the four steps to take.
by anthony glomski and russ alan prince
your $5-million high-net-worth practice
the everyone wins process is at the center of how you can maximize wealthy client relationships. most often, this is a function of aligning interests. the process is also core to generating new business from these clients and other professionals. the ability to add value often plays a significant role in being referred by other professionals to their best clients.
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at the same time, there are many different ways to frame your conversations based on the self-interests of the wealthy to optimize their financial worlds and accelerate results. stress testing is one of those ways.
from the perspective of the everyone wins process, stress testing incorporates knowing your self-interests (including the services and possible financial products you can provide), developing a deep understanding of the world of wealthy individuals coupled with direct alignment. stress testing reveals areas of concern, and some of those areas will likely lead to you providing you or your firm’s expertise.
stress testing
stress testing starts invisibly as you ascertain the self-interests of the wealthy. through the discovery process and by being empathetic, you determine if some of the actions they have taken might not produce their desired results. if there is the possibility a wealthy individual knows what they did was inaccurate or insufficient or – more likely – is unsure, you can more formally engage in stress testing.
at the same time, you are finding out if the wealthy individual is indeed getting or employing the best solutions for his or her unique circumstances. what is commonly the case is the wealthy simply do not know. because of this uncertainty, many of the wealthy are inclined to look to you to help them evaluate better solutions than the ones they are employing.
it is worthwhile to recognize that stress testing is widespread among the super-rich. it is something high-performing single-family offices are regularly doing for their extremely wealthy families. for them, stress testing is a very clever way to make smart decisions and verify that they will likely get what they want and confirm they are dealing with high-quality professionals.
the following are the four steps to stress testing.
step #1: understand the self-interests of the wealthy individual: this is always necessary and central. you need to know – the big picture and the particulars, what is important and what is not.
step #2: determine what he or she wants to accomplish: always, results matter. therefore, you want to understand the outcomes they require and desire. at this point, it is not about how to get there; it’s about where there is.
step #3: evaluate the actions taken and actions that are being considered: once you understand what they want to accomplish, you and whatever experts you need evaluate what the wealthy clients are doing. here, you will also collect and analyze the appropriate documentation.
as part of these evaluations, you need to work on the assumptions. underlying their actions are often a plethora of assumptions. in stress testing, these assumptions get systematically modified to determine how the solutions will work when the “what ifs?” of the scenarios change. it is not uncommon for professionals seeking to sell their services and products to use somewhat optimistic assumptions.
additionally, you will calculate the cost structure. the intent is to have the best and most cost-effective solutions possible. when calculating cost structures, all the expenses, including long-term costs, should be specified and transparent.
step #4: determine if alternative actions are superior: based on the evaluation of the existing actions, alternative solutions might be considered. you show how your recommendations help the wealthy to achieve their self-interests. as exhibit 1 shows, there are five basic courses of action.
examples of stress testing with the super-rich
stress testing can be all-inclusive where you look at everything going on in a wealthy person’s life. most times, stress testing focuses on a particular issue or circumstance or something they have done, such as their estate plan or the way they have structured their business interests. the following are three examples of stress testing with the super-rich.
customized premium financed life insurance: a billionaire family purchased life insurance on several family members to address succession issues and to potentially generate significant investment returns. the solution was a highly customized multilayered premium life insurance transaction that delivers many hundreds of millions of dollars in death benefits at an astoundingly low cost and completely tax-free investment returns.
involved in the transaction were:
- an international life insurance specialist
- a cadre of lawyers
- an offshore reinsurance company
- one boutique investment bank
- a family office consortium in conjunction with a very substantial investment fund that provided the capital to pay the premiums
the transaction is exceedingly complicated, and it made a few family member decision-makers more than a little nervous. overall, they clearly understood there was potential for things going wrong and were, therefore, concerned about the risks. they wanted to be confident they knew all the risks, which led them to stress test the transaction.
a leading international tax lawyer referred us to senior management at the family’s single-family office. after being retained and getting an overview of the transaction, we assembled a team of specialists mirroring the group involved that executed the transaction. one of the experts we brought in is off the grid and was only available because of our previous business dealings. it took the team a couple of months to critically evaluate the transaction.
bottom line: the transaction effectively addresses the needs and wants of the family. it is also 100 percent legitimate. moreover, the professionals who put the deal together were exceptionally clever about it. the family members were quite happy knowing that the actions they took were verified and confirmed.
illegal tax planning: a wealthy individual was quite proud of how ingenious his tax planning was and how well it worked. the complication was that some of his business dealings were being scrutinized, and he wanted to make sure his wealth planning would not cause him any problems. his wealth plan had done several things:
- he transferred some of his businesses to a trust for which he received units of beneficial interest. the business trust makes payments to him, thereby avoiding taxes. the business trust will also not have to pay future estate taxes.
