EFTA01454213.pdf

the least tax-efficient. But, because of its much lower be fully withdrawn and taxed (TDM). In both cases the turnover, the benefit of tax deferral is much lower than TEM and TDM are superior predictors of the asset class Asset Class 2. with the greatest tax deferral benefit in Year 20. Based on the example in 'Deferral Benefit," you Next, we put the metrics to work in actual asset class- might think that we've settled on tax drag as the best es. "Asset Class Assumptions and Tax Deferral Benefits," measure to determine the tax deferral benefit of an p. x, shows a number of asset classes with our long-term asset class. But, that's still not quite right. Though tax (10 year) expected returns, yield and turnover. We cal- drag is a better measure of tax deferral benefit than culated tax drag in the conventional way and also calcu- tax rate or expected return alone, it fails to account lated TEM (20 years) and ranked them by TEM. for the effects of compounding on any tax deferral An interesting observation from this chart is that benefit.' As "Effect of Compounding: p. x, illustrates, when we examine the returns over a long period of time. the tax deferral benefit of each asset class changes. After 20 years, the tax deferral benefit of Asset Class 1 is closervaUon frt., • • almost 300 percent, confirming conventional wisdom. So, why is this the result? Simply put, the tax liability Oi./ Chart thiat hedge fi.4-ids saved each year will grow at the asset class's rate ofreturn. The greater the annual return, the more powerful the aren .: ;:isms y1 the loc., five asset cumulative tax deferral benefit, even if the tax drag is lower. In fact, return can have such an outsized effect on classes offeric; the sireatcst the long-term tax deferral benefit, that some asset classes that have a relatively low tax drag can exhibit surpris- n ta << rno: is - iv' I . ingly strong long-term tax deferral benefit. New Evaluation Metrics Taking all of this together. we make use of metrics that hedge funds aren't among the top five asset classes offer- can help evaluate the utility of owning any asset class in ing the greatest utility in a tax-exempt environment. In a tax-free environment: one for vehicles like PPLI, in fact, they aren't even in the top 10. This casts serious which taxes should never be realized, the tax-exemption doubt on the conventional view that hedge funds arc multiple (TEM) and its counterpart for vehicles like PPVA, when taxes might ultimately be paid. the tax- Effect of Compounding deferral multiple (TDM). The mul- Over time, the tax deferral benefit ofeach asset class changes tiples measure the combined effects of tax drag and compounding to Cirlierence in DifCome in understand the overall tax-exemp- Value After Value After tion (or tax-deferral) benefit over a Value After Value After One Year Value After Value After 20 Years given period. One Year One Year (Tax deferral 20 Years 20 Years (fax Deferral "Better Predictors: p. x, demon- in it', tax Free Benefit} Tar.ite Tay. Fro:, strates that, compared to tax drag, Asset Class I Sli.3minicn $11 SIL.;XX3 1112.8 minion $13M million $24.6 million both TEM and TDM more accu- rately predict the long-term tax Asset (lass2 $10.2 million $10.8 million 18.000 136.Imillion $46.6mllim $9.9 million deferral benefit of an asset class. Note listrmis at, :u& slue of SP trit.that ytiAnS !a Me r.9;rwrs (Aslant Returac In this example, we assume that management tees Al iatues NI US. dollars. in Year 20, the portfolio will pass — Deutsche Asset & Wealth Management without income tax (TEM) or will JUNE 2014 TRUSTS & ESTATES trustsandestates.com 21 CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0112196 CONFIDENTIAL SDNY_GM_00258380 EFTA01454213