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Capital Sufficiency Analysis

Last Updated: March 26, 2014
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Capital Sufficiency Analysis is the process of determining whether your family’s existing and anticipated financial resources will allow you to achieve your financial and estate planning goals. The analysis provides a framework for making decisions about future spending, investment allocation, estate and philanthropic planning.

Although it is impossible to predict the future, Capital Sufficiency Analysis can help you set goals and objectives. A Capital Sufficiency Analysis is strongly encouraged for all of our client families.  Families are encouraged to revisit and update the analysis annually as circumstances and assumptions change.

We start with your goals and objectives. The baseline goal for many clients is to maintain today’s current spending for life without exhausting financial assets. If the analysis indicates that this is likely, then we can examine secondary goals. Secondary goals include:

  • Can I transfer $1MM of wealth to my children today without impacting my current standard of living?
  • Can I fund a $5MM charitable foundation today?
  • Can I maintain my current standard of living and still give at least $5MM to each of my children at my death?

The following are two examples of how our Capital Sufficiency Analysis can help our client families:

DavidJune_Snap1  DavidJune_Snap2

Introducing David and June

David and June just sold their family business. With an investment portfolio of approximately $35,000,000 and what they considered to be a reasonable standard of living, David and June were not overly concerned about outliving their money. Below is a snapshot of their financial situation:

Below is a description of the goals tested using the Capital Sufficiency Analysis:

BASE CASE:

First and foremost, David and June want to know if their goal of maintaining their current level of spending ($1,250,000 annually) is realistic. A secondary goal is to pass $5,000,000 of wealth to their children, either at death or during life.

ALTERNATE I:

Assuming their base case goals are realistic, Alternate I assumes the family establishes a foundation with annual contributions of $1,000,000 over the next 5 years.

ALTERNATE II:

Assuming the above two cases are realistic, can David and June afford to start transferring wealth to their children during their lifetime rather than waiting until death? Alternative II assumes the couple establishes the foundation described in Alternative I and creates a Grantor Retained Annuity Trust funded with $10,000,000 with the remainder benefiting their children.

 

Summary of Results

Base Case – Maintain current standard of living and leave minimum of $5MM to their children

base_case-1

As expected, the base analysis showed a very high probability that David and June would be able to achieve their goals.

Alternate I – Base Case, plus endow private family foundation with annual contributions of $1MM for each of the next five years

alt_case-1

The next analysis focused on how funding a private charitable family foundation during life would impact their goals. The assumed $5MM charitable contribution reduces the probability of success slightly. Many clients would still proceed.

Alternate II – Alternate I, plus establish 10 year Grantor Retained Annuity Trust (GRAT) for the benefit of children

alt_case-2

Given the high probability of success, the Capital Sufficiency Analysis could encourage David and June to explore advanced estate planning strategies.

The Capital Sufficiency Analysis provides David and June a framework for prioritizing their goals and objectives. Can we use the analysis to accurately predict the balance in their GenSpring account in a given year? Absolutely not. But, by making educated assumptions and revisiting the analysis on an annual basis as circumstances change, Capital Sufficiency Analysis allows us to make more educated and thoughtful financial and estate planning decisions.


Introducing Barbara Brink

Barbara Brink inherited $19,000,000 from her deceased husband, but during the past year her portfolio has lost almost 20% of its value. She maintains two homes, one in Maryland and one in California. Barbara’s living expenses have ballooned over the last several years, and her children have grown dependent on her annual gifts to maintain their lifestyles.

Recent declines in her portfolio value have made Barbara concerned about whether she can maintain her current lifestyle. Should she continue to make annual gifts to her children? Should she consider selling one of her homes? She wants to know if her current situation is sustainable before it is too late.

BarbaraBrink_Snap1  BarbaraBrink_Snap2

BASE CASE:

Can Barbara continue her current standard of living and annual gifting without exhausting her investment portfolio

ALTERNATE I:

If base case is unsuccessful, what changes can Barbara make to increase her chances of success

 

Summary of Results

Base Case – Maintain current standard of living without exhausting investment portfolio

base_case-2

Analysis confirms what Barbara fears – Investment Portfolio is not likely to sustain her current lifestyle.

Barbara’s options are fairly straightforward:

  • Reduce personal living expenses
  • Reduce or eliminate gifts to children and grandchildren
  • Sell personal assets to increase balance of investment portfolio
  • Seek employment

In Barbara’s case, reducing or eliminating gifts to children and grandchildren and seeking employment are not realistic. In the Alternate scenario Barbara sells her California home and reinvests 50% of the proceeds in a smaller home or condominium and 50% in her investment portfolio. By selling the California home, she can also cut her annual personal living expenses by $100,000.

Alternate I

BarbaraBrink_AltSnap1 BarbaraBrink_AltSnap2

Alternate I – Reduce living expenses to $650,000 and downsize California home

alt_case-1b

The Alternate analysis shows a high probability of success.

Despite the bleak results of the base case, Barbara was relieved to have a framework for making spending and investment decisions going forward.  As Barbara moves forward it will be important for her to closely track her living expenses and investment performance.  Furthermore it is recommended she revisit the capital sufficiency analysis as circumstances and assumptions change.


Monte Carlo and Simulated Performance Disclosure

The simulated performance information shown which reflects the results of analytical programs obtained by GenSpring is based upon hypothetical performance of various investment indices and/or benchmarks, and does not represent actual GenSpring client portfolio historical results, or guarantee any level of investment performance. Because these are projected results based on certain assumptions, the projections could be incorrect and your return could be significantly worse than illustrated. Therefore, you should not assume the portfolio will be profitable or will meet your objectives.

IRS Circular 230 Disclosure

Any tax related material contained within this communication is subject to the following disclaimer required pursuant to IRS Circular 230: Any tax advice contained in this written communication is not intended to be used, and cannot be used, for purposes of (i) avoiding penalties imposed under the United States Internal Revenue Code or (ii) promoting, marketing or recommending to another person any tax-related matter. The information contained herein is obtained from sources that are believed to be reliable and is provided for reference purposes only. It should not be construed as legal or tax advice and should not be used as a substitute for the advice of a professional legal or tax advisor.


Authored by GenSpring Wealth Advisory Center