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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