Transcript
Intro
Stephan Shipe: Welcome back to the Scholar Wealth Podcast. Today we’re taking a look at two different sides of wealth planning for a major event.
First, how to use a charitable remainder unitrust to manage taxes after selling a highly appreciated property. Then, how a contingency attorney should handle a seven-figure payout while preparing for future cases.
Finally, we’re joined by Anne Rappa, National Fine Arts Practice Leader at Marsh McLennan Agency, who works with high-net-worth families to protect valuable collections.
So let’s go ahead and get started with question one.
Question 1 – Charitable Remainder Unitrust (CRUTs)
Listener: I’m selling a rental property that’s appreciated by almost $2 million, and the capital gains hit is going to be huge. I’ve been thinking about setting up a CRUT to defer taxes and eventually direct the remainder to a donor-advised fund for our family’s giving. How flexible is that structure if I still want to keep control over investments and possibly make gifts to multiple charities later on?
Stephan Shipe: This is a great question to get into because CRUTs can be extremely convoluted in how they’re structured, but they’re not as complicated as they seem on the onset. I think the first time anyone looks at a CRUT, everything kind of glazes over. It’s really difficult to understand and see what’s going on.
So I’m gonna do my best to explain first how it actually works, and then we can talk about the control that you’d have over the investments and the charities in this scenario. So to make sure that you understand — because what’s gonna happen with any type of trust, it’s irrevocable — in this type of scenario, you’re gonna be giving up control.
You’re gonna take the property that has gone up — and you’re saying it’s gone up by $3 million, let’s say it’s doubled in value, say it’s worth $6 million — so you’re going to take this property of $6 million, you’re gonna go put it in this charitable remainder unitrust. The advantage there is as soon as it’s in the trust, you can sell it. And then you sell it and you’re not going to have to pay the capital gains on that sale. So you’re going to be able to avoid all those immediate capital gains on the sale of that asset.
Now, the catch is that that value — the remainder of whatever’s in that trust later on when you die — is going to go to some sort of charitable purpose. In your case, that charitable purpose will be your DAF, and that’s going to allow you to have a little bit more control over how that’s going to be allocated out to different charities. And even before then, you can do some things with it as well.
But the big advantage is that once that value is put into the CRUT, while you can’t touch the remainder, you can pull out an income stream from that CRUT throughout your life. So it’s this really sweet situation where you put this — we’re gonna say $6 million property — into the CRUT, you sell it, now you don’t have to pay the capital gains. The CRUT has $6 million in it. You’re going to control the investments. It’s going to be able to pay you every year some distribution that’s going to be set in the document.
So let’s say it’s 5%. You now have 5% on $6 million, so you’re going to be paid $300,000 a year out of that trust for you to be able to use, and that CRUT will continue to grow over time. And then anything that’s left will go to the DAF.
So what that allows you is to have some sort of flexibility for your future giving. You’re not setting a charity now — you can set the charity later. That’s probably one of the biggest benefits from a charitable side, is that you remain in control. You’re not giving $6 million today over to one charity. You’re putting it into the DAF, and you’re able to pull income throughout your life. So it can be really good.
Now, the downsides of this — you’re losing full ownership. It’s an irrevocable trust, so it’s gone. You have the annual valuation that you’re gonna have to look at, so you’re gonna set a percentage. Your attorney would set a percentage that says you’re gonna pull 3% or 5%, or whatever it is, and then every year you would have to look at the market value of all the assets and say, “All right, I have $6 million in there, so I’m gonna pull $300,000. I have $10 million, I’m gonna pull $500,000.” So you have that, and there is some set of complexity.
It’s not an easy revocable trust you just set up, sign a couple papers and it’s done. There’s some thought that needs to go into this — what type of assets are gonna fund it, how much income you’re gonna pull from it. So this is absolutely a discussion that you’d wanna start having with an attorney.
But as far as the investment side and the capital gain side of things, you are correct that by putting this property into the CRUT, you would be able to allow the trust to own it, sell it, avoid those immediate capital gains, and there would be an income stream that you have from it. And by using the DAF, you’re gonna have a lot more control over the flexibility in any giving that you have as well.
And now onto our next question.
