January 09, 2009
Defying gravity, some charitable giving plans can levitate or even sky rocket in a low interest rate environment or sluggish economy. With a little creativity, donors can achieve their philanthropic, economic and tax goals, even in times of economic uncertainty. Among the star performers are Charitable Gift Annuities, Charitable Remainder Trusts, Personal Residence Remainder Gifts, Charitable Lead Trusts and IRA Charitable Rollovers.
Charitable Gift Annuities
Charitable Gift Annuities are particularly useful for donors unnerved by the ups and downs of interest rates and the stock market. These donors want to be able to count on a stable income, unaffected by future fluctuations in interest rates and stock values, and want the security of payments they cannot outlive.
A CGA provides all this in a simple contract. A charity, in exchange for a gift of cash or other property, agrees to pay an annuity of a fixed amount of money to one or two annuitants for life. Usually the annuitant is the donor, or donor and spouse, but can be any person the donor selects, such as an elderly parent.
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Most charities offer the rates recommended by the American Council on Gift Annuities. The rates vary depending on the number of annuitants (one or two) and their ages. Higher rates are paid to older annuitants on account of their shorter life expectancy. For example, the single-life rates currently available for donors ages 60 to 90 range from 5.5 percent to 10.5 percent.
These rates often compare favorably to the returns on CDs, money market accounts and mutual funds. For instance, the 3 percent paid on a CD can be doubled to 6.1 percent on a CGA for a 70-year old annuitant. Moreover, if the annuity is funded with cash, a significant portion of each payment will be a tax-free return of principal (64 percent tax-free for a 70-year old annuitant, thereby boosting the effective payout rate to 10.2 percent for an annuitant in the top income tax bracket). If the annuity is funded with appreciated stock or real estate, the capital gain is spread over the annuitant’s lifetime, and each payment is part ordinary income, part capital gain and part tax-free return of basis.
Further, donors can claim an income tax deduction in the year of the gift for the amount of the contribution, less the present value of the life payments to be made to the annuitant. To the extent not fully used in the year of the gift, the deduction can be carried forward for up to five years.
The favorable rates (partly tax-free), secure fixed income, income tax deduction and donors’ freedom from investment responsibility, propel CGAs above the turmoil of a financial market in disarray.
Charitable Remainder Trusts
Charitable Remainder Trusts provide another way for donors to increase their income stream in a downturned economy. Let’s take the example of a married couple in their late sixties. They are retired. They would like to increase their retirement income, reduce their income taxes and estate taxes and make a gift to their favorite charitable organization. Let’s say they have $1 million of publicly-traded stock with a low cost basis, and it yields only 2 percent in annual dividends. If they sell the stock, they pay a capital gains tax, leaving less to reinvest.
Instead, they can transfer their stock to a CRT, and the trust then sells the stock with no tax and reinvests the gross proceeds. The net result is that their retirement income over their lifetimes may increase because they have the full $1 million working for them, rather than what would be left after paying capital gains tax. If they set the CRT payout at even the minimum allowed rate of 5 percent, they will have increased their income stream substantially over the 2 percent stock dividends they were receiving.
The CRT donors in our example also get an upfront income tax deduction for the present value of the remainder interest that will pass to charity when the second of them dies. If they cannot make full use of the deduction in the year of the gift, they may carry it forward for up to five years. The increased income stream, in combination with the upfront charitable deduction, work to maximize the economic return to the donor.
To top it off, by transferring $1 million to a CRT, the donors’ estates are immediately reduced by $1 million for estate tax purposes.
Personal Residence Remainder Gifts
Experiencing the downturn in the real estate market, many seniors are more inclined to remain in their homes rather than selling at a reduced price. Others, irrespective of the market, like where they live and remodel their homes to make accommodations for their physical needs, such as a master bedroom and bath on the main floor. With more seniors continuing in their homes, Personal Residence Remainder Gifts deserve increased consideration.
A donor may make a gift to the charity of a remainder interest in a personal residence taking effect at death, while retaining a life estate. The tax benefit is that the donor may claim an income tax deduction for the remainder in the year of the gift. In a low interest rate environment, the calculation of the present value of the future remainder interest produces a larger income tax deduction. For example, a 70-year old with a $500,000 residence is entitled to an upfront deduction of $365,000 for a remainder gift in January 2009. This large deduction, if not fully used in the current year, may be carried forward to shelter income for up to five years. The resulting cash savings can be helpful to donors who have seen declines in their investment values and income.
