In this environment, the thirst for alpha, total return and yield has dominated investor behavior.
However, managing wealth for these factors alone is no longer a worthwhile strategy for the ultra-affluent. The thought leaders of the wealth management industry recognize that wealth must be managed at a higher level, taking into account the effects of legislation and taxation on portfolios as well, as investor behavior.
Chasing marginal return over the life of a client’s portfolio pales by comparison to the effects of managing for tax at the end of a client’s life. Upon death, the wealth transfer tax on a client’s estate is 40%, a significant reduction in the legacy left to heirs and chosen charitable causes.
For a standard family with three children, the estate would be divided 40% to the IRS and just 20% to each child.
There is also the conflict, often unspoken, of a client’s spending versus his or her legacy. It is easy to get caught up focusing on theoretical gross balance sheet returns, as opposed to the real-world metrics of actual spendable income and legacy goals.
Sophisticated advisors to the ultra-affluent are upgrading their strategies for intergenerational wealth transfer and philanthropic planning to see clients live better and leave more. Gifts, insurance strategies, inter-family loans and trust structures eliminate, fund or reduce fund wealth transfer taxes at death, returning control of the legacy back to the client.
This allows clients to feel comfortable spending more now and giving more to charity during their lifetimes, knowing that they have already taken care of their heirs when they die.
Recent tax code changes increased gift allowances for individuals to transfer funds or assets to heirs before death. The legislation is due to expire in five years, so while not urgent, this is a good time for clients and their attorneys to prepare and reevaluate old plans.
Gifted assets receive no cost basis step up at death, making it an efficient strategy to begin curating a legacy during life.
Of more urgency is ensuring a client’s life insurance portfolio is correctly calibrated. Advisors need to prevent starting policies too late and inflating costs or worse, being underinsured for a client’s eventual transfer tax liabilities.
For too long, life insurance has been a dirty word, but the product has entered a renaissance for the ultra-affluent. Perhaps the single most powerful tool when planning for intergenerational wealth transfer, funds invested in life insurance accumulate income tax free and compound exponentially over the life of the policy.
Some advisors are treating insurance as an active asset class by bringing pricing, leveraging and investing through insurance structures to the center of the planning process, ready to be monitored and adjusted over the life of the client. Policies in private-placement life insurance structures are particularly customizable and bring the highest levels of transparency and control to advisors.
Managing wealth for the ultra-affluent brings its own challenges and opportunities. Don’t just manage for returns, manage for tax and legacy, allowing clients to live better and leave more. Disinherit the IRS.
This story is part of a 30-30 series on tax-advantaged investing.