Question 2 – Contingency Attorney Windfall Planning
Listener: I’m a contingency attorney and just received a little over $1 million from a case that finally settled. I know the tax bill is going to be significant and I also need to keep some cash available for future case expenses. How should I balance liquidity with putting the rest to work?
Stephan Shipe: So the contingency-attorney world, as you know, is one of my favorite worlds to learn about and work with people on, because the contingency attorneys out there—you all just embrace the volatility of income. You put all the investments in, you put kind of money where your work is and where your mouth is on it, and when it hits, it hits hard.
So it sounds like that’s going to be the scenario for you as well, in a good way here, with a million dollars in the case recently settled. So the first priority is the tax situation. I would at least reserve 35 to 45 percent for federal and state taxes right off the bat. So a million dollars hits the account—$350 to $450 thousand is going in for state taxes immediately, even before you do anything that could reduce that tax burden later on.
Generally, what I end up seeing is big-case win comes in, you’re trying to reduce the tax impact. So we’re looking at things like maybe, if you’re charitably inclined, good year to start a DAF, right? Maybe not a foundation because of the valuation, but those tend to come up.
The other one that you may want to look into, depending on how your firm is structured—this could be a great opportunity for opening up a defined-benefit pension plan that has a much higher limit than the $69,000 or $70,000 or so that you have for a 401(k). So when you get into the defined-benefit page, you’re talking about hundreds of thousands of dollars.
So if set up correctly—and it depends on what employees you have—it could be worth the complexity for a year to fund this and start up a pension, so that way you could defer a significant amount of this. So again, first set aside some money for taxes before anything goes on, and then I would start looking at: are you charitably inclined? Should we be looking at a DAF? I’d also be looking at possibly doing some pensions.
The downside of that is we’re eating up cash, so we’re just going to be pulling that away. So we want to make sure that that million really—going to depend on how much money did you invest in that case for you to get that million out. So we need to make sure you maintain liquidity for upcoming case costs, any overhead, personal expense.
Typically, when I’m working with contingency attorneys, we’re keeping a pretty healthy cash buffer there—at least a year, maybe two years of personal expenses, any overhead. If you know there’s going to be an expensive case that you’re funding here in the next year and maintaining, that’s a good time to do some planning for the firm—saying, how much do we think we’re going to outlay over the next year or so, both on the personal side and the upcoming-case side?
Let’s pull that back and let’s put that money, along with any money we need for federal and state taxes, into something like a money-market fund over at your brokerage account. Keep that there. Earn your 4 percent—depending on what tax bracket you’re in, maybe we run into a municipal money-market, depending on the state.
So the big thing is going to be a little bit more planning on what to do with the windfall on it. It sounds a lot like just windfall planning in general—in other words, if you had a lottery win of a million dollars or inheritance of a million dollars. But there’s an added component here that you still need dry powder for the next case. So we need to make sure that we’re reserving some of that for investment in the future cases so you can go and get another million- or $5 million-win out of this.
So long-term reserves—we want to think about short-term cash needs. Obviously, taxes—that’s the opposite. No one’s going to like it. You’re not going to like it. But the CPA will love it. You can go in there and you can start doing some tax planning for the next year to see what that looks like, whether or not you need to be making estimated taxes now.
And then you can get a little fancier with it, depending on what you think that next year’s caseload looks like, and start looking at scenarios like maybe next year you’re going to have significantly less income because you just wrapped up this case. So if that’s the case, then maybe it’s a good opportunity for doing some Roth conversions next year—changing around some of the retirement structure during that time.
But great opportunities when you have these big windfalls to do a quick check on what the next year looks like and then work backwards from that—of future investment in the cases, personal expenses, tax. And then if all of that’s covered and you’re saying, “Stephan, I just need to defer some of this tax; I only end up paying 40 percent on this whole thing,” then let’s talk DAF, let’s talk defined-benefit plans, and think to see if those are going to be good options for that cash windfall.
From the Field – Interview with Anne Rappa
Stephan Shipe: And from today’s From the Field conversation, we’re shifting from financial structures to the physical side of wealth — how families can protect the assets they collect and display.
