2008-04-17T03:46:00.001-07:00

570 PRIVATE WEALTH TABLE 31.

1 Expected Returns and Volatility Nominal Pretax Real, After- Pretax Return Tax Return Volatility Diversified public equity 9.75% 4.68% 17.24% Private equity fund 12.62 6.89 34.72 Taxable 10-year AA bond 5.13 0.07 4.74 Tax-exempt 5-year bond 3.52 0.51 5.67 Taxable money market fund 4.75 -0.15 0.45 Hedge fund 8.53 2.47 8.75 TABLE 31.2 Expected Correlations Diversified public equity Private equity fund Taxable 10-year AA bond Tax-exempt 5-year bond Taxable money market fund Hedge fund Taxable Tax- Taxable Diversified Private 10-Year Exempt Money Public Equity AA 5-Year Market Hedge Equity Fund Bond Bond Fund Fund 1.00 0.47 1.00 0.14 0.04 1.00 0.17 0.08 0.78 1.00 -0.01 -0.02 0.17 0.16 1.00 0.39 0.22 0.23 0.28 0.29 1.00 no future value to these gifts. Finally, to allow for a fair comparison, we will gross up the parents' wealth by $4 million to $29 million to reflect the transfer tax they would pay in order to move $8 million into the grantor trust. We are ignoring lifetime gift allowances and some of the more creative methods for transferring wealth in order to keep this example simple. The reader might think we have already failed in that quest, but this is a very simplified example compared to what a practitioner would typically deal with. These assumptions yield the efficient frontier shown in Figure 31.1. Based on the 8 percent volatility solution, the nominal weighted portfolio pretax return is 7.36 percent. However, the impact of estate taxes, income taxes, inflation, and spending combine to produce an expected decline in real wealth from $29 million to just $20.6 million. In our example, the expected nominal wealth, net of estate taxes, was $37.3 million. Discounting for 3 percent annual inflation yields the forecast $20.6 million. The estate tax was very onerous. In this example, the entire estate was subject to estate tax and the amount due was $37.3 million. The next step is to introduce the Joneses' estate plan. As described previously, they have $15 million in direct accounts, $2 million in the retirement account, and $8 million in a grantor trust owned by the children. The parents' spending will begin at $250,000 per year and will be partially met by $100,000 annual withdrawals from the retirement account. These withdrawals will be subject to 40 percent income tax. The parents will make $80,000 in annual gifts and will pay the taxes of the grantor trust. There will be uniform asset location in this example. The asset al-

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570 PRIVATE WEALTH TABLE 31.