the wealth manager; [1]
BusinessWorld. Manila: Jul 11, 2005. pg. 1
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Abstract (Document Summary)
Bahtiar's strategy may be sound for the time being, but the time may come when he
becomes too infirm to continue to manage his portfolio. If he is wise, he will recognize
this and reallocate his assets to retain their value when he starts to feel too old. At that
point, he might move entirely into a diversified portfolio of bonds or at least reduce his
equity exposure. The reason for doing this is that while equities are the best performing
asset class over the long term, they are volatile. If Bahtiar becomes too old to manage
his portfolio and thinks he may only have a short time to live, he may feel that it is more
important to keep the value of the portfolio stable rather than to seek further growth. In
this situation he might feel that if he were to die during a bear market, his beneficiaries
could take fright and sell all the equities at low prices, reducing the value of their
inheritance, so he might prefer to bequeath them a stable portfolio of cash and bonds.
If your estate does have a large potential liability to inheritance tax, there are various
methods you can use to reduce or eliminate it. Much depends on your circumstances
and the laws in force at the time of your death (which may be different from the laws
currently in force). Some countries tax assets wherever they are held in the world, while
others only tax assets held within their own country. Specialist tax advice is expensive,
but it is worth paying for if you have a potentially large tax liability. Here are the main
approaches to reducing/eliminating tax: * Use annual gift allowances. Many countries
allow you to make cash gifts each year. In Taiwan, for instance, you may give away up
to NT$1 million (approximately $30,000) annually without paying tax. * Use tax- exempt
insurance policies. Many countries do not tax certain types of whole-life and endowment
policies. As we saw in the previous chapter, income from insurance policies is generally
tax-exempt, and insurance premiums are often tax-free up to a certain limit. With careful
planning, it may be possible to eliminate inheritance tax liability altogether by heavily
funding an insurance policy.
[David] and Lily's friend, Bahtiar, who lives in Indonesia, manages his portfolio quite
differently. Bahtiar is an experienced retired businessman who holds a widely diversified
portfolio worth $2.5 million through a bank in Singapore. About 60% of the portfolio is in
international equities. Bahtiar has always enjoyed investment and is highly
knowledgeable about exchange rates and US and Asian equities. He has sufficient
investments in Indonesia to cover his daily living expenses, which are comparatively low
and his ambition is to achieve substantial growth in his Singapore portfolio during the
rest of his life. Ironically, because he does not have an immediate need for the money,
he can afford to take more risks with it and consequently has a chance of achieving
better returns.
Full Text (3554 words)
(Copyright 2005. Financial Times Information Limited - Asia AfricaIntelligence Wire. All
Material Subject to Copyright.)
Your financial well-being in retirement will depend on many factors, some of which, such
as your health, are not possible to control. In this chapter we will examine the major
financial issues that affect retired people and discuss ways of managing problems as
they occur. These issues can be categorized as: * quality of life issues * investment
issues * inheritance issues
To understand how these matters might affect you in practice, we will take the
hypothetical case of David and Lily Chun, an elderly couple in Singapore who are quite
wealthy but have gradually become 'asset-rich and cash-poor'. In this feature we will
look at how you can establish what life insurance you really need and how to buy it at a
reasonable cost.
Quality of Life
Many retired people want to enjoy life as fully as possible. Whether you want to spend
more time with your children and grandchildren, pursue hobbies and interests, or remain
actively involved in your profession, as a retiree who has accumulated assets during
your working life, you should be able to enjoy a rewarding retirement. Even affluent
people, however, are sometimes faced with difficult decisions during retirement. (See
example in blue box.)
David and Lily's Dilemma
David and Lily are affluent, but they are falling into one of the classic problems of old
age: they are asset-rich but relatively cash- poor. They are fortunate to live in a nice
house and to have close relatives living nearby, but they are aware that their own
physical and mental health could be harmed if they take a drastic step-down in their
quality of life. The question is, what is the best way for them to fund their on-going living
expenses?
Nobody knows how long they will live, so it is a mistake to base your plans on an
assumed date of death. To be safe, it is better to keep your plans flexible so that you can
adopt a new strategy if your circumstances change.
If David and Lily were different people, they might be perfectly happy to give up their car,
but they are who they are. Although taking a bank overdraft would solve their problems
for a few years, Lily's concerns about accumulating debt are justified. There are other
options, but they need to involve the future beneficiaries of their estate, who are their
son and daughter.
Investment Issues
As we saw in Chapter 10, you may want to adjust you asset allocation after you retire.
Although some people argue that a portfolio should be heavily weighted towards bonds
to give it stability and a predictable income, much depends on your individual
circumstances and wishes. For instance, if you have accumulated substantially more
assets than you need to fund your living expenses in retirement, you might consider
seeking better long-term returns by weighing your portfolio toward equities.