Today we’re joined by Anne Rappa, National Fine Arts Practice Leader at Marsh McLennan Agency. Anne works with high-net-worth families to protect valuable collections — from fine art and jewelry to rare collections — through proper insurance, storage, and risk management. She’ll share what families should know about safeguarding their assets and what can go wrong if key protections are overlooked.
So Anne, welcome to the Scholar Wealth Podcast. Why don’t you start off — tell us a little bit about yourself and your experience.
Anne Rappa: Sure. Thank you so much for having me. I have been in the insurance industry with a focus on fine art risks for about 30 years now, and that includes private collectors, museums, universities, living artists, auction houses — it goes on and on — art dealers.
So I work in both the personal insurance space as well as the commercial space, and that’s really helped me to refine information that I learn from professional standards. On one side I can share with the other, and I hope that this helps me in my service to my clients on a day-to-day basis.
Stephan Shipe: That’s great. I love the mix there of the commercial side — of being able to pull some of those tips and tricks, so to speak, over to the personal side. When you’re talking to families about their collections, what should they consider when first setting up the environment or different protections for their collections?
Anne Rappa: There are a couple of different key starting bits that one should focus on. One is making sure that they maintain their collection management data. That is very important because losing a certificate of authenticity for an artwork that requires such a thing in order to maintain value is very important.
All of the invoices and background data — this all should be part of what one collects. And so if you have the collection data, then we turn to the actual physical space. And if you think of the house in a private collection scenario as the envelope where the art collection sits, we do focus on the appropriate protection of that vessel as the container.
A museum will have a museum building for an art collection. The house that you maintain is the place where the artwork will live, and artwork does have specific fragility associated with it. So maintaining appropriate climate may be something that one would want to consider, in addition to the traditional protections like maintaining your roof properly and having water shutoff valves so that there is no flood, and also introducing appropriate burglar and fire protections.
So it’s all of the same old, same old when you are thinking of protecting your house and making your house resilient — plus, plus, plus. We have particular vulnerabilities when it comes to simple things like accidental damage. So whether or not you want that fragile sculpture or art piece to be on that shelf which is open, or behind a door where a doorknob can hit an artwork — those are things that one should be concerned about and conscious of.
Also, who is hanging the artwork? The way that artwork is hung and who hangs it is very important to the equation. The hanging mechanisms can also erode over the course of time, so having resources in this area is very important. And who those resources are — are they specialized? Are they experienced?
We’ve talked a little bit about my experience in the commercial space — that has helped an enormous amount in being able to establish relationships with resources, because who the museum community uses for conservation, for transport, for art handling, for warehousing is helpful and useful. How they conduct a large move or transport when they have a construction project — that has actually become very good experience for me to lend then to private collectors who are going through similar experiences.
Stephan Shipe: Do you have any rule of thumb around the amount of money that would go into protecting a collection? One of the questions that will come up regularly is someone says, “I have a million-dollar art collection, and I’m trying to figure out how much I should pay these specialists to come in and evaluate everything, to hang it up.” Is there anything that you have in your experience — whether it’s for jewelry or for artwork or anything else — that someone could use to say, “That’s a reasonable amount for me to spend on this”?
Anne Rappa: You bring up a really great point because art collections have a carrying cost associated with them. It isn’t an asset that you put in your closet and forget, or put in your safe deposit box and don’t have to be concerned about. There are pretty significant vulnerabilities that are associated with an art collection.
There are things to consider that are beyond the actual purchase of the object. A really great starting point for a collector is works on paper, because you can really get master artworks created by a fantastic artist at a lower price point than maybe art on canvas by the same artist. But you do have to be careful of how it’s framed, that you protect it from UV light, that it be installed appropriately.
So I think these are things to consider when you are purchasing artwork. Are you interested in having this kind of property that does require additional care? It will require professional installation, professional framing. Those things have, like I said, a carrying cost to them.
It’s not only about maintaining a database with information, but there is a need to periodically reappraise it so that you have an understanding of what the value is. And of course, I’m an insurance broker, so I would be remiss if I didn’t mention the cost of insuring it, which relates to its market value.
