Facing problems of the one percent

Real estate taxes, investment strategies and why wealth management matters

Mar.March 06, 2015 07:00 AM

It’s uncomfortable, but it pays to talk about money.

Consider a potential scenario for a longtime New Yorker: You’ve just inherited your parents’ or grandparents’ Manhattan home — and that abode purchased several decades ago is anything but modest today. A $100,000 townhouse or co-op bought in “the bad old days” might easily be worth tens of millions in the current marketplace. A pretty sweet windfall, right?

However, if your family never discussed how to best manage that asset, you could be saddled with a hefty inheritance tax. In 2013, Congress made permanent a 40 percent tax on estates worth more than $5 million — recently adjusted to $5.4 million for inflation. (Since that price today buys a nice two or three-bedroom condo, your family may not necessarily be thinking in terms of “estates.”)

Likewise, if a relative leaves you the family business, a lack of planning could turn a blessing into a burden. As in the previous scenario, nearly half of the value of that business could be headed to the IRS. “Once you’ve paid an estate tax, lots of market gains get wiped out,” said Edward Renn, who focuses on a blend of income and estate tax planning as a partner at Withers Bergman LLP, an international law firm specializing in tax, trust and estate planning. “In the wrong 10-year period, you can probably find a scenario where death results in a loss in basis [value], instead of an increase.”

Experts agree that the best way to avoid that is simply to communicate with your family, as well as with legal and tax experts. “Really there is no way to put the genie back in the bottle, meaning that if a person is given an significant asset outright, they’re not the ones who can then turn around and set up their own trust,” said Gerard Joyce, Jr. managing director and head of the U.S. Personal Trust group within HSBC’s U.S. Private Bank. “That had to be done by the ancestor.”

Wealth management is “a little bit like planning a wedding,” said Hannah Shaw Grove, an expert with 25 years’ experience working in wealth management and a founder of Private Wealth magazine. “There are so many nuances to managing wealth that you can’t think of until you are in the middle of it.”

With that in mind, Luxury Listings reached out to wealth management experts to help tackle rich-people problems and find billionaire solutions.

Go it alone?

The first hurdle an individual of affluence encounters when deciding how best to manage his or her bundle is whether it is more advantageous to hire legal, tax and financial experts piecemeal, or whether it makes more sense to tap into the infrastructure of an existing institution.

In most every circumstance, the answer is simply a matter of figuring out exactly how much money you’ve got stashed away, be it liquid or hard assets. According to Grove, it isn’t until an individual or family is worth roughly half a billion that it makes sense to hire private specialists. “Most families don’t want to manage their wealth themselves unless they’ve got several hundred million dollars — usually north of $600 million,” Shaw said. “Otherwise it makes much more sense to tap into an existing organization like Morgan Stanley or Northern Trust that has all of the infrastructure and protocols in place, and all of those experts in house. That is really what wealth management is.”

And when it comes to institutions — hungry for ever-more-affluent clients — the number of services on offer is expanding. “Institutions are moving away from pure financial services and are incorporating things that are important to the wealth holder,” Grove said. For instance, many banks and wealth managers are adding more lifestyle services to their suite of offerings, such as concierge support for travel arrangements and luxury acquisitions. They are even helping people curate their collectibles.

And while engaging specialists who work solely on your behalf is certainly a luxury, institutions are becoming more flexible, offering a highly personalized approach to wealth management. “There’s no check list. It’s like a doctor’s visit,” Joyce said of HSBC’s wealth-management services. “We tailor a plan to our clients and get very specific about what they would like to do with their wealth.”

Infinite shades of gray 

A lot of people use wealth management as a euphemism for investment management, i.e., if you have money, shouldn’t it be invested to become more money? But answering that question requires that you have first established clear goals: Are you investing to supplement an income, or for long-term growth? Are you investing in public equities and debt instruments, or are you interested in being in private markets as well? The extremely affluent will even craft an investment strategy that matches up with their political and social ideology, according to Grove.

“There are so many shades of gray in investments,” Grove said.

“Some people invest because they have $1 million and want more. They want to invest to increase the overall principal — it’s about investment gains,” she explains. “Sometimes it’s about staying ahead of inflation. Sometimes it’s about leveraging the tax code.”

