Illustration By Steve Brodner
Imagine a client who, in two days' time and unbeknownst to you, buys a $1.1 million heart-shaped necklace with pearls and matching earrings, spends $610,640 on antiques, and, for $5,950,000, becomes the proud new owner of a New York estate. Of course, most advisors don't have clients who can impulse-spend like this and actually sleep at night. After all, the shopper cited above is Imelda Marcos, who in 1987 was quoted as irately saying, "I did not have 3,000 pairs of shoes! I had 1,060." But people other than royalty will revel in their extravagances and insist upon their toys whether they can afford them or not, and some will do it over your dead body.
Is it up to the financial advisor to try and stop the client who is hell bent on buying a beautiful, new, $8 million Sikorsky S-76 chopper which, with a top speed of 178 mph and a 450-mile range, is perfect for whisking friends to their favorite golf course? Yes and no. One advisor uses this rule of thumb: If a client wants a helicopter, small jet, vacation home, exotic car, luxury yacht, or the latest from Hammacher Schlemmer (a floating, spaceship-shaped Aquatic Pod Suite--only $91,100), he should pay cash. If he can't afford to pay cash, he can't afford to have it.
Driving this point home, however, is another matter. "We don't make value judgments," says planner John Henry McDonald of Austin (Texas) Asset Management Company. McDonald never tells the client that it's bad to buy a given pricey item, opting instead to show the effect the purchase will have on the client's goals. "Can you buy a 'copter?" he'll ask rhetorically. "Sure you can. I don't care. But you should have a conversation with your daughter about why it is you won't be able to send her to private school as you had planned. Tell her why you bought yourself a depreciating asset."
Clients receive quarterly reports showing, in a simple format, the relationship between dollars spent and earned, so that clients can see clearly when their spending exceeds their income. It is an exercise that sometimes has great effect, and sometimes none at all. McDonald cites a client with a net worth of some $8 million who blows close to $64,000 per month. Invest the $8 million at a conservative 6%, he notes, and it will throw off about $484,000 per year. "The guy is going to be in trouble, and we tell him so, and log the conversation."The Voice of Reason
Advisor Elizabeth Holt of the Benchmark Advisory Group (dba The Private Consulting Group of Colorado), with offices in Las Vegas and Englewood, Colorado, says she doesn't attempt to dissuade "anybody who has money enough from doing anything. If a client has $50 million, there's no argument to be made for not buying something that is rational," she says. However, she will inform clients of the long-range impact of their actions. For example, she will explain to a client who plans to spend $300,000 on a new toy that having the toy will take $6 million out of his future financial portfolio. "It makes them think," she says.
What follows is a true story, as told by planner Elizabeth Holt of the Benchmark Advisory Group (dba The Private Consulting Group of Colorado), with offices in Las Vegas and Englewood, Colorado. Holt notes that in early November there was an IRS ruling stating that an individual's charitable remainder trust having an interest and participation in that individual's family limited partnership or LLC is not self-dealing. "This is terrific news," she says, "because we believed the tax law would support this kind of activity, and the IRS affirmed a key piece to strategies that are used to benefit both the wealthy and charity." |
Sam and Mary have plenty of highly appreciated stock. They want a new airplane that costs $8 million. They don't own a business where writing it off makes sense. Furthermore, they want to pay as little tax as possible to use the stock to buy the airplane. They have several choices:
1) Sell the stock and pay cash. The federal tax bill would be 26% for long-term capital gains, rather than 20%, because of alternative minimum tax for preference items. In addition, most states would get another 5%-9% for their share.
2) Collateralize the stock for a loan, selling enough shares each quarter or year to make the payments, thereby stretching out the tax liability. Depending on their other income, the possibility exists that the long-term capital gains bill would go "down" to 20% federal (plus state tax liability).
3) Put a costless collar around the stock with a three-year call. This allows them to get access to 80% of the value of their stock without tax now. The contract protects them on the downside so that there is no chance they will come up short when the contract expires. If the stock goes up, they get to enjoy 20% participation in any increases. They get their airplane paid for with money they don't have to deal with for three years and they have no downside risk in the stock value. By that time, they may sell the plane and pay off the contract with the plane's proceeds plus whatever stock or cash is necessary.
4) They can marry several tax strategies of IRC 664. By establishing charitable instruments, Sam and Mary can sell their stock without any tax, get a substantial tax deduction, and give to charity. The charities can be involved in an LLC which will buy and charter the airplane for Sam and Mary, who will pay the going rate for the use of the plane. Depreciation of the plane will flow through to the LLC, further reducing the income tax liability for the couple over the next five years. The income tax savings will more than cover the expense incurred for the use of the plane.
Advisor Steven Kaye, president of American Economic Planning in Watchung, New Jersey, felt it wasn't in his client's best interest to purchase a new toy in the form of a $200,000 bright-red Ferrari. The client reasoned that after seven years the car would be worth half of what he paid for it, and in seven years would cost him only $100,000. "We said let's examine depreciation plus debt service versus your opportunity cost of investing."
For argument's sake, he pegged the client's debt cost at 10%, meaning he'd be charged a 10% interest rate from the leasing company to purchase the car. He told the client: "The 10% on $200,000 is $20,000 a year. Over seven years that's $140,000. So your cost is not simply derived from losing $100,000 in depreciation over seven years, you'll also have debt service. Now here's your opportunity cost: If you had invested that $200,000 at 10% for seven years, your money would have doubled. By not buying the Ferrari, in seven years you'd have made $400,000. It's up to you. Lose $200,000 or make $200,000." The end result? The client wound up keeping his Porsche 911.
McDonald gauges a client's fiscal health by using a spreadsheet template that quantifies the client's standard of living. "We don't use a CPI, we use an FIF," he explains. FIF stands for Family Inflationary Factor, which indicates how much more the client is spending each year compared to the previous year.
