Private Wealth Management Flashcards
Describe how an individual can attempt to reduce or even avoid the impact of: probate & forced heirship.
Probate: There is often a desire to avoid probate as court fees may be sizable, and the process can cause a delay in the transfer of assets to intended beneficiaries. A will can be challenged, and its contents are often a matter of public record, which may concern some wealthy families as it may cause embarrassment or divulge sensitive financial information. Moreover, many problems can arise in probate when multiple jurisdictions are involved. In some instances, probate can be avoided or its impact limited by holding assets in joint ownership (e.g., joint tenancy with right of survivorship), living trusts, retirement plans, or life insurance strategies. Through these structures, ownership transfers without the need for a will, and hence the probate process can be avoided.
Forced heirship: Under civil law, ownership is a precise concept that is tempered by statutes that place certain limitations on the free disposition of one’s assets. Under forced heirship rules, for example, children have the right to a fixed share of a parent’s estate. This right may exist whether or not the child is estranged or conceived outside of marriage. Forced heirship in civil law countries may reduce or eliminate the need for a will. Wealthy individuals may attempt to move assets into an offshore trust governed by a different domicile to circumvent forced heirship rules. Spouses typically have similar guaranteed inheritance rights under civil law forced heirship regimes. In addition, spouses have marital property rights, which depend on the marital property regime that applies to their marriage. Individuals can attempt to reduce or avoid forced heirship by:
- moving assets into an offshore trust governed by a different jurisdiction;
- gifting or donating assets to others during their lifetime to reduce the value of the final estate upon death; or
- purchasing life insurance, which can move assets outside of realm of forced heirship provisions.
Such strategies, however, may be subject to “clawback” provisions that provide a basis for heirs to challenge these solutions in court.
Source vs. Residence Tax System
Source tax system: A jurisdiction that imposes tax on an individual’s income that is sourced in the jurisdiction.
Residence tax system: A jurisdiction that imposes a tax on an individual’s income based on residency whereby all income (domestic and foreign sourced) is subject to taxation.
3 potential double taxation conflicts
- Residence-residence conflict - 2 countries claim residence of the same individual, subjecting the individual’s worldwide income to taxation by both countries
- Source-source conflict - 2 countries claim source jurisdiction of the same asset
- Residence-source conflict - individual in Country A subject to residence jurisdiction, assets in Country B subject to source jurisdiction - most common source of double taxation, most difficult to avoid with tax planning
Evaluating Capital Sufficiency: Monte Carlo Model vs. Deterministic Model
- The Monte Carlo model assumes a simple average return and a standard deviation of returns for the portfolio, whereas the deterministic model assumes linear portfolio growth (straight-line manner, simple but unrealistic).
- Both models should use forward-looking capital market assumptions.
- Monte Carlo models can incorporate customized input data
Major Tax Categories
- Taxes on income - interest dividends realized and unrealized capital gains
- Wealth-based taxes – property and transfers
- Taxes on consumption – sales & value-added taxes
Life Insurance
- Premiums paid by the policyholder are not considered part of the policyholder’s estate at the time of death nor are subject to a gratuitous transfer tax.
- Death benefits are tax-exempt in most jurisdictions.
- Combining life insurance and trust management can be a powerful retirement planning strategy.
Portfolio Reporting
- Asset allocation report
- Performance summary
- Detailed performance (by asset class or individual securities)
- Historical performance (since inception)
- Contributions/withdrawals
- Purchases/sales
- Currency exposure
- Wealth manager may add economic/market commentary letter
- If goals-based investing is used -reporting may focus on progress towards the goals (vs. performance of asset classes/securities)
- Benchmark reports - performance by asset class relative to the benchmark
Mass Affluent Segment
- Financial planning, risk management, retirement planning
- Non-customized solutions
- High client/manager ratio
- Commissions structure to fee-based
- Can be discretionary or not
High-Net-Worth Segment
- Lower client-to-manager ratio
- Customized investment management, tax planning, wealth transfer issues
- Less liquid investments (due to higher wealth), more sophisticated portfolios, requirement for stronger product knowledge
Ultra-High-Net-Worth Segment
- Multi-generational time horizons, highly complex tax and estate-planning considerations
- Other services: bill payment, travel planning, advice on acquiring assets such as artwork, wine, etc.
- Few clients/manager
- Typically, multiple family members - family governance issues
- Services usually takes a team approach
- Even may involve a “family office” - dedicated advisors
Robo-Advisors
- Primarily digital client interface / experience
- Gathers info, uses MVO to recommend portfolio allocation, implements w/MFs & ETFs
- Will also monitor and rebalance as needed
- Provide regular reporting
Mortality Tables
A mortality table allows for estimating the present value of retirement spending needs by associating each outflow with a probability based on life expectancy.
A mortality table illustrates an individual’s life expectancy at any given age. A wealth manager can use a mortality table to estimate the present value of a client’s retirement spending needs by assigning associated probabilities to annual expected cash outflows.
Annuity Method
The calculated price of an annuity equals the present value of a series of future fixed outflows during retirement. Annuities provide a series of fixed payments, either for life or for a specified period, in exchange for a lump sum payment.
Monte Carlo Simulation
Monte Carlo simulation yields an overall probability of meeting retirement needs by aggregating the results of many trials of probability-based estimates of key variables, and it is a flexible approach for exploring different retirement scenarios. This simulation models the uncertainty of the key variables and the uncertainty or variability in the future outcome. A Monte Carlo simulation uses assumptions of probability distributions for the key variables and then runs a large number of independent trials that generate many random outcomes. These outcomes are then aggregated to determine the probability of reaching investment objectives.
An advantage of Monte Carlo simulation for retirement planning is its flexibility in modeling and exploring different scenarios. Typically, retirement goals are more complex than a fixed, annual cash flow need.
Risk Management Techniques
High severity high frequency - Risk avoidance
High severity low frequency - risk transfer
Low severity high frequency - risk reduction
Low severity low frequency - risk retention