“If you get all those things working together, you can save a lot of money in taxes,
and have more principal to work with, which can have a compounding effect and increase your overall portfolio,” she said, adding that in recent years, there has been a trend toward increasing allocations to alternative investments, like hedge funds and private equity, on the high net worth end of the spectrum.

The tax man cometh

Experts are cagey about disclosing exactly how much they can save their clients through creative tax mitigation strategies. Plus, they add, every client comes with a special set of circumstances. But all agree that tax planning — specifically, planning to avoid them — is as important as savvy investing.

“Mitigating taxes is a very serious activity for the ultra-high net worth,” Grove said. “A really good year on the stock market would be double digits, but taxes are significantly higher than that. So even if you have really good investment performance, you are continuing to see erosion from taxes.”

A frequent tax-mitigating mistake made by the middle-class millionaire (meaning, someone with “only” about $10 million) is owning his or her own life insurance policy, according to Renn. Instead, Renn recommends tapping into an irrevocable life insurance trust. “If you put several million into an irrevocable life insurance trust, that coverage is not part of anybody’s estate, meaning that you don’t lose half of it to federal estate taxes,” he said.

But when it comes to moving serious money from one generation to the next, dodging that estate tax requires serious long-term planning. In fact, parents can save their children hefty sums by transferring all their valuable assets to irrevocable trusts and by utilizing their lifetime transfer tax exemptions, said Renn. “The properly drafted trust will also provide creditor protection,” he said. “If a child/beneficiary were sued for malpractice, a slip and fall, a breach of contract or by a soon-to- be-ex-spouse in a divorce, the assets in the trust would be protected.”

Renn helped one successful entrepreneur move $90 million of a $150 million business to his children and grandchildren without paying any estate taxes through the use of trusts — a scenario he recalls in his 2008 book, “Protecting the Family Fortune.”

With such amazing sums at stake, it’s best to think like a Boy Scout and be prepared. Or as Renn puts it: “A failure to plan is a default to higher taxes.”

Risky business

Whenever millions (or billions) of dollars are in play, the stakes can get high. That’s why it’s important to manage risk on the stock market, as well as insure hard assets and consider personal security.

“We talk a lot about diversification within a client’s trust portfolio. Most clients aren’t well diversified in their business — it’s usually one business, geography or industry. So it can be comforting for them to know that their overall portfolio will counterbalance their own business activities,” Joyce Jr. said. “That being said, there is no right or wrong answer. It is a personal decision that reflects an individual’s risk tolerance.”

Joyce added that more and more people are asking for their portfolios to be diversified on an international basis to spread the risk on a global scale. “In general, we are aiming for long-term diversified portfolios, not trying to hit the hot market,” he said.

But for the wealthy, there are risks beyond the stock market, and wealth management firms are addressing that by coordinating insurance into an individual’s overall strategy, according to Grove. “You want to make sure that in addition to just managing your liquid assets, you are also thinking about your hard assets and personal property,” she said. “Let’s say the family has a couple of high-value properties, collectables, jewelry and a significant wine collection. You need coordination between your wealth manager and all your insurance providers – life insurance, property insurance, auto insurance, health insurance, etc.”

And as the spectrum of wealth management becomes increasingly broad, personal security is also on offer. “One of the things that is a real issue for the affluent is being targeted for theft, cyber crime and extortion,” Grove said. “We’ve seen a big increase in private security services
being incorporated into wealth management
offerings. It’s one of those things you don’t think about until suddenly it presents itself as an issue.”

Good deeds — and goals

While certain Ayn Randian billionaires may still think greed is good, for most people, philanthropy is an essential aspect of stewarding their wealth. And once again, the key to philanthropic success is communicating a clear vision. “If you just write a check to a charity, you might not be giving in the most tax efficient fashion,” Grove said. “If you use planned giving vehicles, it could ultimately be a much bigger gift overall.”

And those vehicles are most often found within wealth management institutions, which have decades of experience giving away charitable dollars efficiently. “One of the first things you have to figure out is what are you interested in supporting and what impact you want to have,” Joyce Jr. said. “The current trend in philanthropy is impact investing. People want to make sure their money is making an impact, and they like things that are discreet and distinct.”

He added that his younger clients are especially interested in philanthropy, but not necessarily in writing checks to, say, the Red Cross. Increasingly, young affluent individuals are telling charities that they want to fund something specific.

“People want to know if, for instance, their gift is going to help cure a particular disease in a particular region,” Joyce Jr. said.

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