"Just because the price of gas goes up doesn't mean that you're going to spend more," he notes. "But if the price of gas goes up and you buy three more cars, the fact that you bought three more cars is a hell of a lot more important than the fact that gas went up. So we use the FIF, and show the client the effect of their actions."Keeping Up With the Upkeep
It's common for new spenders caught up in the excitement of their new acquisitions to underestimate what their final costs will be. "Typically, the guy will say he wants to buy the car and his wife will say she wants to make the nest nicer," says Holt. They'll find themselves hiring an interior decorator and spending $300 to $600 per yard for fabric and other "ridiculously overpriced stuff." To give the client an accurate assessment of real cost, Holt will allocate and tack on to the purchase price of the house a certain percent to cover furniture, interior design, and related work. In addition, she will add on each year another 3% to cover ongoing maintenance, repairs and utilities. "That $750,000 house is going to cost you $20,000 a year to keep it up," she says, "but many people never think of that."Share and Share Alike
There's no better time for an advisor to show his or her financial creativity than when a client insists upon a purchase, and says, "Make it happen." It's one thing for a rich person to buy an exotic car; it's quite another when it comes to items like jets and helicopters. Advisor James Coffman, who works in Austin Asset Management's Georgetown (Texas) office and was once in the jet-leasing business, believes that if money is an issue, don't purchase the item. Rather, lease it, and tell clients that they are paying the costs of the airplane either way.
|Sharing The Ride|
Following the lead of the corporate jet industry, which according to the National Business Aviation Association has seen the number of companies using fractional ownership of jets jump from 89 in 1993 to 1,125 in 1998, Sikorsky Aircraft offers its flagship S-76 corporate helicopter (mentioned at the beginning of the article) via a shared-ownership plan through Sikorsky Shares, which is managed and operated by Associated Aircraft Group, a helicopter service and independent Sikorsky subsidiary based in New York State. Sikorsky itself is a subsidiary of United Technologies Corporation. |
Here's how the fractional ownership option works. Included in the price of the "shared" helicopter is 24-hour-a-day equipment availability, along with crew, fuel, maintenance, scheduling, and dispatch. Ownership use of the aircraft, for anywhere from two to 16 persons, is divided into flight units; these units, defined as a single trip within a specified geographic area, are a departure from traditional hourly in-flight billing. For example, a helicopter trip from New York City to the Hamptons on Long Island would use two flight units.
All shares, from 1/2 to 1/16, are for a five-year period. For a 1/16 share of the $8 million copter, there is a $500,000 acquisition fee, to which is tagged on a $7,435 monthly management fee. With this particular fractional ownership plan, the owner receives 75 flight units, each at an added cost of $695. Eight additional flight units, above the 75, are available each year, at $695 each. The flight units cover all flight costs, including pilots. The New York City to the Hamptons trip, one-way, would therefore run $1,390. If a person were to charter the Sikorsky S-76 for the same trip, the cost would be about $11,000.
The acquisition fee for a 1/4 ownership share is $2 million, which includes 300 flight units and an extra $29,700 extra in monthly management fees. Each flight unit costs $695 and 30 additional flight units are available each year, at $695 each.
Sikorsky Shares can be reached at 877-745-7676, or www.sikorskyshares.com.
Another twist is to purchase or lease an airplane or helicopter, use it part-time, and lease it out to others. Another is to register a purchased/leased piece of equipment with a "fleet pool," where it is leased out part-time to others. Advisor Steven Kaye has a client who planned to lease a used helicopter for about $700,000 and keeping it at a Manhattan heliport. He asked Kaye to mitigate the cost. Kaye reached an agreement with the heliport owners whereby the heliport leased the copter from Kaye's client, paying him a retainer to ensure access to it, plus a fee for airtime use, which retails for roughly $600 per hour.
"By leasing his helicopter out, he was getting passive income," says Kaye, "which wound up being tax-free because he had these passive losses to apply to it." Had the client not followed his advisor's advice, the helicopter-related costs would have been double.
If not a helicopter, perhaps a jet? Need a six-seater Cessna 421 for a weekend outing? Skyjet (www.skyjet.com), which claims to be the nation's first online reservation system for private jets, will find one, charging $500 per hour. A Lear 55, Citation III, or Falcon 200, which seat six to nine persons, will run $2,250 to $2,700 per hour, including pilot, crew and fuel.
Fractional ownership, similar in concept to condominium time-sharing, is a good way to reap the benefits of the part-time ownership, without the true costs of ownership and operation (see box above). If your client has his eye on a specialty yacht, Florida-based WestWind Resort on Water (www.westwindrow.com) is one of a number of companies offering various time-sharing plans. Or clients can simply spread the cost among friends or business associates.Let the Uncle Pay
Planner Kaye has a client who fell in love with a $2 million, 96-foot yacht. "We told him he really couldn't afford it," says Kaye, "and jokingly added that he'd have to give up his pricey penthouse office to lower his expenses enough. A bell went off in his head." The client gave up his office, bought the yacht, and now travels around the world. "Because the yacht is his bona fide office, he enjoys a good tax write-off for a good portion of it," Kaye notes.
The key for advisors is to make sure that if there's a way for the government to help pay for it, it will. "Make sure you're owning the toy in the right tax entity," says Holt--at the very least, an LLC or family limited partnership (see sidebar, page 52). "Don't let clients make this purchase outright; a company's got to own it, where it can be a legitimate business deduction."
By the time you're through reining in clients' whims, you may need a self-indulgent breather yourself. May we suggest that instead of buying that multimillion-dollar, 84-foot, cockpit-motor yacht, you charter it. And remember, try to figure out a way to mix pleasure with business.