Generation skipping

CFA Level III Portfolio Management
#1

There’s a question in the Schweser review workshop questions that is confusing me. (private wealth management - 10 d)

Its trying to establish the relative value of generation skipping vs bequesting twice(and getting taxed twice).

The theory behind it makes sense. Its more efficient to skip a generation. However, im not sure why they calculated it the way they did.

The way the generstion skipping is computed is

(1+r) ^ 40 x (1-t)

fv of not generation skipping is

((1+r) ^ 5 x (1-t) ) x ((1+r) ^ 35 (1-t))

the first generation dies in 5 years and the second in 35 years.

The confusing part is why the generation skipping is calculated as n=40 when they will technically be taxed within 5 years(upon first death) and hence will not get to compound returns for the additional 35 years.

#2

They will be taxed once in 40 years instead in no skipping option where will be taxed twice, after 5th and again after 35th year. However, it’s academic approach, in reality Tax Authorities has additional “penalty” taxes for such tax avoidance in the attempt.

#3

Just remember generation skipping increases the wealth by a factor of 1 / (1-t) where t is the estate tax