How does estate asset allocation change as clients climb the wealth ladder?
The IRS recently offered a bit of insight into the finances of the high net worth when they released Statistics Of Income estate tax data for taxpayers filing in 2014 (so, the majority of those included died in 2013). Just a reminder, the estate tax exemption that year was set at $5.25 million and the top rate was 40 percent.
Before we dig into the numbers, it’s important to recognize that these figures represent gross estates and accompanying deductions. Assets that aren’t included in the gross estate (for instance, most things held in irrevocable trusts, anything passed on during life via inheritance alternatives, lifetime gifts made up to the exemption amount, etc.) aren’t represented in this data. So, these filers are probably worth quite a bit more in reality than what appears in the IRS’ records and, some of the asset class results may be skewed. Certain assets that are more difficult to remove from the gross estate may be overrepresented in terms of percentage of a given estate, others may be included strategically to, say, achieve a step up in basis.
The first item to note is that publicly traded stock was the most popular asset regardless of wealth level. Bonds were also popular across the board, though to a lesser extent than stock, particularly among those with gross estates exceeding $50 million.
Beyond those two constants, there are several noticeable trends as wealth level increases:
Taxpayers in the lowest bracket ($5 million - $10 million) have a higher percentage of their estate in personal residences, retirement plans and other real estate (defined as commercial property, undeveloped land, REITs and residences other than the primary). Yet, as decedents get wealthier, all three of these categories decline noticeably. These results aren’t particularly surprising, as these classes generally represent single (or very few) large assets, which predictably make up less of an estate as it grows. Retirement accounts, for instance, generally have limits placed on the amount you can contribute, so as wealth level increases, the percentage of the estate that they represent decreases as the client diversifies into new classes, and other assets simply accumulate value more quickly.
On the other hand, as wealth level increases, so too does the relative value of art, closely held stock and other limited partnerships (defined as the value of all limited partnerships other than private equity, hedge funds and farms, which all have their own categories), all assets which are relative non-factors for the lowest bracket. Though there are myriad potential reasons based in complex estate planning for the inclusion of these assets in an estate, they’re largely beyond the scope of this article, so we’ll go with the simplest explanation. Entry to these asset classes, in any meaningful way at least, is barred by money. Art, for example, is a growing and attractive asset class but is also extremely expensive; both to own and to pass on. Wealthier decedents are more likely to be able to afford to own art and their heirs (or, more likely, the estate itself) are better able to bear the estate tax cost of inheriting it.
As mentioned above, since we can’t see what’s kept outside of the gross estate, it’s fairly difficult to determine the impact of estate planning based on these figures alone. However, the areas where planning is most visible are the relative percentage of charitable contributions and how much net estate tax is ultimately paid. The amount (in terms of percentage of gross estate) of charitable deduction taken increases drastically with wealth level. The highest wealth bracket takes a charitable deduction that’s roughly twice as effective (worth around 20 percent of the gross estate) as the next closest group. Additionally, the highest wealth bracket pays out a similar or lower percentage of the gross estate in net estate taxes than every bracket but the lowest one (which, since it’s lowest bound is set at $5 million, includes a number of filers who don’t exceed the exemption threshold at all, dragging the average way down). This comparison gives credence to the idea that the assets that the wealthiest bracket included in their estates were put there for specific reasons. There is less of a direct correlation between wealth level and planning in this area though, as the second highest bracket ($20 million - $50 million) looks to have paid out the highest percentage.
Though by no means a complete look, these numbers do offer some insight into where the wealthiest Americans are putting their money and offer some indication of the effectiveness of estate tax planning.