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Oxford Financial Group, LTD


Oxford Financial Group, LTD


Expert Perspective

News, research and market insights from our team of experts.


Current Issue | December 20, 2018

Planning with Aspirational Assets – Guarding the Alpha

By: Julia Weaver, J.D., Director, Family Office Services and The Trust Company of Oxford

Assets with high-return potential, also known as "aspirational assets", provide a unique opportunity for estate planning. Such assets are defined widely in the investment management industry. According to Bryan Dunnivant, CFA, MBA, Managing Director and Oxford Investment Fellow, "Aspirational investing refers to investment strategies that seek outsized returns to substantially increase wealth, enhance lifestyle and achieve client dreams and aspirations." Bryan elaborates that for clients able and willing to take on a measured amount of additional risk, "aspirational investments may include private equity and/or illiquid assets, concentrated positions and niche strategies, specifically designed to be further out on the risk/reward spectrum."

In layman's terms, aspirational assets are the "get ahead" or "high-alpha seeking" assets with the potential for returns you talk about on the golf course. For purposes of this article, "alpha" is used broadly to describe the excess or abnormal return over and above broad market returns.

What you may not typically discuss on the links, however, is the tax haircut this new wealth may suffer when it passes to your heirs. Under current law, transfers of wealth for affluent families may be taxed at the rate of 40%. This represents the current federal estate tax rate for transfers of wealth in excess of the exemption thresholds ($5.49 million per person, $10.98 million per couple, in 2017).

As is now common knowledge, both the House and President-elect Trump's tax proposals call for the repeal of the estate tax. However, any such proposals must go through the legislative process and face possible concessions or even a Senate filibuster.

Additionally, even if the federal estate tax is repealed, it may be replaced with a different type of death tax, to wit: a recognition of capital gains upon death (over and above certain exemption amounts). President-elect Trump's tax reform proposal calls for such a tax upon death for capital gains in excess of $10 million. This would be a significant departure from our history of unlimited basis "step-up" adjustments upon death and could result in continued death tax exposure of up to 20% on appreciated assets, certainly worthy of ongoing planning considerations.

Herein lies the intersection point between the worlds of investment management and tax planning. By strategically shifting a portion of highly appreciating aspirational assets into structures that will avoid gift or estate tax, we freeze the taxable value at the current fair market value. Future appreciation, or the prized "alpha", may thereby avoid these onerous tax scenarios, enabling heirs to retain a greater percentage of the future growth in the family’s wealth.

There are several key estate planning strategies effective for this type of tax freeze. Ideally, such a technique is designed to accomplish several objectives:

  • Freeze future appreciation out of the taxable estate.
  • Avoid triggering a capital gains tax upon the transfer of assets into the strategy.
  • Avoid triggering a taxable gift upon the transfer into the strategy.
  • Enable the taxpayer to keep as much control as possible, in particular for strategies involving business interests.
  • Align the cash flow and liquidity needs of the taxpayer(s) with the strategy.

Why is a highly appreciating aspirational asset ideal for a freezing strategy?
The answer: arbitrage, the art of capitalizing on the spread between two rates. The greater the spread, the greater the chance of success of the strategy.i

A freezing strategy is designed to take advantage of the arbitrage between the actual rate of return on the transferred assets and a set "hurdle rate". The hurdle rate is comparable to the interest rate on a loan, but for these strategies it is the rate that is both prescribed and required by the IRS to be paid back to the Grantor. The spread between the required hurdle and the appreciation rate of the underlying asset will largely determine the amount that will be paid, outright or in trust, to the grantor's heirs, free of estate tax (under current law).

Notably, the optimal structure for a freezing strategy will be significantly affected by any future estate tax reform and the ultimate nature of any revisions to the estate tax. Your team of advisors will tailor freezing strategies to either mitigate capital gains recognition upon death or estate inclusion for transfer/estate tax purposes.

What is Accomplished by a Freezing Strategy? A Tale of Two Investments
For illustration purposes, we project results using a Grantor Retained Annuity Trust (GRAT). As with other freezing strategies, a GRAT is a technique designed to achieve estate tax savings by freezing future appreciation from the grantor's estate, while providing the grantor with an annuity stream for the fixed GRAT period.

