By: David R. Foster, JD, AEP, CLU, CHFC, CAP FLMI
During moments of crisis, be that a global pandemic, a natural disaster, or economic downturn, many individuals and families step up to provide support for those who are negatively impacted. They use their time, effort, talents and financial resources to help out those in their community, their country, and even those from foreign lands. Charitable giving is a very personal part of one’s financial and estate plan. Similar to other aspects of your financial life, having a plan substantially increases your odds of achieving your goals. Careful consideration of what to give, how to give, how much to give, and when to give, is important. For those interested in incorporating a planned giving strategy into their overall financial and wealth transfer plans, no matter what your goals are, there is a strategy that will help you get there. Below we provide brief introductions to a few common planned giving strategies as well as issues to consider when developing your plan.
First, a Word on Taxes
Donor surveys consistently find that taxes are NOT a main motivator behind charitable gifts. That said, it makes sense to take advantage of charitable tax incentives whenever possible. To claim a charitable income tax deduction a taxpayer / donor needs to itemize their taxes. The Tax Cuts and Jobs Act of 2017 contained provisions that substantially lowered the number of taxpayers who itemize. The law increased the standard deduction ($12,400 for an individual and $24,800 for a married couple filing jointly in 2020) and capped deductions for state and local property taxes and state income taxes (or state sales taxes) at $10,000. This has resulted in a decrease in the number of taxpayers who itemize from roughly 30% of taxpayers to roughly 10%.
One solution for those who give on a regular basis is to bundle their charitable gifts. For example, if you regularly gift $15,000 per year to your favorite charities and find that those gifts are no longer deductible since you are claiming the standard deduction, consider bundling those gifts into one $45,000 gift this year. One way to accomplish this would be to utilize a donor advised fund (described below). A donor advised fund would allow you to make a lump sum gift (say $45,000) in the current year, claim a charitable income tax deduction, and spread out distributions to various charities over the next few years ($15,000/yr. for 3 years). Then you may start the process all over again with another lump sum gift.
Gifting Assets While Retaining Income
Charitable Gift Annuity
There are strategies available that allow the donor to contribute assets or property while retaining a right to income. One example is the charitable gift annuity. A charitable gift annuity is a contract between the donor and a charitable organization in which the donor makes a gift to the charitable organization in return for a contractual promise to make income payments back to the donor for life. Annuity payments may be made based on a joint-life basis whereby payments continue until the death of the last survivor of the annuitants. The annuity payment to the annuitant is calculated based upon life expectancy and assumed interest rates (typically rates recommended by the American Council on Gift Annuities). The donor will receive an income tax deduction based upon the difference between the fair market value of the property gifted and the present value of the annuity stream. The advantage for the charitable organization is that they receive immediate access to the full contribution.
Charitable Remainder Trusts
In a charitable remainder annuity trust (CRAT) the donor(s) makes a contribution to the trust and receives income at least annually for a term of years (not to exceed 20 years) or for the life of the donor(s). Upon the death of the donor(s), or the expiration of the term of years, the trustee distributes the remaining trust property to a qualified charity chosen by the donor(s). In a CRAT, the income payments are determined at the time of the contribution and are a fixed amount based on a percentage of the total value of the contribution.
Donor makes a $1,000,000 contribution, with a 5% payment rate. This pays the donor a $50,000 fixed annual lifetime income (up to 20 years). The donor receives a $458,420 income tax deduction (based on 1.2% Sec. 7520 rate) today.
A Charitable Remainder Unitrust (CRUT) is similar to a CRAT except the income is determined each year based upon a fixed percentage of the trust value, meaning the income may change annually.
Donor makes a $1,000,000 contribution to CRUT, receives lifetime CRUT payments of 5% (annually). Donor receives an income tax deduction today of $554,310 (assumes 1.2% Sec. 7520 rate).
Year 1 trust value = $1,000,000, unitrust payout of $50,000 (remaining years depend on growth of trust assets).
Funding Future Charitable Gifts Today
Charitable Lead Trusts
Similar to CRTs, a charitable lead trust (CLT) is a “split-interest” trust with both an income beneficiary and a remainder beneficiary. The trust makes distributions, at least annually, to a qualified charity for a term of years or for the life of an individual or individuals (the income beneficiary). Think of it as the opposite of a charitable remainder trust. Upon the death of the measuring life or lives, or at the end of the term period, the remainder of the trust assets are distributed to the donor’s chosen beneficiaries (the remainder beneficiary). The remainder beneficiary may be the donor themselves or the donor may name a remainder beneficiary other than themselves, often the donor’s children.
10-year Charitable Lead Annuity Trust
Donor makes a $1,000,000 Contribution, charity receives a 5% payout for 10 years ($50,000). Current year tax deduction is $478,690 (Based on .8% Sec. 7520 Rate (May, 2020)).
Remainder value passes on to family and heirs, amount depending on growth of trust assets.
In a private foundation the donor creates a charitable organization (the foundation) and makes contributions to it. The foundation will make payouts each year to charitable organizations. A minimum of 5% of the value of the foundation must be distributed each year. The donor(s) may retain the right to decide which qualified charities receive the payouts. The donor receives a current year income tax deduction even though gifts to charity may be delayed until future years. Private foundations may be appealing to families who want to involve their children in the family’s charitable initiatives.
Donor Advised Funds
A donor advised fund is essentially an account, often established by a community foundation or financial service company, designed to hold and invest assets and eventually distribute funds to charitable organizations. The donor makes irrevocable, tax deductible, contributions to the fund and retains the right to make recommendations to the fund as to the amount, timing and recipient of the charitable grants. However, the ultimate decision on distributions must remain with the fund. The donor often has the option of naming the fund and, within limits, establishing a written purpose for the fund. While there are no current legal requirement to make charitable distributions of a specific percentage of fund assets, the issue has been proposed and may change in the future. A donor advised fund is similar to a private foundation without the high expenses, exposure to excise taxes, complex administration and reduced income tax deduction limitations.
Estate Charitable Gifting Strategies
Many of the strategies mentioned above may be utilized in your estate plan as opposed to during your lifetime. But the simplest and most common means of making a charitable gift out of an estate is by making a bequest to charity in your will. You can make a general bequest to charity by simply stating in your will that a certain charity or charities will receive a bequest. The bequest may be a percentage of the estate or may be defined as a specific dollar amount. The bequest may be a contingent bequest, meaning that gifts to charity are made only if certain heirs do not survive you. And bequests may be restricted, limiting how the charity may use the gift.
In a retained life estate arrangement the owner(s) of real property (personal residence, vacation home, farmland, etc.) irrevocably gifts the property to a charitable organization while retaining the right to use the property for the duration of their lives or for a defined period of years. The donors receive an immediate tax deduction based on the value of the remainder interest expected to pass on to charity.
Finally, a Word on Interest Rates
You might be wondering what interest rates have to do with charitable planning. As it turns out, the attractiveness of many of the strategies mentioned above depend in part on interest rates, with some providing more favorable tax results when interest rates are low and some when interest rates are high. We are currently in a period of historically low interest rates. Of the strategies mentioned above, charitable lead trusts and life estates are more appealing from a tax perspective when interest rates are low, while charitable remainder trusts and gift annuities tend to be more attractive as interest rates rise.
DISCLOSURES: The information presented does not involve the rendering of personalized investment, financial, legal or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein. Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed. Any opinions, projections, forecasts and forward-looking statements presented herein are valid as on the date of this document and are subject to change. Past performance is no guarantee of future performance. As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money.