I do know that an art conservation professional, logistics companies, warehouses in this area — all of them — it’s expensive to have an art collection. This is something that is a passion project, and most people who are investing — with air quotes — because if someone is forming an art collection, it’s typically because they’re passionate and interested in history and culture, and they want to have these objects around them.
Stephan Shipe: You mentioned one of the things that I was going to actually bring up next, which is this appraisal idea — because the values of these collections matter and fluctuate over time. How often should someone be getting these appraised, and how should someone think about insurance when they’re looking at appraisal values — everything to make sure that they’re actually getting that protection in it?
Anne Rappa: Well, it really depends on the level of insurance that you’re purchasing. There’s typically an inverted relationship — the higher the limit, the lower the rate, until you hit a certain amount, and then you’re at market capacity. And when there’s saturation of market, then there’s a minimum rate. But we’re talking now about, like, a billion-dollar collection.
The day-to-day collector should have a desire to insure the object based on its market value, and this means retail replacement cost in terminology used in the appraisal industry. Those insurance policies can be scheduled insurance policies, or they can be blanket insurance policies. Some people really like to have a schedule — that’s an agreement upfront of what the values and the limit would be in the event of a claim.
They don’t necessarily have a collection manager, so this is a way where they also have an insurance company helping to collect the data for them and maintain that full schedule. They like to see the objects, they like to see a schedule of insurance.
Those insurance policies traditionally require that any objects that are above about $500,000 in value be reappraised routinely. When I say routinely, that’s every three to five years. There are some objects that escalate in value faster than other objects. I think that a European furniture collection would be just fine being reappraised every five years — that market is pretty static.
Modern and contemporary collections, the consumer may want to have a better pulse on where the values are, and that would be every three years to every five years. There are ways also to compartmentalize coverage — to have a blanket policy, which allows for coverage to be based on current market value at the time of loss. So this is when you buy a limit of coverage and there’s no specific schedule, but at the time of the loss, you would then need to show your loss and have appraisal data provided to the insurance carrier at that time.
You can’t escape having your objects appraised — it’s either on the front end or the back end in the event of a claim. And there is some comfort in having that schedule and the agreement of values. In really big-limit situations, we have the ability to modify basis of valuation to be a combination of both current market value and scheduled value, whichever is greater.
So it’s important that you work with an insurance broker that understands the market well enough to be able to have a conversation with you as the collector and understand first what your needs are and what you feel comfortable with.
Stephan Shipe: In general, is there a difference in cost — from an insurance cost perspective — of a schedule versus a blanket policy?
Anne Rappa: There doesn’t necessarily have to be. Blanket policies that are in the larger limit-size category can be comparable in terms of price to a scheduled policy. But again, a blanket policy is a good construct in a specific situation, and it’s important that any economic decision maker have a good understanding of the pluses and the minuses of these products so that they can make an informed decision — which is what I love about the job that I do, because I take the client on a journey with me to first have a discovery conversation and make the determination with them, not for them, of what products are available, what is their tolerance for risk.
A small thing can be a big thing. Like someone can come to me specifically for a blanket policy, but their artwork is moving so often that it may not really be a good candidate for that sort of construct. And then we talk through the why and come to a conclusion together.
A scheduled policy is a finite value. There’s typically also an escalation factor. A scheduled policy in the personal lines arena with the major carriers in the high-net-worth space will also have a 50 percent inflation guard above that scheduled value. So there’s some flexibility that exists.
What we try to do is negotiate the broadest terms that we can, and ultimately the policy comparison work is very important when we’re talking to one of our clients. There are only five major exclusions traditionally, but do you understand what those are, for example?
Stephan Shipe: When you’re looking at these other types of risks, what’s commonly overlooked? Because you’re going through a lot of different things that people are having to take into account, and you’d walk clients through all this. What are the ones that you see — someone has a collection and they’re looking at this risk, and you look at it as an obvious “this is something we’ve got to take care of right now,” or in experiences you’ve had with someone?
Anne Rappa: In those types of scenarios, there are really high-level issues and really common issues. So let’s talk about what’s common first, because those are things that can so easily be overlooked.
Someone comes to us and has a scheduled insurance policy, and no one for a million years has looked at their collection management system to reconcile their schedule to their collection. We find these individual objects that are not insured or not insured properly because they traditionally have a blanket policy that has a blanket component of coverage — but those blanket components have a per-item maximum.
