Private Wealth Management Flashcards

Question

Capital Gains Tax Formula (Tax Drag)

Answer 1

FVIF_AT = PV[(1 + r)ⁿ(1 - t_cg) + t_cgB] B = tax basis / MV Example: Invest $100 for 20 years at 9%, tax_cg = 25% ``` No taxes: FV = 100(1.09)²⁰ = 560.44 - cost basis(100) = 460.44 FV = 100[(1.09)²⁰(1 - 0.25) + 0.25(1) = $445.33 - cost basis (100) = 345.33 Tax drag ($) = 115.11 Tax drag (%) = 115.11/460.44 = 25% ```

Answer 2

* No lost compounding of return * Tax drag increases over time * if no initial ug/l and costs basis = 1, tax drag = the tax rate * if initial ug/l is a GAIN: tax drag is \> than tax rate * if initial ug/l is a LOSS: tax drag is \< than tax rate

Answer 3

FV_AT = PV[(1 + r)(1 - t_w)]ⁿ Example: 1000 invested 20 years, pretax return of 10%. Wealth tax of 3%. Compute value and tax drag FV_AT = 1000[(1 + 0.10)(1 - 0.03)]²⁰ = 3658.38 3658.38 - 1000 = 2658.38 If no tax = 1000(1 0.10)^20 = 6727.50 - 1000 = 5727.50 5727.50-2658.38 = 3069.12 (53.6%)

Answer 4

1. TD_$ and TD_% increase over longer time periods 2. **TD_$ increases but TD_% decreases at higher rates of return** 1. Tax on initial value is constant, so higher return is less of a % 3. TD_% is lowest for moderate time horizon/return 4. TD_% is higher when time horizon is longer/higher or shorter/lower

Answer 5

**Accrual Equivalent Return:** R_AE = (FV_AT / initial investment)^1/n - 1 **Accrual Equivalent Tax Rate:** T_AE = 1 - (R_AE / r) **Example:** 1000 invested for 20 years, pretax return of 10%. Return has annual tax of 30%. FV_AT is 3869.68, tax drag = 49.9% R_AE = (3869.68 / 1000)^1/20 - 1 = 7% T_AE = 1 - (.07 / .1) = 30%

Answer 6

FV_TEA = PV(1 + r)ⁿ FV_TDA = PV[(1 + r)ⁿ (1 - t_n)] FV_taxable = PV [1 + r(1 - tax)]ⁿ

Answer 7

If taxes now are **less** than future taxes - Use Tax Exempt If taxes now are **more** than future taxes - Use Tax Deferred If they are the same, doesnt matter

Answer 8

r_AT = r(1 - t) std_AT = std(1 - t) Government shares in gains and losses: makes taxable account the lowest risk

Answer 9

1. **Traders** - daily investors. No tax alpha due to realized gains 2. **Active** investors - many gains are longer term. 3. **Passive** investors - hold equity and defers gains 4. **Exempt** investors - avoid taxation

Answer 10

* Asset _allocation_ is more important than asset _location_. * First get assest allocation, then try to minimize taxes * High trading reduces after-tax return due to taxes/costs

Answer 11

* Combined probability: (a + b) - (a \* b) * PV: expected real spending / (1 + r)ⁿ **_Risks_** * based on probabilitys. Approx. half will live longer * Real spending could increase

Answer 12

RV_tax-free = _[1 + r__g_(1 - t__ig_)]_ⁿ [1 + r_e(1 - t_ie)]ⁿ (1 - T_e) **r_g** = pretax return for receiver **t****_ig** = tax rate on earnings for receiver **re** = pretax return for giver **t_ie** = tax rate on earnings for giver **T_e** = Estate tax **T_g** = Gift Tax

Answer 13

RVtaxable gift receiver = **[(1 - T_g)]**[1 + r_g(1 - t_ig)]ⁿ [1 + r_e(1 - t_ie)]ⁿ (1 - T_e) **Note:** Same as standard except for the bold r_g = pretax return for receiver t_ig = tax rate on earnings for receiver r_e = pretax return for giver t_ie = tax rate on earnings for giver T_e = Estate tax T_g = Gift Tax

