A colleague and I have recently devoted some time to developing a new facet of estate planning that we call “Zero Tax Planning.” The idea is simple. First, we use traditional estate planning techniques to reduce estate taxes as much as possible, while keeping assets within the family. Then, once traditional methods are exhausted, we make charitable gifts of any remaining taxable estate. Because there is an unlimited estate and gift tax deduction for charitable gifts, this method will work for any estate, no matter how large or small.
Of course, eliminating estate taxes is only one goal of estate planning. Clients often have many competing needs and goals that we must address. Fortunately, the non-profit and financial industries have developed several sophisticated charitable giving methods, that allow clients to achieve their family, financial, tax, and philanthropic goals simultaneously.
So without further ado, here are the Top Five Methods of Charitable Giving, ranked from simplest to most sophisticated:
1) Outright Gifts (Lifetime, Bequests, Devises, and Legacies)
The simplest way of giving to charity is to just do it. You can make an outright gift by handing over cash or writing a check. You can donate a car, a house, stocks, bonds, mutual funds… you name it. You can gift during your lifetime, or upon your death.
(aside: the term bequest and legacy traditionally referred to a gift of personal property in a will; devise to real estate. Today they commonly used interchangeably, and can be made via will or trust.)
When making outright gifts, make sure to keep records so that you can authenticate the transaction to the taxing authorities.
2) Charitable Gift Annuities
For donors looking to retain an income stream, while removing property from their taxable estates, a charitable gift annuity is a worthwhile option. With a gift annuity, the donor transfers property to a charitable organization, and the charity makes periodic payments back to the annuitant. Then, when the annuitant dies, the remainder of the property vests in the charity. The property transferred to the annuity is immediately removed from the donor’s taxable estate, reducing his or her estate tax. Further, the donor receives an immediate partial income tax deduction for the present value of the annuity’s remainder interest. The annuity payments to the grantor are partially taxable income, and partially non-taxable return of principal.
3) Pooled Income Funds
A pooled income fund is similar to a gift annuity, in that the donor receives an income stream, and the charity receives a remainder interest. However, with a pooled income fund the donation is invested into a professionally managed fund, and the donor receives periodic payments of the income generated by the investments. Because the income generated by the fund varies with the market, the periodic payments will vary. Conversely, with a charitable gift annuity, the annuity payments would be predetermined based on actuarial rates.
Tax-wise, the donor receives an immediate partial income tax deduction. However, because payments to the donor consist solely of fund income, they will be taxable on the donor’s 1040 in their entirety. Fortunately, the entirety of the gift will be removed from the donor’s taxable estate.
Because they are so similar, it can be difficult to determine whether a charitable gift annuity or pooled income fund is the right solution for a family. Although individual circumstances vary, typically, a pooled income fund is typically more appropriate for larger gifts, especially when the immediate income tax deduction is desirable.
4) Charitable Remainder Trusts
A charitable remainder trust is essentially a do-it-yourself version of a charitable gift annuity. With a CRT, the donor establishes a trust, and funds it with money or other assets. The trustee then invests the trust’s property, and makes periodic payments to the donor, or other income beneficiary. Finally, when the income beneficiaries pass away, the remainder passes to one or more charitable organizations.
So what is the benefit of a CRT? Flexibility. The donor of a CRT can name multiple charitable beneficiaries, while gift annuities and pooled income funds are specific to each charity. The CRT can have multiple income beneficiaries. The donor can reserve the right to change the charitable remainder beneficiaries. The income stream to the donor can be structured in a variety of ways (percentage of trust assets, set dollar amount, limited to net trust income, etc.). Each allowable arrangement has its requisite legal acronym, so we have CRATs, CRUTs, NICRUTs, NIMCRUTs, and FLIPCRUTs. Confused yet? That’s okay. If you’re considering this type of planning, you need to speak with an attorney who can walk you through it.
Finally, charitable remainder trusts allow the donor, if they are also the trustee, to handle all of the investment decisions for the trust. This control is forfeited with a gift annuity or pooled income fund, and is attractive for many donors.
5) Establishing a Private Foundation
For donors who want to take complete control of their philanthropic endeavors, establishing a private foundation may be the answer. A private foundation essentially operates on an ongoing basis towards the furtherance of a stated charitable purpose. Typically, the private foundation is endowed by one or more wealthy individuals, or a wealthy family, or corporation. The foundation then invests and manages its endowment, and makes disbursements to other organizations with direct charitable or educational operations. These disbursements are often determined through a grant-making process.
While a private foundation may come into existence through a wealth person’s estate planning, the foundation could continue long after the founder’s death.
Of course the pathways to establishing and funding a private foundation are numerous, and the tax implications labyrinthine. However, for wealthy individuals that want to leave an ongoing philanthropic legacy, they are a powerful tool.
The largest, and perhaps the most famous, private foundation is the Bill & Melinda Gates Foundation.
So there you have it, my Top Five Methods of Charitable Giving. Of course, these aren’t the only way to give to charity. For those not in a position to make financial gifts, consider making a gift of your time and volunteering for a local charity. If you are interested in learning more about integrating philanthropy with your estate plan, please feel free to contact me.