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| Scenario Planning |
A Family Way
Rosario J. Ruffino, M. Cullen Thompson and Justin McCarthy
11/01/2007
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ESTATE PLANNING
Goal: Protection and planning
for distribution of existing assets upon death.
Recommendation: Create a
will, which includes testamentary trusts, such as a credit shelter trust and
possibly a qualified terminable interest property trust (QTIP). This will allow
the client to control how, when and to whom her assets will be distributed in
the event of her death. The credit shelter trust allows for efficient use of her
estate tax exemption (grows to $3.5 million in 2009), minimizes the subsequent
estate tax upon the spouse’s death, and allows her to choose the eventual
beneficiaries of the remaining assets. Those assets that remain in her name,
specifically the $20 million inheritance, could be placed in a QTIP trust, which
utilizes the unlimited marital deduction to defer estate tax until the death of
her husband. It also provides her husband with an income interest in the assets
for life, and allows Altman to control the distribution of the inherited assets
upon her husband’s death.
PRENUPTIAL AGREEMENT
Goal: Protect inherited
family assets in the event of a divorce.
Recommendation: Altman
already has a substantial estate prior to her upcoming marriage. Generally,
assets that are acquired or inherited prior to marriage are not considered
marital property unless there is commingling with funds obtained during
marriage. A prenuptial agreement may make certain that these assets are kept
within her family. The prenuptial agreement should be drafted in contemplation
of her will in order to prevent any conflicts.
INSURANCE PLANNING
Goal: To hedge human capital
(i.e., wage income), add a lifetime investment aspect and ultimately provide
liquidity for estate taxes.
Recommendation: Life
insurance is perfectly negatively correlated with an individual’s wage income,
providing the necessary hedge to protect the insured’s family from the potential
loss of income. In the context of an investment portfolio, whole life insurance
provides tax-deferred, fixed-income-like returns. Building cash value on a
tax-deferred basis within a life insurance policy is simply an exercise of asset
location—holding assets that generate ordinary income and would otherwise be
subject to high marginal tax rates in tax-deferred vehicles. The tax-deferred
internal rate of return on the cash value compares to the taxable return of many
fixed-income investments and should be modeled as such. Additional benefits of
cash value life insurance are creditor protection (in certain states) and
flexibility with regard to access of funds. Cash value life insurance is an
efficient means of paying estate taxes, particularly on non-income-generating
assets such as real estate. The policy should be purchased within an irrevocable
life insurance trust in order to avoid having the proceeds included in the
taxable estate.
INVESTMENT STRATEGY
Goal: Portfolio
diversification with an emphasis on providing real after-tax returns that are
less correlated to the client’s wage income.
Recommendation: Altman has a
high level of sophistication and knowledge of financial markets. Combined with
an opportunistic nature, long-term horizon and high level of absolute wealth, we
recommend the following portfolio structure:
• 10 percent investment-grade bonds
• 60 percent global equities
• 30 percent alternative assets (real estate, commodities,
private equity, hedge funds)
Fixed Income: Given that the
whole life insurance is in place and the low real returns attributable to fixed
income, we recommend an allocation sufficient to serve any potential short-term
liquidity needs without subjecting the portfolio to the significant opportunity
cost of holding bonds over long time horizons. By integrating these assets into
a cohesive framework, overall portfolio volatility and equity market
diversification can be controlled by the inclusion of other asset classes.
Equity: The global equity
allocation would include exposure to high-quality domestic, international
developed and emerging market equities. International and emerging market
exposure provides currency diversification, as well as exposure to strong global
growth. Approximate weights for the equity allocation are:
• 25 percent U.S. large- and mid-cap
• 5 percent U.S. small-cap
• 30 percent international and emerging markets
Alternative Assets: Alternative assets reduce dependence on traditional equity markets, providing powerful diversification potential
combined with attractive returns, resulting in a portfolio structure with higher
anticipated risk-adjusted returns.
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