Answer 14

RVtaxable gift giver = **_(1 - T_****_g** **_+ T_****_g****_T_****_e**_**)**[1 + r__g_(1 - t__ig_)]_ⁿ [1 + r_e(1 - t_ie)]ⁿ (1 - T_e) **Note:** Same as standard except for the bold r_g = pretax return for receiver t_ig = tax rate on earnings for receiver r_e = pretax return for giver tie = tax rate on earnings for giver T_e = Estate tax T_g = Gift Tax

Answer 15

* If RV \> 1 --\> Gift now * If RV \< 1 --\> Bequest at death * If RV = 1 -- \> Gift now * 1 / (1 - T_e) * Tax exempt receiver is best to give now * Once gifted cannot be recovered * Could underestimate future needs

Answer 16

FV_{no skipping} = PV [(1 + r)ⁿ¹ (1 - t)][(1 + r)ⁿ² (1 - t)] FV_skipping = PV [(1 + r)^{n1 + n2} (1 - t)] Then: Relative value = Skip / No skip Example: 5% return, 40% tax rate. 15 year first generation 30 year second generation

Answer 17

* Tax treaties between countries * **Exemption** - income taxed by source country only * **Credit** - tax owed to source country reduces taxes to the residence country * If t_residence \> t_source the difference is still owed * **Deduction** (only partial relief) * **ALWAYS START WITH SOURCE**

Answer 18

$2.6M of income for residence. 750K of that is from source residence tax = 35%, source tax = 40% **_Exemption_** Source: 750,000(.40) = 300K, Residence: 1,850,000(0.35) = 647,500 Total tax owed = 300,000 + 647,500 **_Credit_** Source: 750,000(.40) = 300K, Residence: 1,850,000(0.35) = 647,500 Residence: 750,000(0.35) = 262,500 - less than 300K so waived Total tax owed = 300,000 + 647,500 **(if residence tax \> source you owe more)** **_Deduction_** Source: 750,000(.40) = 300K, Residence: 1,850,000(0.35) = 647,500 Residence: 750,000-300,000(0.35) = 157,500 Total tax owed = 300,000 + 647,500 + 157,500

Answer 19

Objectives: 1. Reduce the risk 2. Generate liquidity 3. **Optimize tax efficiency** Constraints: 1. Restriction on sale (e.g. insider) 2. Desire for control 3. Has other uses for assets (real estate)

Answer 20

**Rule-Based:** defines exact percentage (think US) **Risk-Based:** considers underlying economincs (derivatives can change risk and increase margin ability)

Answer 21

1. **Personal** risk bucket: protect from proverty (cash/CDs) 2. **Market** risk bucket: maintain standard of living (stocks/bonds) 3. **Aspirational** risk bucket: private business, concetrated positions, real estate, etc.

Answer 22

1. Set objectives/constraints 2. Identify best strategies 3. Identify tax advantages/disadvantages 4. Identify other advantages/disadvantages 5. Document decisions

Answer 23

AKA Corporate estate tax freeze: transfers appreciation and tax liability to a future generation. **TAXABLE** event **Example:** restructure company with voting perferred and nonvoting common stock **Voting preferred** keeps control, cash flow, and has no initial unrealized tax liability **Nonvoting common** minimal initial value and tax, captures future growth

Answer 24

1. Create a LP 2. Gift the asset to the partnership 3. Giftor serves and GP and retains control 4. LPs have limited marketability and no control 1. Results in valuation discounts which reduces gift taxes 5. Future value and tax liability goes to LPs

Answer 25

* **Sell the asset** - triggers tax liability and loss of control * **Monetize the asset:** borrow against the asset * Structure to eliminate as much risk as possible without the tax liability coming due * **Hedge the asset value:** uses derivatives to limit downside risk * OTC: create counterparty risk, provide flexibility * Exchange traded; enters offsetting transaction, prices are publicly recorded, more transparent.

Answer 26

* **Short Sale box:** borrow same stock and sell short to get cash * Makes the position riskless (earns R_f) * **Equity Forward Sale Contract:** enter in a forward contract to sell * Known sale price and eliminates up/down movement * **Forward Conversion with Options:** selling calls and buying puts * **Total Return Equity Swap:** Pay return on asset and receive LIBOR * Returns above LIBOR investor pays. * Returns below LIBOR invest receives

Answer 27

1. Buy a protective put (portfolio insurance) 2. ATM puts are the most expensive. 1. To reduce expenses; 1. Buy OTM put (no protection unless stock falls below strike) 2. Buy a put with shorter expiration 3. Use knock-out put (raises too much option terminates) 4. Purchase a collar

