Folding charity into planning goals
Incorporating charitable giving into financial planning offers numerous benefits. For benefactors, it offers an opportunity to pass along their values to their heirs, whether it’s appreciating a particular cause or simply appreciating acts of generosity. Heirs may be inspired to continue what their predecessors started, developing a continuing legacy that reaps multiple benefits spanning generations.
From a financial standpoint, charitable contributions can help individuals improve their tax situation during life, as well as mitigate the tax impact on their heirs. A legal or financial advisor can help determine the best vehicles for contributions and position an estate for a more favorable tax outcome.
Considerations about giving
Before beginning a charitable giving plan, consider its affordability. If making gifts during a lifetime, weave anticipated contributions into an annual budget to ensure that donations won’t overwhelm current demands on resources. Factor in additional savings that may be necessary for future expenses related to retirement and healthcare. If sharing finances with a partner, discuss and come to an agreement on giving plans, including contribution amounts, beneficiaries and level or term of commitment.
Financial matters and philanthropic efforts are largely private matters. However, family members may harbor preconceived notions about an estate’s value and how it should be distributed. If granting significant gifts during a lifetime or at death, consider sharing your plans with potential heirs. Not only will this communication help to manage their expectations, but it may help fine-tune estate plans if the needs of heirs are greater than anticipated.
Finally, in making a large gift, some individuals may have very specific views about how it should be given to and used by an organization. If so, consider contacting the intended recipient about intentions to ensure that the requirements are practical and welcome.
Know your options
Charitable giving can take many forms, in terms of both how and what to give. The simplest option – during life and after death – is an outright gift. In a will, the benefactor simply needs to include a statement specifying which charity is receiving the gift and how much the gift should be, either an exact amount or a percentage of the estate. The gift is then deducted from the taxable estate, reducing the tax bill for heirs.
More complex options for structuring gifts to charity include charitable trusts. Depending on the vehicle selected, donors may be able to benefit from tax breaks, but also from a steady income source.
Leaving assets with Charitable Remainder Trusts
Charitable Remainder Trusts (CRTs) are a compelling option for donors seeking to generate some income while leaving some assets to charity. With a CRT, a donor places assets in a tax-exempt trust to create an income stream for a specific period of time, up to 20 years. Once the established period has passed, any remaining assets in the trust are transferred to the desired charity.
It’s important to know that CRTs are irrevocable, so the benefactor relinquishes all rights to the assets, whether stocks, bonds, mutual funds or real estate. However, the advantage is that donors may avoid capital gains, estate and gift taxes on appreciated assets transferred to the CRT, as these may be sold through the trust. Of course, the income realized from the trust would be subject to ordinary income taxes.
In addition to the tax benefits, CRTs offer individuals some flexibility in determining an income stream, based on a percentage of assets (5 to 50 percent) in trust. Two types of CRTs are available: annuity trusts and unitrusts.
Annuity trust
With an annuity trust, the donor receives a fixed payment from the trust that is based on the initial fair market value of the assets. Because the income does not change during the specified life of the CRT, there is a chance that payments may not keep up with the rate of inflation. Plus, if the asset base appreciates in value, the donor will not benefit from that growth.
On the other hand, if the CRT is funded with assets generally expected to generate income and hold their value, like bonds, the donor can achieve some income protection even in down markets. Also, having a reliable source of steady income can provide peace of mind.
Unitrust
A unitrust offers more flexibility, but carries additional risk. While the donor also receives a fixed percentage of trust assets as income, the basis for the income is the current fair market value and assets are valued annually. This approach means that as the asset base grows, so does the payout, allowing the donor to participate in market upswings. Donors also participate in market downturns, as losses to the asset base will impact the income payout. Unlike with an annuity trust, a unitrust permits donors to continue adding to the asset base of a unitrust.
Pay charity first with Charitable Lead Trusts
Rather than leave a trust’s remaining assets to a charity, individuals can make the charity the lead as the recipient of a regular income. With Charitable Lead Trusts, assets are placed in trust, and a fixed percent of assets are directed to a charity for a specified number of years. The donor may be subject to a discounted gift tax when the assets are transferred, but once the set period of time expires, remaining assets pass to heirs and are free of estate taxes.
Don’t forget retirement assets
When considering which assets to transfer to charity, don’t forget about assets saved in retirement accounts. Naming a charity as a beneficiary of retirement assets can be an incredibly tax efficient way to give and to reduce tax liabilities. Normally, assets from Traditional IRA, 401(k), profit sharing, SEP and Keogh plans may be subject to estate and income taxes, both on a federal and a state level. By designating a charity as a beneficiary, the assets are deducted from estate taxes, bypass income taxes and are put to work, 100 percent, for the designated charity.
Roth IRAs also may have charities designated as beneficiaries, but doing so will eliminate a significant tax advantage for heirs. Because contributions were made with after-tax dollars, withdrawals from the account will be tax-free for heirs (provided the account has been open for at least five years).
Planning promotes effective giving
By incorporating charitable goals into financial planning, business owners have an opportunity to focus efforts and be more effective in their giving. Consult with a legal representative or a financial advisor to learn which strategies work best for your particular situation to maximize donations and retain a legacy for heirs and your business, while reducing tax liabilities.
Renee Newman serves as senior vice president and wealth management director for Sterling Bank.
