Case Studies and Articles

Too Much Stock – Too Little Diversification – Vaughn Henry & Associates

Too Much Stock – Too Little Diversification – Vaughn Henry & Associates

Too Much Stock – Too Little Diversification

Vaughn W. Henry © 2000

John Li (50) is a systems engineer for one of the biggest suppliers of sophisticated computer equipment for the Internet.  He and his wife, Katherine, have two girls, both finishing professional programs in graduate school.  As a result of prudent investing, good luck and a wildly successful public offering of his employer’s stock, John is considering early retirement so he can travel and enjoy his hobbies of flying and sailing.  Besides his significant retirement plan account, John has $3 million in zero basis stock in his employer’s company and is in line with qualified stock options to acquire an additional $5 million over the next three years.  Faced with planning for the disposition of an estate of $10 million (almost all of it in an undiversified portfolio), John and Katherine decided that they’d like to build a “Zero Estate Tax Plan” into their estate planning.  In short, they’re willing to give to charity those assets that would otherwise default to the IRS in the form of estate and capital gains taxes.  As a part of this strategy, they will also make aggressive gifts of stock to their two daughters and other family heirs over the next few years.  By freezing estate growth and squeezing the value of the assets, the Li’s estate planning team will be able to eliminate the unnecessary taxes.  Additionally, it will provide an excellent retirement income stream and leave their heirs in control of a family influenced charity funded with unused retirement plan assets and stock proceeds from their charitable remainder trust (CRT).

Sell CRT
Net fair market value (FMV) $3,000,000 $3,000,000
Taxable gain on sale $3,000,000
Capital gains tax (20%) at federal level $600,000
Net amount invested $2,400,000 $3,000,000
Annual return of reinvested portfolio 10% 10%
   Reinvested for 10% annual income produces $240,000
   Trust payout of 5% (averaged with 10% returns over trust term of 40 yr.) $433,190
Annual average after-tax cash flow @ 39% tax $146,400 $264,246
Years – projected joint life expectancy 40 40
Taxes saved with $579,600 deduction @ 39% $226,044
Tax savings and cash flow over 40 yr. $5,856,000 $10,795,878
Total increase in cash flow $5,856,000 $10,795,878
Total value of asset in estate in 40 yr. $2,400,000 $0
Estate taxes on this asset at 55% $1,320,000
Net value to family $1,080,000
Total insurance expense for wealth replacement $0 – $530,000
Insurance benefit in wealth replacement trust $0 $3,000,000
CRT remainder value to family charity $0 $21,119,966
Total value to Li family from this asset only $1,080,000 $23,589,966

How does this work?  The stock that John owns is publicly traded, so its value is readily ascertained and is easily transferred to the Li Family Charitable Trust.  This §664 CRT will take the highly appreciated stock and sell it without current tax liabilities and reposition it into a more balanced portfolio of equities designed for both growth and security.  The CRT, with John as trustee, will buy and hold stocks and mutual fund shares so that most of the portfolio will continue to appreciate while John and Katherine, as income beneficiaries, receive quarterly payments of 5% of the trust’s value every year.  They’ve made the decision that leaving each daughter with a $5 million inheritance is part of their family’s financial goals, so with some stock and life insurance held in trust, the two girls will be well protected for the future.  Everything else in their estate will be either spent during retirement or left to their charitable trust when they pass away.   After examining the numbers, the Li family felt that it made great sense to re-exert control over their social capital and follow through with their plan. Since John felt a need to sell in order to diversify his unbalanced portfolio, the only comparison to be made was between selling – paying tax – reinvesting the net proceeds and contributing the stock – reinvesting inside the CRT.   By combining a charitable remainder trust with a wealth replacement trust for their heirs, John leaves his family in control of the estate and produces a “Zero Estate Tax Plan” that suits their planning goals with a family financial philosophy of wealth preservation and charity.


Henry & Associates


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