Bahtiar's strategy may be sound for the time being, but the time may come when he
becomes too infirm to continue to manage his portfolio. If he is wise, he will recognize
this and reallocate his assets to retain their value when he starts to feel too old. At that
point, he might move entirely into a diversified portfolio of bonds or at least reduce his
equity exposure. The reason for doing this is that while equities are the best performing
asset class over the long term, they are volatile. If Bahtiar becomes too old to manage
his portfolio and thinks he may only have a short time to live, he may feel that it is more
important to keep the value of the portfolio stable rather than to seek further growth. In
this situation he might feel that if he were to die during a bear market, his beneficiaries
could take fright and sell all the equities at low prices, reducing the value of their
inheritance, so he might prefer to bequeath them a stable portfolio of cash and bonds.
Inheritance Issues
In this section we will examine inheritance issues under civil law, which, although it
differs from country to country, generally allows a person to decide how his or her wealth
will be distributed after death.
The way to ensure that your wishes are carried out is to make a will, which is a legal
document that describes how you want your 'estate' (your wealth) to be distributed.
Although many countries allow you to write a 'home-made' will, this is unwise because it
could be disallowed by the courts. It is much safer to have a will drawn up by a qualified
solicitor. You can change your will at any time, either by making a new will, or by
attaching a 'codicil', which is a supplement to an existing will.
Intestacy
If you die without having made a will, you are said to have died 'intestate'. Every country
has its own intestacy rules, but in general the estate is distributed to the spouse and/or
close relatives according to a pre-set formula.
This is highly undesirable for a number of reasons: * The pre- set distribution formula
may not coincide with your wishes. For example, some money may be given to
individuals to whom you wanted to give nothing. * The administration of the estate is
done by a court-appointed administrator. This will usually cost much more money and
take much more time than if you had appointed your own 'executors' (people to
administer the estate) in a will. This could cause problems for your spouse, for instance,
if he or she has to wait years before receiving the money from the estate. * If you
happen to die in another country, there could be even more delays and costs, depending
on the laws of that country. * It could ruin your plans to mitigate your inheritance tax
liability.
Making a Will
It is important to make a will as soon as you begin to accumulate assets, so some
people make their first will as soon as they become adults, or just before they go into
military service. For retired people, planning how to pass on your wealth to others is
especially important and it is quite possible that you will make alterations to your will
several times during your retirement as your circumstances change.
Making a will does not cost much. In most countries a solicitor will charge less than $300
for the job and will advice you on how to insert clauses to protect against certain risks.
For example, suppose you have left all your wealth to your spouse in the will, but you
are both killed in a car accident: who should be the beneficiary in that event? A good
solicitor should also advice on laws that could affect your will. In some countries, a
spouse may in some circumstances be able to apply to the court for maintenance even if
you have excluded them in your will, so you would need to take this rule into account.
Also, in some countries, your existing will may be cancelled if you marry, so you would
need to make a new one at that point.
One important point that you should be aware of relates to appointing the executors.
Although you can appoint professionals, such as a lawyer or a bank, as executors, they
may charge the estate quite heavily for their services after your death. For this reason it
is preferable where possible to appoint trusted friends or relatives as executors. (They
can also be beneficiaries in the will.) Choose people who are honest, reliable and good
at dealing with paperwork and bureaucracy. If they need specialist advice, they can
always engage a lawyer to help at a lower cost than if the lawyer were an executor. If
your estate is very large and you expect to have a major inheritance tax liability, you will
need to seek advice from a specialist in taxation before drawing up the will.
It is worthwhile discussing your wishes informally with your executors so that they
understand the situation as fully as possible. Some beneficiaries may be wiser about
dealing with money than others, and you may wish to structure the distribution of assets
accordingly. For example, if one of your children is a spendthrift, or very young, you
might choose to arrange that his or her inheritance is put in trust (see page 202) and that
only the income is paid out. This would prevent the beneficiary from squandering the
capital sum of the inheritance. It is also important to discuss your plans with your
spouse. If your spouse has relied on you to make all the money decisions for many
years, he or she may be incapable of making sound decisions after your death. You can
help them to prepare by giving them more responsibility for the finances now (as a kind
of practice) and also by discussing plans for how they can manage their lives after you
have gone.
Reducing Inheritance Tax
Inheritance tax rates vary quite widely across the region and are generally on a sliding
scale according to the size of your estate, so the kind of tax planning you need depends
upon both the amount of your wealth and the country where you pay tax.
Among the very rich, for whom inheritance tax is often a major worry, attitudes diverge.
