyst inputs various spending rates and other inputs.
- Gets for each spending rate, probability of outliving assets
What does **relative after-tax value **tell you?
Relative after-tax value can tell us if a recipient would be better off getting a gift now or when we die.
How is the relative value of a tax-free gift given during one’s lifetime calculated?
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
How is the relative value of a taxable gift given during one’s lifetime calculated?
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
How is the relative value of a taxable gift given during one’s lifetime **when taxes are paid by the donor **calculated?
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
Under generation skipping, the value to the third generation is what?
1 / (1 - t)
where t is the gift/inheritance tax rate
Why can making a charitable gift be advantageous?
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.
How can you calculate the relative value of donating to charity vs making a bequest?
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.
Why are life insurance policies tax efficient?
In mos jurisdictions, life insurance proceeds pass to beneficiaries without tax consequences.
What are the three types of tax conflicts?
- residence-residence conflict
- two countries claiming the same resident
- source-source conflict
- multinationals with business in multiple places
- residence-source conflict
Which two methods provide **complete **resolutions of the residence-source conflict?
- credit method
- exemption method
Which method provides partial resolution to the residence-source conflict?
- deduction method
What is the credit method?
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.
What is the exemption method?
residence country charges no income tax on income generated in a foreign country that enforces source jurisdiction.
What is the deduction method?
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)
