As a founder, you meticulously plan business strategies well in advance. Applying the same foresight to your financial plan can help ensure both your company and personal legacy thrive.
As your company develops and your wealth grows, your financial strategy should evolve in tandem to ensure it continues to support your business goals and secure your personal financial future. A key, but often overlooked, part of building and preserving significant wealth is knowing where to hold different investments in order to minimize tax drag. This strategy is known as asset location (not to be confused with asset allocation, which involves investing in a variety of asset types to help balance risk and return in a portfolio). Asset location, rather, focuses on strategically placing your investments in different types of accounts based on their unique tax treatments in order to maximize after-tax returns.
Using asset location strategies can help you keep more of your earnings, potentially allowing you to reinvest in your business or save more for the future. Moreover, exploring advanced tools like trusts can further enhance your financial plan, offering powerful ways to manage wealth, minimize federal income and transfer taxes, plan for beneficiaries, and fulfill philanthropic goals.
Here are several strategies to consider.
1. Irrevocable Trusts
Legacy planning is an important consideration for founders who want to help ensure their business runs smoothly and their family is financially set for the long haul.
By strategically locating assets in the following types of trusts, you can permanently gift the assets to beneficiaries and potentially reduce federal estate and gift taxes. When setting up an irrevocable trust, you’ll need to decide between a grantor and a non-grantor trust, and consider the kinds of assets to place in these vehicles based on their tax treatment.
- Grantor Trusts: In a grantor trust, you (the grantor) pay the federal income taxes, allowing the trust’s assets to potentially grow federal income tax-free for the beneficiaries. As such, these trusts can be well-suited for assets that you expect to appreciate significantly in value, such as early-stage company shares.
- Grantor Retained Annuity Trust (GRAT): After you transfer assets into the trust, you will receive back the amount contributed, plus interest, in the form of annuity payments over a set period. If structured properly, at the end of the set period, any remaining assets, including appreciation, may pass to the beneficiaries, free of federal gift and estate tax. Accordingly, GRATs may also work well for assets expected to appreciate significantly.
- Non-Grantor Trusts: With a non-grantor trust, the trust itself or its beneficiaries are responsible for the federal income taxes, which can be particularly beneficial in managing your overall federal income tax exposure. A distinct advantage for founders is the ability of non-grantor trusts to facilitate Qualified Small Business Stock (QSBS) “stacking.” Since the trust is treated as its own separate taxpayer, it can hold QSBS and potentially multiply — or stack — the available exclusion from capital gains. For asset location purposes, this trust structure is often ideal for assets that generate income or are expected to grow significantly, especially when the goal is to use separate federal income tax benefits that are specific to the trust as a taxpaying entity.
2. Charitable Trusts
Charitable trusts can offer a compelling way to help you fulfill your philanthropic intentions and secure a lasting legacy, while also potentially reducing federal income tax liabilities. These powerful tools may be especially useful for experienced founders whose wealth is heavily tied up in highly appreciated, illiquid assets like company stock.
There are a number of options to consider in this area as well:
- Charitable Remainder Trusts (CRTs): CRTs offer a strategic way to manage highly appreciated assets, such as company stock, by transferring them into an irrevocable trust that provides an income interest (either an annuity payment or a unitrust amount) to the grantor (or other individuals) for life or a term of years and the remainder to one or more designated charitable organizations. For a company founder, placing business interests into a CRT before a binding sale agreement is finalized may maximize tax benefits, including deferring capital gains taxes, obtaining an immediate charitable contribution federal income tax deduction and reducing estate taxes. Additionally, investing the sale proceeds in diversified securities with long-term growth potential can further leverage the trust’s federal income tax-exempt status.
- Charitable Lead Trusts (CLTs): In contrast to CRTs, CLTs are designed to initially provide regular payments to your chosen charities for a set period of time. After this term, any remaining assets in the trust are transferred to your beneficiaries, often with significant federal gift and estate tax savings. This strategy can be ideal if you’re committed to both philanthropy and wealth transfer. Within grantor CLTs, you may want to invest in tax-efficient securities due to the federal income tax liability you face on trust income. For non-grantor CLTs, consider prioritizing growth-oriented, high-yielding investments to help maximize the trust’s tax-deductible charitable payments.
Working with Your Morgan Stanley Financial Advisor
As a founder, navigating the financial landscape requires a strategic approach that goes beyond the basics. Asset location strategies can help you effectively balance risk and optimize tax efficiency across your portfolio, ensuring that your investments work harder for you.
The good news is you don’t have to do this alone. Your Morgan Stanley Financial Advisor can talk you through which strategies make sense for your finances. By taking the time to create your financial plan, you will have a roadmap for what’s ahead — even if you can’t see around the corner just yet.
To learn more, ask your Financial Advisor or Morgan Stanley representative for a copy of the Global Investment Office report, “A Good Match? Marrying Wealth Structuring and Investment Selection Decisions.”