Some very wealthy people believe that their family should not inherit too much money
because they might use it irresponsibly. Others don't like to think about their own deaths,
and so avoid the issue until it is too late.
Most people, however, would like to pass their wealth on to their family without paying
inheritance tax.
If your estate does have a large potential liability to inheritance tax, there are various
methods you can use to reduce or eliminate it. Much depends on your circumstances
and the laws in force at the time of your death (which may be different from the laws
currently in force). Some countries tax assets wherever they are held in the world, while
others only tax assets held within their own country. Specialist tax advice is expensive,
but it is worth paying for if you have a potentially large tax liability. Here are the main
approaches to reducing/eliminating tax: * Use annual gift allowances. Many countries
allow you to make cash gifts each year. In Taiwan, for instance, you may give away up
to NT$1 million (approximately $30,000) annually without paying tax. * Use tax- exempt
insurance policies. Many countries do not tax certain types of whole-life and endowment
policies. As we saw in the previous chapter, income from insurance policies is generally
tax-exempt, and insurance premiums are often tax-free up to a certain limit. With careful
planning, it may be possible to eliminate inheritance tax liability altogether by heavily
funding an insurance policy.
For the very wealthy, the following methods may be appropriate: * Keep some of your
assets offshore in a jurisdiction that does not levy inheritance tax. But be careful! This is
not as simple as it sounds. You must ensure that the country where you pay tax will not
lay claim to any of these assets, that the entity holding the assets offshore will turn them
over to the beneficiaries quickly, and that there will be no legal problems if you die in a
third country. Take specialist advice. * Use trusts. Trusts are a kind of 'slow motion' gift.
They have many uses, and, depending on the laws of your country, can sometimes be
used to avoid inheritance tax. They are administered by trustees who are often
expensive, so it is very important to weigh up the pros and cons of having a trust before
committing yourself.
Example: Needing More Cash
David and Lily Chun are a retired couple in their late seventies living in a house in
Singapore that is worth, at the current market valuation, S$3 million. David has a small
pension paying S$700 a month and the couple have a portfolio of mutual funds that
generates an annual income of $20,000. They have no other income, so their total
annual income before tax is:
Pension 700 x 12 = 8,400
Investment income 20,000
Total $38,400
David and Lily have two grown-up children who are both married with children of their
own. Their son lives in the US with his wife and their daughter lives nearby in Singapore.
David and Lily find it difficult to live within their means. For many years they have
enjoyed a good lifestyle and they want to maintain it. They have a maid and a car and
they like to throw parties occasionally. David likes to take short trips abroad every two or
three months. Although they paid off all their debts long ago and do not spend very
much on most days, two expense items seem to be increasing alarmingly: the car and
health care. * David and Lily's car
David and Lily paid cash for their car some years ago, but within three years they will
probably have to buy a replacement for $50,000.
Road tax, insurance, petrol and maintenance is costing them $1,200 a month.
Maintenance costs are high by Singapore standards because David and Lily are
becoming a little shaky at the wheel. They often bump and scrape other cars and must
pay for the damage. Their total car expenses are a large proportion of their income:
$14,400 a year, which is just over half their gross income of $38,400. * Health Care
David and Lily are mentally alert and physically active, but like many people of their age
they have a number of chronic physical illnesses. This year Lily had to have a minor
operation that cost $3,000. Last year David was hospitalized twice after overexerting
himself on his trips abroad and had to spend $5,000 on treatment.
They are both concerned that their health expenses may increase in the future.
Asset Allocation During Retirement
David and Lily receive S$20,000 a year from their investments, which are exclusively in
bond funds. The total value of their investments is, say, S$400,000. They rely on this
income to pay for most of their living costs, so they do not invest it. Since they do not
reinvest the interest, the inflation-adjusted value of their portfolio is slowly dwindling.
Their adviser has suggested that they reinvest a proportion of the income to keep the
value of the portfolio in line with inflation, but they have chosen to delay the decision until
some future date.
David and Lily's friend, Bahtiar, who lives in Indonesia, manages his portfolio quite
differently. Bahtiar is an experienced retired businessman who holds a widely diversified
portfolio worth $2.5 million through a bank in Singapore. About 60% of the portfolio is in
international equities. Bahtiar has always enjoyed investment and is highly
knowledgeable about exchange rates and US and Asian equities. He has sufficient
investments in Indonesia to cover his daily living expenses, which are comparatively low
and his ambition is to achieve substantial growth in his Singapore portfolio during the
rest of his life. Ironically, because he does not have an immediate need for the money,
he can afford to take more risks with it and consequently has a chance of achieving
better returns.
