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LM4 Topics in Private Wealth Management 2024 Level III Notes © IFT. All rights reserved 1 LM4 Topics in Private Wealth Management 1. Introduction .......................................................................................................................................................3 2. Components of Return and Tax Status of The Account.....................................................................3 Taxation of the Components of Return...................................................................................................3 The Tax Status of the Account....................................................................................................................5 3. The Jurisdiction that Applies to the Investor ........................................................................................6 4. Measuring Tax Efficiency with After-Tax Returns ..............................................................................7 Tax Efficiency of Various Asset Classes and Investment Strategies ............................................7 Calculating After-Tax Returns ....................................................................................................................8 5. Capital Accumulation and Asset Location............................................................................................ 14 Capital Accumulation in Taxable, Tax-Deferred, and Tax-Exempt Accounts........................ 14 Asset Location................................................................................................................................................ 15 6. Decumulation Strategies and Charitable Giving Strategies .......................................................... 18 Tax Considerations in Charitable Giving............................................................................................. 18 7. Tax Management Strategies and Basic Tax Strategies.................................................................... 19 Basic Portfolio Tax Management Strategies ...................................................................................... 19 8. Application of Tax Management Strategies......................................................................................... 20 Investment Vehicles .................................................................................................................................... 20 Tax Loss Harvesting .................................................................................................................................... 22 Quantitative Tax Management................................................................................................................ 23 9. Managing Concentrated Portfolios......................................................................................................... 24 Risk and Tax Considerations in Managing Concentrated Single-Asset Positions ............... 25 10. Strategies for Managing Concentrated Positions in Public Equities....................................... 26 Staged Diversification and Completion Portfolios........................................................................... 26 Tax-Optimized Equity Strategies—Equity Monetization, Collars, and Call Writing .......... 27 Tax-Free Exchanges..................................................................................................................................... 29 Charitable Remainder Trust..................................................................................................................... 30 11. Managing Concentrated Positions in Privately Owned Businesses and Real Estate........ 30 Personal Line of Credit Secured by Company Shares..................................................................... 31 Leveraged Recapitalization ...................................................................................................................... 31 Employee Stock Ownership Plan............................................................................................................ 31
LM4 Topics in Private Wealth Management 2024 Level III Notes © IFT. All rights reserved 2 Strategies for Managing Concentrated Positions in Real Estate ................................................ 31 Mortgage Financing..................................................................................................................................... 32 Real Estate Monetization for the Charitably Inclined—An Asset Location Strategy ......... 32 12. Directing and Transferring Wealth...................................................................................................... 33 Objectives of Gift and Estate Planning ................................................................................................. 33 13. Introduction to Estate Planning............................................................................................................ 35 Introduction to Estate Planning: Wills, Probate, and Legal Systems........................................ 36 Lifetime Gifts and Testamentary Bequests ........................................................................................ 36 Efficiency of Lifetime Gifts versus Testamentary Bequests......................................................... 38 14. Estate Planning Tools................................................................................................................................ 40 15. Managing Wealth Across Generations................................................................................................ 44 General Principles of Family Governance........................................................................................... 44 Family Conflict Resolution........................................................................................................................ 44 Family Dynamics in the Context of Business Exit............................................................................ 45 16. Planning for the Unexpected.................................................................................................................. 46 Divorce.............................................................................................................................................................. 46 Incapacity ........................................................................................................................................................ 46 Summary ............................................................................................................................................................... 48 This document should be read in conjunction with the corresponding reading in the 2024 Level III CFA® Program curriculum. Some of the graphs, charts, tables, examples, and figures are copyright 2023, CFA Institute. Reproduced and republished with permission from CFA Institute. All rights reserved. Required disclaimer: CFA Institute does not endorse, promote, or warrant the accuracy or quality of the products or services offered by IFT. CFA Institute, CFA®, and Chartered Financial Analyst® are trademarks owned by CFA Institute. Version 1.0
LM4 Topics in Private Wealth Management 2024 Level III Notes © IFT. All rights reserved 3 1. Introduction This reading focuses on three key aspects of private wealth management: • The impact of taxes on wealth accumulation • The management of concentrated positions in public or private assets • The basic tools and techniques for preserving wealth through generations 2. Components of Return and Tax Status of The Account In many countries, tax rates can exceed 50%, greatly reducing realized returns. Understanding tax structures will help the portfolio manager make better decisions for taxable clients, such as which asset classes and securities to invest in and when to realize gains and losses. The three fundamental elements of investment taxation are: • Taxation of the components of return • The tax status of the account • The jurisdiction that applies to the investor (and/or account) We will cover these elements in the following sections. Taxation of the Components of Return The general categories of taxes observed in most countries are: • Income Tax: It is calculated as a percentage of taxable income. Taxable income generally includes wages, rents, dividends, and interest. Often different rates are applied to different income levels. Cross-border investments, which are common in the portfolios of many wealthy families, may generate taxable income in both the investor's home country and the country where the investment is located. • Gains Tax: Any profit that arises from the sale of an asset (including financial assets) is called capital gain. Capital gains are often differentiated from income and taxed at different rates. • Wealth or Property Tax: A wealth or property tax most often refers to the taxation of real estate, but it may also apply to financial and other assets. Such taxes are usually assessed on an annual basis. • Stamp Duties: Taxes imposed on the purchase price of shares or real estate. Foreign investors may be subject to higher rates than domestic investors. • Wealth Transfer Tax: Taxes levied on the transfer of assets from one owner to another using some mechanism other than an outright sale/purchase transaction. Examples of wealth transfer taxes include “estate” or “inheritance” taxes paid upon the investor’s death and “gift” taxes paid on transfers made during the investor’s
LM4 Topics in Private Wealth Management 2024 Level III Notes © IFT. All rights reserved 4 lifetime. In some cases, the person transferring the asset is liable for these taxes; in others, the recipient is liable for them. Thus, investors pay taxes on: • What they earn – income and gains tax • What they own – wealth or property tax • What they buy – stamp duty tax • What they transfer – gift and estate tax Interest, Dividends, and Withholding Taxes Preferential treatment for some types of interest income: Debt instruments produce income in the form of interest payments. Many countries give preferential treatment for some types of interest income. For example, in the United States income from municipal bonds is often exempt from income taxes. Double taxation: Double taxation refers to a situation where the same income is taxed twice. For example, corporate earnings are taxed at the company level and then taxed again at the investor level when the investor receives a portion of the earnings as dividends. To mitigate this issue, some countries provide specific exemptions. For example, in the United States, dividends from most domestic companies and qualifying foreign companies are taxed at a lower tax rate if the stock is held for at least 60 days. Withholding taxes: Cross-border investments are often subject to withholding taxes. These taxes are imposed by the country in which the investment is made on the interest/dividend/royalties generated by the investment. The income will be taxed in the country where it was earned and may be taxed again in the investor's home country. The taxing jurisdiction will withhold taxes on gross income earned within the jurisdiction, regardless of any offsetting investment expenses or losses available from the taxpayer's other investment activities. Capital Gain Taxes Capital gains may be realized or unrealized capital gains. • Realized – The profit booked when an investment is sold. • Unrealized – The amount an investment appreciates above its purchase price before it is sold. To calculate the tax liability on a particular trade, we need to know the asset’s tax basis and holding period. • Tax basis – Also known as ‘cost’ basis, it is usually equal to the amount paid to acquire an asset. For equities, this would be the share price multiplied by the number of shares plus commissions and other trading costs. Capital gain = Selling price – Tax basis