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<!doctype html>
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<title>Study Session 4 | Reading 12 | Estate Planning in a Global Context</title>
<meta name="description" content="Chartered Financial Analyst Level 3 Study Materials">
<meta name="author" content="MacLane Wilkison">
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<section>
<h1>Reading 12</h1>
<h3>Estate Planning in a Global Context</h3>
<p>
<small>Created for <a href="http://alchemistsacademy.com">AlchemistsAcademy</a> by <a href="http://alchemistsacademy.com/about">MacLane Wilkison</a></small>
</p>
</section>
<section>
<section>
<h1>Basic Concepts and Definitions</h1>
</section>
<section>
<h2>Estates, Wills, and Probate</h2>
<ul>
<li>Estate - all of the property a person owns or controls</li>
<li>Estate planning - the process of preparing for the disposition of an estate upon or prior to death</li>
<li>Will/testament - outlines the rights others will have over one's assets upon death</li>
<li>Probate - legal process confirming the validity of a will</li>
</ul>
<aside class="notes">
An individual's estate may consist of financial assets, tangible physical assets, immovable property, and intellectual property. In a will, the testator is the author of the will whose assets will be distributed. If a will has not been legally validated via probate, the testator will be considered to have died inestate and a court will rule on the disposition of his or her assets. Assets held in joint ownership with right of survivorship will automatically transfer to the surviving joint owner(s).
</aside>
</section>
<section>
<h2>Legal Systems, Forced Heirship, and Marital Property Regimes</h2>
<ul>
<li>Civil law - legal system that applies a set of codified core princiles to particular cases</li
<li>Common law - legal system that draws abstract rules from prior cases</li>
<li>Shari'a law - Islamic law; similar to civil law in the estate planning context</li>
<li>Forced heirship rules - gives children the right to a fixed share of a parent's estate</li>
<li>Community property regimes - each spouse accorded an indivisible 50% interest in income earned during marriage</li>
<li>Separate property regimes - allows each spouse to own and control property independently</li>
</ul>
<aside class="notes">
Under common law, testators are generally allowed freedom of disposition by will. Under civil law, restrictions are often placed on dispositions.
</aside>
</section>
<section>
<h2>Income, Wealth, and Wealth Transfer Taxes</h2>
<ul>
<li>Four general taxation types</li>
<ol>
<li>Income</li>
<li>Spending</li>
<li>Wealth</li>
<li>Wealth transfers</li>
</ol>
</ul>
<aside class="notes">
Income can be taxed periodically or on an accrual or cash basis as it is received. Alternatively, it can be deferred until a gain on an asset is realized upon disposition. Wealth-based taxes can be assessed on a net worth basis, based on one's comprehensive wealth. Wealth transfer taxes may apply to lifetime gratuitous transfers (gifts made during one's lifetime) or to testamentary gratuitous transfers (transfers made upon death).
</aside>
</section>
</section>
<section>
<section>
<h1>Core Capital and Excess Capital</h1>
</section>
<section>
<h2>Hypothetical Life Balance Sheet</h2>
<img src="images/12/hypothetical-life-balance-sheet.png" alt="hypothetical life balance sheet" />
<aside class="notes">
The hypothetical life balance sheet is a comprehensive accounting on an individual's assets and liabilities, capturing both financial and other easily liquidated assets as well as implied, non-tradable assets such as their human capital or net employment capital. Explicit liabilities are considered along with implied one's representing the capitalized value of the individual's desired expenditures. The amount of capital required to fund current and future expenditures is referred to as core capital. Any assets remaining after deducting the core capital is referred to as excess capital and can be thought of as that individual's net worth.
</aside>
</section>
<section>
<h2>Estimating Core Capital with Mortality Tables</h2>
<ul>
<li>Core capital can be estimated by discounting the expected spending over an individual's remaining life expectancy</li>
<li>Survival probabilities can be determined using a mortality table</li>
<li>Core capital = p(Survival<sub>1</sub>)×Spending<sub>1</sub>/(1+r)<sup>1</sup> + ... + p(Survival<sub>j</sub>)×Spending<sub>j</sub>/(1+r)<sup>j</sup></li>
<li>Monte Carlo simulation may also be used to estimate core capital</li>
</ul>
<aside class="notes">
A safety reserve can be added to the core capital caluclation to hedge the risk that returns will be lower than expected.