Bahtiar is a realist and understands that the long-term real returns of his equity portfolio
depend upon its overall performance, so he trades very infrequently and does not
attempt to pick individual stocks. He reinvests all the dividends and other income he
receives from his investments.
Bahtiar has a good relationship with his advisers and occasionally seeks to take
advantage of medium- to long-term trends by buying a widely diversified selection of
equities in a particular market when he believes that it is very undervalued.
Since retiring over a decade ago, Bahtiar's portfolio has achieved an overall annual
return of 5% (adjusted for inflation) in US dollar terms. He is perfectly satisfied with this
and knows that if he can continue to achieve this level of growth, his portfolio will grow
substantially over the long term.
A Short-term Solution?
David and Lily need more cash to fund their current lifestyle. They are reluctant to dip
into their mutual funds, since this would reduce their investment income in the future.
Their house is very valuable, although it was worth much more during the housing boom
of the late 1990s. A bank has told them that it is willing to give them a $100,000
overdraft facility secured on their income.
David is eager to use the overdraft facility. He feels that this cash will cover any large
expenditure, such as a replacement car, for the next few years. 'After all,' he says to his
wife, 'We don't know how long we are going to live. Let us enjoy ourselves while we can.'
Lily is less happy with the overdraft idea. Although the potential debt of $100,000 is
small compared with the $3 million value of their house, she would prefer to give their
children the house free of all debt after she and her husband pass away. Furthermore,
she knows that house prices and interest rates fluctuate. What if the value of their house
continues to sink while the interest rate on the bank loan rises? If David dies first, will Lily
be stuck with a $100,000 loan that is growing, because of the compounding effect of the
interest? How could she pay it off?
David and Lily know that if they give up their car, most of their money worries would be
solved, but they feel that doing so would have a bad effect on their psychological wellbeing. The car gives them freedom to go anywhere they want and makes them feel
young. If they had to rely on other people to ferry them around, they might feel old and
useless - and, Lily thinks, this could have a very bad effect on David's health.
For this reason, Lily would like to keep the car for as long as possible. Secretly she
believes that she will live longer than David and she knows that she would be happy to
give up the car after his death. David knows that Lily expects to outlive him, but he is not
sure that she is correct - he thinks that it is quite possible that she might pass away first.
David is determined to keep the car.
But rich people don't die intestate...
Yes, they do! According to the Taipei Times of February 28, 2004, Wen Say-ling, VicePresident of Inventec Corporation, died intestate in late 2003 with assets worth an
estimated NT$3 billion and had not done any estate planning. Under Taiwanese
inheritance law, his estate could be liable to the maximum inheritance tax rate of 50%
and the remainder distributed to close relatives. Media reports alleging the existence of a
hitherto unknown illegitimate daughter gave rise to speculation that she might have
some entitlement to the estate.
Inheritance and Islamic Law
In a number of countries in the region, Muslim citizens are governed by Islamic law
which has some important differences from civil law regarding inheritance. These
countries include India, Singapore, Malaysia, Indonesia.
In general, under Islamic law daughters receive a third of a son's inheritance and
adopted children are not entitled to inherit. Complex inheritance problems may arise with
inter-faith marriages that can only be resolved in the courts.
Owing to the complexities, this book will not address estate planning where one or more
of the individuals involved is Muslim. Specialist advice is needed.
Terminology for Wills * Estate - your assets and money. * Testator - the person who
makes the will. * Beneficiary - a person who will benefit from the will. * Codicil - an
addition or alteration to an existing will. * Executor - a person who has been nominated
by the testator to administer and distribute the estate. You can usually have more than
one executor. A female executor is sometimes called an 'executrix'. * Trust - a legal
mechanism that allows you to make gifts in 'slow motion' for many years after your
death. The chief uses of trusts are, first, to try to ensure that money reaches the
beneficiaries in the right way and at the right time (for instance, you can leave money in
trust for unborn grandchildren), and second, to mitigate inheritance taxes. * Trustee - a
person who is responsible for administering a trust. * Intestate - the state of dying
without having made a will. * Probate - the process of obtaining legal approval from a
court that the will is in order. The court normally grants probate once the value of the
estate has been certified and any inheritance tax due has been paid. Although the
executors may get permission to distribute some of the assets earlier, most of the estate
is usually only distributed after probate has been granted.
This series was excerpted with permission of the publisher John Wiley & Sons (Asia) Pte
from "Citibank: Guide to Building Personal Wealth" by Gough, Copyright 2005 by John
Wiley & Sons (Asia) Pte Ltd. This book is one of Citibank's many initiatives in its ongoing
investments education campaign and is available at major bookstores and from the
Wiley website at www.wiley.com. You may also log on to www.citibank.com.ph for more
information on Citibank's financial literacy campaign, products and services.