The transfer of assets to a GRAT is a gift, potentially subject to transfer tax. However, the value of the gift can be reduced to zero by predetermining the grantor's annuity payments so that their present value essentially equals (and thereby negates) the value of the initial gift.

A 6% return results in a remainder interest to heirs in the amount of $2,633,000, free of estate taxation under current law. For families with wealth in excess of the exemption amounts, this translates into a potential federal estate tax savings of nearly $1.1 million.ii

For a GRAT entirely funded with a successful aspirational investment with a return of 12%, this remainder value increases to $9,066,000 after the 8 year GRAT term. For this same family, this now translates into a potential estate tax savings of over $3.6 million, wealth now in the hands of your heirs and not the IRS.

Clearly, the tax-savings impact of a freezing strategy is more potent when the underlying investment successfully yields a greater return. However, investors should understand such aspirational returns cannot be assumed and require a higher degree of risk of loss.

"Maintaining" a Freezing Strategy for Maximum Impact
Should the underlying investment fail to meet performance expectations, then various opportunities exist to actually capitalize on volatility in order to enhance the performance of an overall strategy. A "power of substitution" (a/k/a swapping powers) can be utilized to maximize the freezing impact.iii Swapping powers can be used to swap flat or loss assets out and appreciating assets in to tax-excluded vehicles. The flat or under-performing assets can then be “Re-GRATed” in order to capture the next rebound inside a new GRAT… enhancing the arbitrage between the hurdle rate and the possible high-performance rebound.

A well monitored and maintained freezing strategy can have significant impact on future estate tax exposure. A regular review of assets and appreciation expectations can reveal opportunities for this type of strategic planning.iv

Final Thoughts
Many facts and circumstances unique to each client's situation and the underlying asset should dictate the ultimate selection of strategies (or combination thereof). Your Oxford team of advisors can assist in determining the proper strategy to help "guard the alpha" associated with your aspirational investing goals.

Exhibit 2: Additional "GRAT" Considerations

Valuation Issues
Assets that are more difficult to value will likely require valuations both when transferred to the GRAT and later if used for annuity payments. Often, harder to value assets, which may include private equity investments and closely held business interests, are better suited for longer terms (such as an 8-year term) to allow the income and/or distributions to cover the majority of the annuity payments.

Short Term Rolling GRATs
Multiple GRATs, each with various funding dates and annuity payment dates, allow for greater probability that one or more will be successful. A rolling GRAT strategy is one which systematically establishes new GRATs with a defined pool of assets. Grantor receives annuity payments and then continues to systematically establish additional GRATs with assets received from annuity payments. Beneficiaries then receive the remaining trust property from each GRAT at its respective termination.

Because the value of a GRAT is included in the grantor's estate should he or she predecease the GRAT term, shorter term GRAT strategies also address mortality concerns. Each GRAT term that is survived by the grantor results in the successful transfer of the remainder interest to beneficiaries, and assets being removed from grantor's taxable estate.

Graduated GRATs and Back-Loading Returns
The more time assets remain in the GRAT, the greater the principal is able to grow, enhancing the freezing effect. While a GRAT requires its annuity payments to be paid in full, regulations allow the annuity payments to be structured with graduated payments, increasing annually by up to 20% each year.

The enhanced performance potential with graduated payments is reflected in the previous Exhibit 1. Assuming the high performance return of 12%, a level (non-graduated) annuity stream would reduce the tax-free remainder interest from $9,066,000 down to $7,679,000 for the same 8-year GRAT.


i While not at all an exhaustive list, the two most common freezing strategies are the Grantor Retained Annuity Trust (GRAT) and the sale of assets to an Intentionally Defective Grantor Trust (IDGT, also referred to as a SIDGT when associated with the sale of assets). The GRAT and SIDGT strategies each have their own nuances that make them appropriate for a specific situation.
ii Notably, the Grantor must survive the term of the GRAT or all assets will come back into the Grantor's taxable estate.
iii IRC §675(4)
iv Grantor must substitute other property of an equivalent value. The Trustee must use diligence to ensure that property of equivalent value is substituted for the reacquired property and to convert, to the extent possible, any unproductive property in place of productive property, that swapped assets are converted to productive property to the extent feasible.