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Lessons From the Family Office
October 13, 2010
Tim J. Cestnick FCA, CPA, CFP , TEP Where we’re
we re going

Using a Family Office:
Family Offices Defined

Lessons From the Family Office: UHNW Best Practices
2
Where we’re
we re going
Using a Family Office:
Family Offices Defined
3
Family Offices Defined
A Family Office is an organization A
Family Office is an organization
dedicated to managing the personal fortunes and lives of lf t
d li
f
families with exceptional wealth.
4
Family Offices Defined
The Family Office represents a centre of influence and stability to f fl
d bl
help wealthy families ensure the preservation and growth of their financial assets and family y
heritage.
5
History of Family Offices
Chi (1600 BC)
China (1600 BC):
Servants (buried with family))
Ancient Rome:
major domus (head of house))
Middle Ages:
major‐domo
major
domo (chief steward)
(chief steward)
6
History of Family Offices
European history dates family office services back more than 300 years; generally in the form of private banks.
ll i th f
f i t b k
Europe:
Rothschilds (1700s)
7
History of Family Offices
Original U.S. family offices were created by wealthy merchants in the 19th century who wealthy merchants in the 19
century who
hired trusted advisors to oversee their wealth while they were traveling.
North America:
John D. Rockefeller office: Rockefeller & Co. (1882)
Co. (1882)
8
Family Offices Defined
The Family Office represents high value wealth management by close l
lh
b l
advisors based on a relationship characterized by intimate knowledge and trust.
g
9
Family Offices Defined
Family Office Advisory
• Family Financial Philosophy
• Family Governance Development
• Leadership Succession Planning
• Family Education
• Fostering Entrepreneurship
• Fostering Philanthropy
• Family Conflict Mediation
Wealth Advisory
Wealth Advisory
• Family Goal Alignment
• Tax and Estate Planning
• Financial Planning
• Insurance Planning
• Succession Planning
• Tax and Estate Planning
• Financial Planning
• Insurance Planning
• Succession Planning
• Business Consulting
Business Consulting
• Business Consultingg
• Accounting and Bookkeeping
• Accounting and Bookkeeping
• Tax Preparation
• Tax Preparation
• Budgeting and Bill Paying
• Budgeting and Bill Paying
• Investment policy development
• Investment policy
• Investment policy
• Asset Allocation
• Manager Search and Selection
• Fee Negotiation
• Asset Allocation
• Manager Search and Selection
• Fee Negotiation
• Asset Allocation
• Manager Search and Selection
• Fee Negotiation
• Performance Measurement
• Performance Measurement
• Performance Measurement
• Consolidated Reporting
• Consolidated Reporting
• Consolidated Reporting
• Custody and Settlement
• Custody and Settlement
• Custody and Settlement
• Income Distributions
• Income Distributions
• Income Distributions
Complexity of Service Offering
Investment Advisory
10
Source: The Family Office Exchange
Level of Wealth
Family Offices Defined

Types of Family Offices:

Single Family Office
Single Family Office

Multiple Family Office
11
Family Offices Defined
Lessons From the Family Office:
UHNW Best Practices
UHNW Best Practices
12
Lesson 1:
Lesson 1:
Planning must be values‐based g
Pland vision‐focused
Planning
i mustt be
b
values-based
values
based and
vision focused
vision-focused
13
MISSION

VISION


VALUES
GOALS
SUSTAINABILITY
DISCOVERY
CONFIDENCE
CLARITY
4
1
MANAGE THE RESULTS
IDENTIFY THE ISSUES
PLANNING
HORIZON
IMPLEMENT THE SOLUTIONS
CRAFT THE SOLUTIONS
3
2
IMPLEMENTATION
CREATIVE SOLUTIONS
RESULTS
DECISIONS
STRATEGIES

TACTICS

TOOLS
14
Lesson 2:
Lesson 1:
Preserving and growing wealth Pl i mustt be
Planning
b
is about understanding fi based
financial realms
i l and
l
values
values-based
vision focused
vision-focused
15
Financial Independence
Family Legacy
Family’s approach must provide integration among three key financial realms
Optimization
The optimal solution requires clarity regarding outcome in
clarity regarding outcome in all three realms
Social Legacy
Integration & Optimization
16
Understanding Financial Realms
Define & Protect
Define & Protect
Define & Protect
Social Social
Capital
Family
Legacy Capital
Financial Independence
Independence Capital
Priority
Families must protect p
these interests from bottom to top
Protecting this hierarchy is at the centre of every planning decision
17
Understanding Financial Realms
% of family wealth tied to y
operating business
100%
Americas
Europe
Rest of World
40%
40%
28%
30%
24%
20%
10%
Families understand importance of capital set apart from the business
Source: Wharton Business School 2008
18
Understanding Financial Realms
Asset Allocation By Wealth Level
Families have capital Families
have capital
outside of the business
Americas
Billionaires
Europe
Billionaires
Americas
Millionaires
Europe
Millionaires
Equities
ii
47%
25%
45%
30%
Fixed Income
16%
15%
15%
17%
Hedge Funds
Hedge Funds
20%
12%
12%
13%
Private Equity Funds
9%
12%
9%
12%
Real Estate
4%
11%
10%
18%
Other Tangible
3%
4%
4%
3%
Principal Investment
0%
20%
5%
6%
Other Stores of Value
1%
2%
1%
2%
Source: Wharton Business School 2008
19
Lesson 3:
Lesson 1:
Tax Alpha is critical to Pl i mustt be
Planning
b
preserving and growing lth and
valueswealth.
values-based
based
vision focused
vision-focused
20
Tax Alpha
Alpha is the value added by money managers over and above returns
managers over and above returns provided by the market itself.
Tax Alpha is the additional after‐tax return generated through effective t
t d th
h ff ti
tax structuring.
21
Tax Alpha: Capital Gains Reserve



