Russ Alan Prince and Hannah Shaw Grove
11/01/2007
In a recent telephone survey, we asked 259 affluent individuals—approximately half had less than $10 million in net worth and the balance had more—their views on investment performance and tax mitigation (Exhibit 1 below). Our goal was to determine which was more important to them.
The responses to the survey confirmed two things: Managing a tax bill is a far greater concern for the wealthy than investment appreciation, and the more money individuals have, the more passionately they feel about shrinking their tax burden.
Nearly all of the respondents with a net worth in excess of $25 million ranked tax mitigation as most important (96 percent). Slightly fewer (85 percent) of those with a net worth between $10 million and $25 million agreed, as did three-quarters of the least wealthy group, commonly referred to as middle-class millionaires or the working wealthy (Exhibit 2 below).
There are a number of reasons for these results. Some affluent individuals are content with their net worth or are secure in their ability to generate more, so, consequently, they are interested primarily in maximizing what they have and preserving principal.
However, we found that for most of the wealthier respondents, the ability to mitigate taxes will produce a greater "in their pocket return" than even strong investment performance. And, with the assets they have to work with, they have the opportunity to utilize various bright-line tax strategies.
Meanwhile, those surveyed who are less wealthy still seek opportunities to grow their net worth, and many are willing to explore the different options available to them. Also, their more limited pool of personal assets proves to be more restrictive when considering various bright-line tax strategies.
Taxes come in numerous forms, so we also questioned our survey participants about the specific taxes they were most interested in mitigating. Not surprisingly, the group with the lowest overall net worth thought that income taxes had the greatest impact on their personal finances. However, those respondents worth between $10 million and $25 million were about evenly split between income taxes and investment taxes paid on gains and dividends. And while roughly half of the wealthiest group focused primarily on reducing their investment tax obligation, income and estate taxes also loomed large.
Despite the considerable wealth of the respondents, estate taxes were of the least concern to everyone—and almost off the radar screen for the middle-class millionaires (Exhibit 3 above). While estate taxes can be punishing, they are often not an immediate concern, because the other two types of taxes must be paid regularly. Furthermore, people discuss estate taxes in the context of dying, which discourages many people from addressing the matter.
Only one in five respondents had taken any steps to reduce their
taxes, even though most of them expressed interest in doing so. However, there
is a greater disparity when viewed by wealth level. About 60 percent of the
wealthiest segment had already done some advanced planning to manage their
taxes. The rest of the respondents were far less likely to have taken any
action; just 30 percent of the mid-tier group and less than 10 percent of the
least-wealthy group had engaged in tax-planning activities (Exhibit 4 previous page).
Those with greater wealth are in the best position to mitigate
their tax burden. The array of legal strategies that can be employed goes up
nearly exponentially as the level of personal wealth increases. From
international tax arbitrage strategies to the use of captive insurance
companies, and from derivative-based transformational strategies to the use of
special-purpose entities and partnership structures, the wealthy are
better-positioned to use bright-line transactions that can lower their tax
bills.
While roughly half of the wealthiest group focused on reducing their investment tax obligation, income and estate taxes loomed large. |
For a much smaller group, there is an aura of uneasiness and confusion surrounding the process. About a third of the total number of respondents said that they were uncomfortable with the strategies that were recommended to them. However, it is worth noting that there is a significant difference between the least-wealthy and most-wealthy segments: Only 16 percent of the least-wealthy group cited discomfort, compared with 64 percent of the wealthiest group; about half of those in the middle expressed concern. This is due to the fact that the more wealth a person has, the more likely that the individual will be presented with tax mitigation strategies.
About one-quarter of those surveyed thought that tax mitigation strategies were too complicated to warrant the effort and expense, although the wealthiest segment was least likely to think so.
Finally, a small group thought the strategies might be illegal. For these individuals, the idea of taking actions to lower any of their tax bills is too unnerving to even consider.
It’s no surprise that the wealthy population is unhappy with the scope of its tax responsibilities. More telling is the degree of importance wealthy investors place on tax mitigation, especially as compared to investment performance, and the relative lack of action and resources within a community that is receptive and in need of the expertise.
Russ Alan Prince is president of Prince & Associates, a market research and consulting firm for the affluent, and the author of more than 35 books on related topics. Hannah Shaw Grove, an author and columnist, is an expert on the behavior, concerns and finances of affluent consumers.