Answer 28

1. Index tracking with active management 1. Cash from a monetized position invested in an index 2. Coordinate around the concentrated position 1. Diversification around the concentrated position

Answer 29

**Perfect Hedge -** eliminating all risk. Could be considered a sale (Tax due ASAP) **_Cross Hedge (increases unsystematic risk)_** 1. Short sale a similar stock 2. Short sale an index that contains the concentrated position 3. Purchase a put on the concentrated position

Answer 30

* Create a fund and contribute our concentrated position * Others do the same to create a diversified portfolio * Own the initial % contributed * High costs and legal restrictions

Answer 31

1. **Strategic Buyer** - wants to use the business (pays the highest price) 2. **Financial Buyer** - think private equity fund 1. may restructure, add value, then sell the business 3. **Recapitalization** - Issue debt to finance purchase of owner's stock 1. Owner can sell shares and the company takes on the debt 2. Retain Control and could receive dividends 4. **MBO or sale to employees** - taxable and loss control 1. Requires discounted price and they have to borrow 5. **IPO or ESOP**

Answer 32

1. Use mortgage financing to borrow funds 1. a nonrecourse loan is like a protective put (they could only take the property) 2. Sale and leaseback 3. Put in a chartitable trust

Answer 33

* The discounted cash flows of what you make * **High HC requires more life insurance** * Steady income = lower discount rate, higher HC * Sales/commission income = higher discount rate, lower HC (less insurance) * Start off with high HC, low FC, but switches over time Example; wages 100,000, growth 4%, r = 3%, risk = 10% _% of Life Wages % \* Wages PV_ Year 1 98% 104,000 101,920 90,195 Year 2 98% 108,160 105,997 83,011 Year 3 97% 112,486 109,111 75,619 Total HC: 248,825

Answer 34

1. **Education** - no savings or risk managment 2. **Early Career** - saving is difficult, life insurance for family 3. **Career Development** - financial obligations increase (kids college), building up FC 4. **Peak Accumulation** - Highest FC accumulation, financial obligations slowing, risk is reducing 5. **Preretirement** - focus on FC for retirement, risk reducing, tax planning 6. **Early Retirement** - new lifestyle, expenses could increase 7. **Late Retirement** - highy unpredictable, longevity risk, increase health care

Answer 35

Taking Financial and Human capital and comparing to all debt, lifetime expenses, and planned bequests.

Answer 36

1. **Health** risk: insure with health insurance 2. **Earnings** risk: losing job, disability, how risky the job is 1. Insure with disability insurance 3. **Longevity** risk: insure with annuities 4. **Liability** risk (getting sued): insure with liability insurance 5. **Premature death** risk: insure with life insurance 6. **Property** risk (flood, fire, etc): insure with property insurance

Answer 37

* **Term** - "pure insurance" only for a period of time * **Perm** - last for lifetime and includes a cash value * **Whole Life** - set periodic premium * **Universal life** - allows adjustments to premium and how it's invested * **Mortality credits** - risk shared/pooled

Answer 38

**_Issues_** * When will death occur? * Return on premiums * Company expenses * Profit Margin **_Process_** * Mortality esimates * **Net premium** (what to charge) - ROI & mortality (males get charged more) * **Load** - added to net premium to make a profit

Answer 39

* Fixed have a higher initial payout (Variable potentially higher over time) * Fixed payouts based on initial interest rates (if low, low payments) * Fixed easier to analyze * Variable allows an early payout/close * Variable higher fees (fixed lower)

Answer 40

1. Effective annual return by receiver increases since they are tax exempt 2. Gift would not be taxed 3. Tax deduction immediately

Answer 41

**_Human Life Method_** PV of excess income \* years until retirement **_Needs Analysis Method_** + PV of needs + all expenses - portfolio - business or another income

Answer 42

**_↑ Time Horizon ↑ Return_** Capital G. (B=1) ↑TD$, ↑TD% **=**TD$, **=**TD% Captial G. (B\>1) ↑TD$, ↑TD% **↑**TD$, **↑**TD% Capital G. (B\<1) ↑TD$, ↑TD% **↓**TD$, **↓**TD% Annual Weath ↑TD$, ↑TD% ↑TD$, ↓TD%

Private Wealth Management Flashcards

(67 cards)