Can defer capital gain over a period as long as d f
l
d l
five years
Must collect sale proceeds over more than ll
l
d
h
one year to claim a reserve under 40(1)(a)
C
Can sell to:
ll
 Child
 Spouse or common‐law partner
 Caution if selling to corporation
22
Claim a CG Reserve
Greg
1
Nancy
FMV sale
$600,000 Cash
$600,000 Investment
2
$100 000 ACB
$100,000 Note
1/5 due upon demand, immediately
$500,000 Capital gain
1/5 due upon demand, /
p
,
Jan. 1, 2011
$97,500 Tax in Alberta
…and so on
We can spread the tax We
can spread the tax
over five years
4
Charge prescribed rate –
currently 1%
3
Nancy sells: No tax!
Tax Alpha: Capital Gains Reserve

Additional Idea:
 $600,000 could remain invested in Nancy’s name to split income
 Will save tax if she has lower marginal tax Will save tax if she has lower marginal tax
rate than Greg
 No attribution due to prescribed interest No attribution due to prescribed interest
rate charged on note
24
Tax Alpha: Capital Gains Reserve

What if Greg dies
h if G
di within five years?
i hi fi
?





Still gets reserve in year of death [ITA 72(2)]
Transferee includes amounts in income over balance includes amounts in income over balance
of the five years If leave note to surviving spouse:
g p
cancelled and income inclusion in year of spouse’s death
If leave note to children: kids include amounts in income over balance of five years
income over balance of five years
Bottom line: Opportunity to make sale prior to death to defer tax on capital gain
p g
25
Tax Alpha: Capital Loss Transfer

Transferring Capital Losses



One spouse has capital losses, no gains
O
h
i ll
i
Other spouse has capital gain, no losses
Can transfer unrealized losses to spouse
26
Tax Alpha: Capital Loss Transfer




Anne owns Publico shares. ACB $50,000. FMV $10,000.
Husband Hal reported capital gains of $ ,
$40,000 in 2009.
Let’s transfer Anne’s losses to Hal.
Hal can carry losses back to 2009 and
Hal can carry losses back to 2009 and recover taxes paid.
27
Tax Alpha: Capital Loss Transfer
3
STEPS
1
Anne sells Publico
A
ll P bli shares. Triggers h
Ti
$40,000 capital loss on the sale.
2
Hal buys Publico shares for FMV of $10,000; superficial loss; Anne’s loss denied; added to ACB of Hal’ss shares.
denied; added to ACB of Hal
shares.
3
Hal sells Publico shares for FMV of $10,000; ACB is $50,000; capital loss of $
,
;
$ ,
; p
$40,000 realized.
28
Tax Alpha: Capital Loss Transfer

Ti
Time line is important
li i i
Step 1: Step
1:
Anne sells
Step 3: Step
3:
Hal sells
30 days Step 2:
Step 2: after Hal buys
Step 1
29
Tax Alpha: Capital Loss Transfer

Can also transfer capital losses to a C
l
f
i ll
corporation you own



But not from the corporation to you
Best to sell on open market or directly to the corp.
Can do a direct transfer between spouses instead of selling on the open market