- in another jurisdiction, he sold appreciated property to another trust in exchange for an annuity, which in turn sells the assets and reinvests the money. he claims recognition of the built-in gain over his life, and the trust is not included in the estate.
- he transferred his family home to yet another trust and received units that were claimed to be part of a taxable exchange, resulting in a stepped-up basis for the property. the trust is thus in the rental business and claims to rent the residence back to him. he does not pay rent because he is the caretaker of the property.
- he created a hierarchy of trusts owning other trusts. one trust on top, in effect, holds the trust units of 41 trusts, and this trust distributes the income from those trusts.
it quickly became apparent that what he and his advisors had created were many trusts, some dubious in nature, that held selected assets and income streams. a criminal mistake was that by vertically layering these trusts, there were arguably fraudulent expenses being charged to subsequent trusts, resulting in a decrease in taxable income. simultaneously, the approach resulted in the illusion of separation of control to protect the assets in the trusts.
creating abusive trusts and layering them the way he did can come in a wide variety of forms, with almost all of them clearly used for questionable, if not illegal, purposes. it is analogous to russian matryoshka dolls, where one doll hides within a similar doll. unless all the dolls are opened, you cannot find the only one that is not hollow.
in this case, the super-rich individual claimed he thought he was just being smart about wealth planning. what he was doing was illegal, and even if he did not know it, the advisors who guided him and did the work most assuredly did – or should have. regardless, he was on the hook for this planning. because of stress testing, he completely redid all his wealth planning.
too much money too soon: we reviewed a will in which the youngest son, currently 6 years of age, would, on turning 12, receive an inheritance of slightly more than $250 million. who would hand this much money over to a 12-year-old? not many super-rich families would hand over a quarter of a billion dollars to a 12-year-old, and this family would not think of doing so.
the technical failure was the transposition of two numbers. the will should have stated that the son inherits the fortune at 21 years of age, not 12. again, who would hand this much money over to a 21-year-old? how many super-rich families would entrust $250 million to a 21-year-old when that person is only 6 years old today? we pointed out that, in fact, it might actually be “safer” to give a 12-year-old $250 million than give a 21-year-old that amount.
some extremely wealthy families might hand a quarter of a billion dollars to a 21-year-old without restriction, but this family was appalled by the idea. there was a serious breakdown in communication between the family and the advisors involved in the estate plan.
because of stress testing, the super-rich family’s estate plan was dramatically adjusted and updated. currently, it’s tightly aligned with the family’s overall agenda, and the son will inherit substantial wealth in a very disciplined manner – but not a quarter of a billion dollars when he turns 12 or 21. the estate plan delivers the framework and structure for creating a dynasty while insulating family members from losing wealth through taxes, litigation or divorce.
stress testing for the wealthy
stress testing is quite common for the super-rich. a large percentage of single-family offices are regularly stress testing to make sure optimal results are being achieved for their extremely wealthy families. meanwhile, stress testing is becoming more prevalent among the wealthy who are far from being super-rich.
based on our research and extensive experience, there is a poignant difference between stress testing with the super-rich and stress testing with less wealthy families. generally speaking, stress testing by the super-rich tends to find fewer errors or opportunities for improvement than for those who are less wealthy. this fact is probably because of the caliber of professionals engaged by many super-rich families and their single-family offices. their approach to due diligence is usually intense. however, when “failings” get discovered, they tend to be quite severe.
more mistakes among the wealthy: stress testing for individuals and families who are not super-rich tends to uncover more mistakes and more missed opportunities. it is more likely for the wealthy, in contrast to the super-rich, to be plagued by pretenders, predators and exploiters.
it is fairly common, for instance, for stress testing to uncover deadly “back doors” to a wealthy family’s asset protection plans. for example, some extremely successful entrepreneurs structure multiple company holdings in separate entities. however, they fail to insulate those entities from adversities that may occur in their personal lives. this error is quite prevalent among a great many business owners and real estate entrepreneurs. however, when it comes to the super-rich, the back doors are more likely to be locked tight.
conclusion
for the most part, stress testing is a very attractive service the wealthy want and appreciate. because of the swarm of pretenders, predators, exploiters and even true professionals who are not that client-focused, mistakes are all too common and missed opportunities are quite prevalent.
although you can formally provide stress testing and charge for the service, it also comes about as you uncover the self-interests of the wealthy and even other professionals. for example, the “thriving through the covid-19 crisis and beyond” workshop is a form of stress testing. stress testing is implicit as the participants are considering their self-interests, their actions and what they need to do to make the most of their current situation. whether stress testing is explicit or implicit, it will often lead to more business for your high-net-worth practice.