The First Deadly Sin That Can Undermine High-Net Worth Families

First Deadly Sin: Incomplete Investment Policies

The use of an Investment Policy Statement, which states the return target and risk management policies and risk tolerance of an investment portfolio, has become “standard practice.” However, in most cases, the emphasis therein is on total return and does not consider how to best manage assets with overall objectives in mind, particularly in the context of cash flow.

For example, most high-net worth families have large periodic expenditures: for example, estimated income tax payments, large life insurance premium payments, required distributions from trusts and payments of estate tax under IRC Section 6166. Further, there is the issue of how to pay estate tax, typically at the death of the second spouse.

Consider the case of the poor beneficiaries whose mother passed away while the stock market was plummeting. Yes, she had an Investment Policy Statement. Yes, the Investment Policy Statement was aggressive: 100% in stocks because Mom’s portfolio was otherwise in income-producing real estate and deeds of trust. So, her stock portfolio, which we will round down to a value of $1,000,000 at date of death, was fully taxable at a 45% estate tax rate ($450,000 of tax). The good news (sort of…) was that the six-month “Alternate Valuation Date” the portfolio had dropped to $700,000, so estate tax was $315,000 only. However, by the time the estate tax was paid, nine months after date of death, the portfolio had dropped to $500,000.

You can figure this one out: Mom died early in 2008 and the estate tax was due at the end of 2008. In this case, if the stock/bond mix had been 60/40 to accommodate the estate tax on the portfolio, the heirs would have inherited $146,000 more after estate tax.

The moral of this story: what goes up must come down…. Just don’t die while everything is going down.

Next blog: Second Deadly Sin: Missing and Irrelevant Beneficiary Designations