So you can have a $700,000 object that was never put on this policy and a $50,000 blanket provision, which could really have you, in the event of a claim, be out of pocket to a significant degree. If you have a scheduled policy, it is important that you look at that schedule, your collection, to be sure that every object that should be scheduled is actually on the policy.
It sounds so simple, right? But this is something that is frequently an error, and it’s something that we — that’s one of the first steps of what we traditionally do in the intake process.
And then higher-level issues — like if you have a lot of objects that are going out on museum loan, or to an art dealer for consignment, or to an auction house — really looking through to see who is insuring, at what point are they insuring. Because traditionally there’s a transition of insurance responsibility, and what is that insurance policy? Is it the same as yours, or are there different terms and conditions?
Also, at times, museums will apply for government indemnity. So do you know what that means? Because that is not commercial insurance, and that coverage exists and differs one country to another. There’s a U.S. indemnity program, a U.K. indemnity program, there are different municipalities with different insurance programs.
And so I would say, when objects go out, those are higher-level issues — but we can help with review of the facilities and the protections of those offsite locations.
By the way, it’s not rocket science. I will tell you my big secret — I’m looking at the same protections that I would a residence or a warehouse just to know. For a warehouse, is it a mono-use location that’s a dedicated fine art facility, or is this a mini storage location where there are multiple tenants and different types of property that are within it?
The granular details are a compilation of these somewhat simple things, but we focus on them in a very dedicated way. If I were to write a to-do list for an art collector, it would probably start like we opened this up with — collection management would be probably number one, because when you have a conceptual artwork and you have the physical object and you’ve lost the certificate, and that object therefore has no market value anymore, that is a very sad circumstance.
Reviewing all of this, I think, with your insurance broker when you are at a level of being a serious collector is fairly important.
Stephan Shipe: At what level do you think that is?
Anne Rappa: That’s a really great question. There could be complication without a lot of high value, but I would say when you are interested in forming a larger collection and you label yourself an art collector, there’s a certain level of dedication that will naturally be associated with that.
It isn’t premium-advantageous for anyone under a $1 million limit of coverage to buy a standalone separate policy, because you can have that be insurance associated with a good homeowner’s product. But I traditionally am involved with complicated situations or high value collections, and I don’t necessarily distinguish one from the other, because you can have a lower-valued collection but have it be complicated by outgoing loans and all of these other factors.
I would say that it’s something that one should self-label. I take care of whomever it is that calls me, and usually those are referrals from existing clients who have also worked with me. I am not the Marsh McLennan Agency 800 number, so if someone is calling me, it’s usually because they’ve heard my voice, they’ve heard my name.
But I’ve taken care of $1 million, $5 million, $50 million, $1 billion — I love those programs, of course. Not only are they high limits, but they’re incredible collections that traditionally operate in the same way that a museum would operate. And it’s a beautiful, wonderful experience to be able to give back some incredible advice to a dedicated art collector who is amassing a collection that’s at that collecting category.
Stephan Shipe: Fascinating background that you have there and working on some very interesting projects. Thank you so much for sharing some of these experiences with us and giving us some insight into a very small area of the insurance landscape. So thank you so much for being on today.
Anne Rappa: You are welcome. Have a wonderful day. Thank you for your time and thank you for the opportunity.
Outro
Stephan Shipe: That’s our show. Thanks for listening, and we’ll see you next week.
Hey, this is Stephan Shipe. Thanks for tuning in to the Scholar Wealth Podcast. If you have a question you’d like us to tackle on a future episode, share it with us at scholaradvising.com/podcast. We’d love to hear from you. Until next time.
Disclaimer: The information provided in this podcast is for general informational and educational purposes only, and is not intended to constitute financial, investment, or other professional advice. The opinions expressed are those of the hosts and guests and do not necessarily reflect the views of any affiliated organizations. Investing in financial markets involves risk, including the potential loss of principal. Past performance is not indicative of future results. Before making any investment decisions, you should consult with a qualified financial advisor who can assess your individual financial situation, objectives, and risk tolerance.