</aside>
</section>
</section>
<section>
<h2>Transferring Excess Capital</h2>
<ul>
<li>Lifetime gifts and testamentary bequests considerations</li>
<ul>
<li>Tax-free gifts: RV<sub>TaxFreeGift</sub> = FV<sub>Gift</sub>/FV<sub>Bequest</sub></li>
<li>Taxable gifts: RV<sub>TaxableGift</sub> = FV<sub>Gift</sub>/FV<sub>Bequest</sub></li>
<li>Location of gift tax liability</li>
</ul>
<li>Generation skipping</li>
<li>Valuation discounts</li>
<li>Deemed dispositions</li>
<li>Charitable gratuitous transfers</li>
</ul>
<aside class="notes">
The relative value of a tax-free gift is the FV of the gift divided by the FV of a comparable taxable bequest in the future. Similarly, the relative value of a taxable gift is the FV of the gift divided by the FV of a comparable taxable bequest in the future. The jurisdiction in which a taxable gift occurs can be important. For example, some jurisdicitions impose the tax liability on the donor rather than the recipient and vice-versa, which effects the relative value of the gift. In jurisdictions where each transfer is taxed, it may make sense to make a gift directly from the first to third generation in order to avoid the tax liability associated with an intermediate transfer to the second generation. If a tax is applied to the fair market value of a gift, various discounts may be applied in some cases (e.g. privately held firms valued at a high cost of capital, lack of control discounts for minority interests, illiquidity discounts). Gifts can often be structured in a way to qualify for these discounts. Deemed dispositions are testamentary bequests that are taxed as if they were sold, which can trigger realized capital gains taxes.
</aside>
</section>
<section>
<h2>Estate Planning Tools</h2>
<ul>
<li>Trusts - an arragement created by a settlor who transfers assets to a trustee</li>
<ul>
<li>Control - ability to make resources available to a beneficiary without yielding complete control</li>
<li>Asset protection - gates the assets from claims against the settlor by creditors or other parties</li>
<li>Tax reduction - </li>
</ul>
<li>Foundations - legal entity established to hold assets for a particular purpose (i.e. philanthropy)</li>
<li>Life insurance - requires the payment of a premium in exchange for a contractual obligation to pay death benefit proceeds to a named beneficiary</li>
</ul>
<aside class="notes">
Trustees are considered the beneficial, not legal, owners of the trust assets. Revocable trusts allow the settlor to retain the right to rescind the trust, irrevocable trusts do not. Thus, irrevocable trusts provide a greater degree of asset protection from claims against the settlor. Fixed trusts have a predefined distribution schedule. Discretionary trusts allow the trustee to make distributions as desired.
</aside>
</section>
<section>
<h2>Cross-Border Estate Planning</h2>
<ul>
<li>The Hague Conference - organization working toward the convergence of private international law</li>
<li>Tax system</li>
<ul>
<li>Source jurisdiction vs. residence jurisdiction</li>
</ul>
<li>Double taxation</li>
<ul>
<li>Residence-residence, source-source, and residence-source conflicts</li>
<li>Foreign tax credit provisions</li>
<ol>
<li>Credit method: T<sub>Credit</sub> = Max[T<sub>Residence</sub>, T<sub>Source</sub>]</li>
<li>Exemption method: T<sub>Exemption</sub> = T<sub>Source</sub></li>
<li>Deduction method: T<sub>Deduction</sub> = T<sub>Residence</sub>+T<sub>Source</sub>(1-T<sub>Residence</sub>)</li>
</ol>
</ul>
<li>Tax avoidance vs. tax evasion</li>
</ul>
<aside class="notes">
Source jurisdiction refers to the imposition of taxes on income derived within a nation's borders. Residence jurisdiction refers to the imposition of taxes on income earned by residents. Residence-residence conflicts occur when two or more countries make competing claims regarding the residence of the same individual. Source-source conflicts occur when two or more countires make competing claims on the source jurisdiction of an asset. Residence-source conflicts occur when an individual is subject to the residence jurisdiction of one country while some of her assets are subject to the source jurisdiction of another country. Source jurisdiction is often given priority through double taxation relief to the individual on the part of the residence country. Under the credit method, the residence country reduces its taxpayers' domestic tax liability for taxes paid to a foreign country exercising source jurisdiction; thus, the tax liability equals the greater of the tax liability due in either the residence or source country. Under the exemption method, the residence country imposes no tax on foreign-source income by providing taxpayers with an exemption; thus the tax liability is the tax imposed at the foreign source. Under the deduction method, the residence country allows taxpayers to reduce their taxable income by the amount of taxes paid to foreign governments. Tax avoidance refers to the development of tax liability reduction strategies conforming to both the spirit and letter of the relevant tax code. Tax evasion refers to the practice of illegaly circumventing tax codes.
</aside>
</section>
<section>
<h1>THE END</h1>
<h3><a href="http://alchemistsacademy.com">AlchemistsAcademy.com</a></h3>
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