Must file a special election to transfer at Fair Market Value vs. ACB (elect out of 73(1) of ITA)
30
Lesson 3:
Lesson 1:
Conflict‐free open architecture p
Plis absolutely critical.
Planning
i mustt be
b
values-based
values
based and
vision focused
vision-focused
31
Conflict Free Open Architecture
Conflict-Free
Conflict‐free open architecture is the ability to access the very best
is the ability to access the very best solutions for the family, wherever in the world they may be without any
the world they may be, without any bias driven by advisor selfishness.
32
Conflict Free Open Architecture
Conflict-Free
Lack of open architecture can be caused by…
Advisors
Advisors can only offer a limited range of solutions
Family
Family’s limited resources restrict access to solutions
access to solutions
Regulators
Regulators deny access to solutions or make solutions unattractive
solutions unattractive
Advisors don’t have access to the best expertise
33
Conflict Free Open Architecture
Conflict-Free
Conflicts of interest can arise when…
Family
Advisors
Advisor is paid on the sale of products
Advisor compensation varies by product
Advisor is paid on certain assets and not others
Advisor receives referral fees
Family members having differing goals and objectives
Doesn’t mean the advisor is doing the wrong thing
hi
34
Lesson
Lesson 1:
Lesson 4:
4:
Strategic philanthropy is Strategic
philanthropy is
Pl
Planning
i
must
t
b
be
important to family harmony.
values-based
values
based and
vision focused
vision-focused
35
Self Directed Social Capital
Families have a choice in how they support society:
 Voluntarilyy
 Involuntarily
Social Capital
36
Self Directed Social Capital
Most Canadians use the default method to donate social capital: Involuntary giving
Social Capital
37
Self Directed Social Capital
Some families recognize that voluntary giving can be thought of as “self‐directing” their social capital
Social Capital
38
Self Directed Social Capital
 Self‐directed giving has advantages:
 more efficient
 more effective
 more meaningful
Social Capital
 timely  comes with recognition
39
Giving Strategies
Insured Bequest of Shares
 All
Allows shareholder to donate shares h h ld t d
t h
of private company to charity
 Results:
no tax to CRA
 no tax to CRA
 greater value to heirs
40
Giving Strategies
Jack
Trust
Frozen shares FMV = $2 M
Holdco
$1 M Life Insurance Policy
Common shares
Common shares
41
Giving Strategies
 Holdco is owner and beneficiary of life insurance ld i
db
fi i
f lif i
policy
 Policy is a joint last‐to‐die policy
l
l
d
l
 Annual level cost for insurance coverage = $9,521 for life (both spouses age 60 today)
(
)
 Total cost of $238,025 to age 85
 Alternative: $24,766 per year for 10 years
42
Giving Strategies
 On death of surviving spouse: deemed sale d h f
d
d l
of frozen shares – Tax of $464,100
 Will of surviving spouse: leaves bequest of $1 M of frozen shares to charity (half of f
frozen shares)
h
)
 Tax credit on terminal tax return of surviving spouse; tax savings of $464,100
43
Giving Strategies
 Death benefit from life insurance of $1 M hb
f f
lf
f$
paid into Holdco; tax free receipt; increases CDA of Holdco
CDA of Holdco
 Holdco uses proceeds to redeem shares b
bequeathed to charity
th d t h it
p
g$
 Holdco then repurchases remaining $1 M of frozen shares from Estate (within 1 year of death) for a promissory note
44
Giving Strategies
 Results:
l
 Deemed dividend to Estate of $1 M Deemed dividend to Estate of $1 M
(no tax since we can use CDA)
 Capital loss in Estate of $1 M (stop loss rules apply to reduce loss to $500 000) l
$500,000); loss will save $116,000 in ill
$116 000 i
tax
45
Giving Strategies
Estate
X
Gift shares
Charity
Trust
Holdco
Common shares
Common shares
$1 M Cash
46
Giving Strategies
Charity
Estate
Trust
$1 M Note
X
$1 M Cash
Holdco
Common shares
Common shares
47
Giving Strategies
Charity
Estate
Trust
$1 M Note
$1 M Cash
Holdco
Common shares
Common shares
48
Giving Strategies
No Gift
Bequest of Shares
Insured Bequest of Shares
Value to heirs
$1,535,900
$1,000,000
$2,000,000
Value to charity
$ 0
$1,000,000
$1,000,000
Value to CRA
$ 464,100
$ 0
($ 116,000)
49
Investment Approach to Giving

Some families think about giving as i
investing
ti

Why?

Results in more meaningful donations
50
Investment Approach to Giving
Develop a
philanthropic
plan
Self-direct the
social capital
Understand
the charity
Maximize the
tax credits
Consider
diversification
Give for the
long term
51
Lesson 5:
Lesson
1:
A i t
An integrated approach to t d
ht
planning is the only way to
planning is the only way to Pl close gaps.
Planning
i mustt be
b
values-based
values
based and
vision focused
vision-focused
52
Integrated Planning Closes Gaps
X
IN
NSURAN
NCE
X
INV
VESTMENT
LEGALL
X
ACCOUN
NTING
FAMILY OFFICE CLOSES THE GAPS
53
Where We’ve
We ve Been

F il Offi
Family Offices Defined
D fi d

Lessons From the Family Office:
Lesson 1: Planning must be values‐based and vision‐focused
Lesson 2: Preserving and growing wealth is about understanding financial realms
Lesson 3: Tax Alpha is critical to preserving and growing wealth
Lesson 4: Strategic philanthropy is i
important to t tt
family harmony
54
Contact us

The WaterStreet Group Inc.

T 905.332.4455

5500 North Service Road
5500 North Service Road

T 1 877 974 7687
T 1.877.974.7687

Suite 1004

F 905.332.5955

Burlington, Ontario

E [email protected]

L7L 6W6

w www.waterstreet.ca
55
The WaterStreet Group Inc
The WaterStreet Group Inc.
5500 North Service Road
Suite 1004
Burlington, Ontario
L7L 6W6