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Estate optimization requires an understanding of how each planning tool is expected to perform across time. This is done by projecting out asset values to show when assets will transfer to heirs and what transfer taxes might affect the transfer. In addition, the cash flows generated by each tool should be illustrated across time to spot unnecessary income tax, capital gains, or AMT tax exposure created by the tool. The estate plan architect must know how to adjust each tool to minimize taxes. For example, a TCLAT can have very good results or very bad results depending on the eight interrelated assumptions about rate of return, pay out rates, growth rates, trust term, discounting percentages, contribution amounts, timing of distributions, and desired deductions.
Even if an adviser knows how to design the TCLAT and all other recommended tools with great precision, the focus on precise detail may cause the adviser to ignore problems that often develop when tools are combined. For example, an instrument that results in a zero transfer tax can easily produce additional income, capital gains, or AMT taxes. Alternatively, tools like annuities that have low income taxes can easily produce very negative transfer tax consequences.
An estate plan architect should have a process that helps monitor how cash flows from each planning tool are affected by all types of transfer taxes and income taxes. An adviser can easily under-estimate the complexity inherent in solving a tax minimization puzzle that involves optimizing cash flow after payment of six types of taxes listed above. Too many advisers optimize cash flow to a client or the client’s beneficiaries after minimizing just a few of the taxes. This short-sighted approach is tantamount to claiming that a Rubik’s Cube puzzle has been solved when only two or three of the six sides have uniformly-colored squares. Anyone who thinks carefully about the mathematics behind optimizing returns after taxes will realize that the tax puzzle, like Rubik’s puzzle, has literally quintillions of possible solutions that should receive fair consideration while looking for the optimal outcome.
Optimizing an estate plan can create much more complexity than one faces when optimizing Rubik’s Cube. Whereas the cube has a finite number of possible solutions with predictable movements for each square on the cube, an estate plan is comprised of legal tools that can have very different performance depending on which financial instruments fund each legal tool. Because investment returns can have a significant impact on the well-being of beneficiaries, prudent investor guidelines typically require that estate planning tools have investment policy statements that describe the optimal mix of portfolio assets for each tool. An astute adviser will therefore combine the estate optimization process with a portfolio optimization process in order to create true wealth optimization.
The portfolio optimization process helps an adviser “stress test” each legal tool under different rate of return assumptions. When projecting out cash flows generated by different types of portfolios, it is possible to produce millions of projections and choose only the scenarios that optimize the after-tax cash flow and wealth transfer benefits for the client. As clients and advisers consider the incremental benefits of combining portfolio optimization with estate optimization, they see that these techniques can both help reduce taxes.
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Voorhees Family Office Services, Inc.
650 Town Center Drive, Suite 890, Costa Mesa, CA 92626
Phone: (800) 447-7090 • Fax: (866) 447-7090
©Tim Voorhees, 2002-2017 |
