What are the main estate planning and wealth transfer strategies tested on CFA Level III?
The estate planning section of CFA Level III is challenging because it involves tax law concepts that overlap with financial planning. Can someone outline the key strategies, including gifting, trusts, and cross-border considerations?
Estate planning for CFA Level III focuses on transferring wealth efficiently across generations while minimizing transfer taxes (estate, gift, and generation-skipping taxes). Here are the core strategies:
1. Lifetime Gifting
Transferring assets during your lifetime uses the gift tax exemption and removes future appreciation from your estate.
Key concept — Relative After-Tax Value of Gifts vs. Bequests:
RV_gift = FV_gift × (1 - t_gift) / [FV_bequest × (1 - t_estate)]
If RV > 1, gifting is preferred. If RV < 1, bequeathing is preferred.
Example: Caldwell family has $5M in appreciated stock. If gifted now (gift tax rate 40%), the recipient pays capital gains tax on future sale. If bequeathed at death (estate tax rate 40%), the recipient gets a stepped-up basis, eliminating the embedded capital gains. The relative value calculation determines the optimal path.
2. Generation-Skipping Transfers
Transferring directly to grandchildren (skipping a generation) avoids one layer of transfer tax. However, the Generation-Skipping Transfer Tax (GSTT) applies at the highest estate tax rate to prevent unlimited skipping.
3. Trust Structures
| Trust Type | Tax Treatment | Use Case |
|---|---|---|
| Revocable living trust | Grantor taxed; included in estate | Avoid probate, maintain control |
| Irrevocable trust | Removed from estate | Estate tax reduction |
| Grantor Retained Annuity Trust (GRAT) | Grantor receives annuity; remainder to heirs tax-free if assets outperform | Transfer appreciation tax-free |
| Charitable Remainder Trust (CRT) | Income to donor; remainder to charity | Income stream + estate reduction |
4. Cross-Border Considerations
For clients with assets in multiple jurisdictions:
- Source jurisdiction vs. domicile jurisdiction taxation
- Tax treaties may reduce double taxation
- Forced heirship rules in civil law countries override testamentary wishes
5. Valuation Discounts
Minority interests and lack-of-marketability discounts (typically 15-35% combined) reduce the taxable value of transferred assets, particularly for family business interests.
Exam Tip: CFA Level III constructed-response questions often present a client scenario and ask you to recommend the optimal wealth transfer strategy considering tax rates, investment horizon, and family circumstances.
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