An alternative for a donor who desires an additional income source is to transfer the remainder interest in exchange for a CGA. The donor retains a life estate and receives a lifetime annuity and current income tax deduction.
If the donor should later vacate the residence before the life estate expires, the donor has several early exit options. The donor may lease the home and collect the rent for the remainder of the life estate. The donor and charity may agree to a joint sale of their interests to a third party and split the sale proceeds actuarially. The donor may make a gift of the remaining life estate to the charity and take an additional income tax deduction. The donor may transfer the remaining life estate to the charity in exchange for a Charitable Gift Annuity, or to a Charitable Remainder Trust, and receive an income stream for life and an income tax deduction.
Charitable Lead Annuity Trusts
Charitable Lead Annuity Trusts pay out a fixed annuity amount to a designated charity for a set number of years. When the trust ends, all remaining assets are distributed to (or continue in trust for) designated family members.
The goal of every CLAT is to generate income and appreciation at a rate greater than the IRC Section 7520 rate (the rate of growth assumed by the IRS). If it does, this excess passes to family members free of gift tax and estate tax. The Section 7520 rate for January is only 2.4 percent. Highly appreciating assets that can beat the IRS hurdle rate are the ideal choice for funding a CLAT. For example, if the CLAT grows by 7.6 percent (interest, dividends and appreciation), the difference of 5.0 percent accumulates for the family.
Superlative results are possible for CLATS when there is a confluence of low interest rates and depressed asset values. The value of the remainder gift to family is calculated at the time the CLAT is created. Low interest rates reduce the amount and/or shorten the term of the payout to charity necessary to zero out the calculation of the remainder gift. Contributing de-valued assets expected to rebound in the coming years can further boost the odds of a CLAT producing a significant transfer to family.
Taking a CLAT to the next level involves first transferring assets into a Family Limited Partnership and then transferring a nonvoting interest in the FLP to the CLAT at a discounted value. The valuation discount allows the upfront valuation of the remainder to be zeroed out with even smaller payouts and/or shorter terms. Whether a CLAT is funded with $100,000 or $100,000,000, the remainder, whatever amount it actually grows to be at the end of the term, can be transferred to family with zero gift tax.
IRA Charitable Rollover
A vast amount of wealth has been stored up in Individual Retirement Accounts. Individuals over 70-½ years of age must take minimum distributions from their IRAs to avoid significant penalties. These distributions are subject to income tax and, ultimately, estate tax.
Welcome news is that Congress has just extended the IRA Charitable Rollover. Individuals at least 70-½ may direct IRA distributions of up to $100,000 to qualified charities in each of the years 2008 and 2009. These distributions count toward the required minimum distributions (but are not limited by those amounts) and are excluded from federal gross income. IRAs are now an alternative source of tax-efficient contributions.
Advisors’ Role in Initiating Discussion of Charitable Giving Benefits
There’s more to charitable giving than just the financial and tax advantages. Donors also derive the personal satisfaction that comes from supporting a favorite charitable organization, building relationships with the organization’s staff and other donors, involving family members in philanthropy, and receiving recognition of their generosity from the organization and community.
It’s for all these reasons – financial, tax, philanthropic and social – that we as professional advisors have a role and responsibility to play in initiating a conversation about charitable giving with our clients, and providing counsel to them in accomplishing these goals. There is much to be gained by charities and donors alike – in the best and most challenging of economic times.
About the Author
Hahn Loeser is a 100+ member law firm. Steve is a Partner and Co-Chair of its Estate Planning Group. Consisting of 20 attorneys and 8 paralegals, his estate team is one of the largest and most respected in this field.
Steve has served as President of the Estate Planning Council of Cleveland and Chair of the Cleveland Bar Association’s Estate Planning Institute. He is an OSBA Board Certified Specialist in Estate Planning, Trust and Probate Law.
He is also a software consultant for BNA Estate and Gift Tax Planner, the gold standard in estate planning software produced by the Bureau of National Affairs, Inc., Washington, D.C., a Fellow of the American College of Trust and Estate Counsel, and a frequent speaker and author of national and state publications.
His awards include Best Lawyers in America for Trusts and Estates and Ohio Super Lawyers. He is admitted to practice in Ohio, Florida and Arizona.
Steve’s community involvements include serving as a Trustee of Great Lakes Theater Festival and Chair of The Cleveland Museum of Art’s Planned Giving Council.
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