By Michael DeFillipo
Writer and author Nelson Henderson once said, “The true meaning of life is to plant trees, under whose shade you do not expect to sit.”
For many of us, that sums up why we donate money, property and other assets to synagogues, educational institutions and other charitable organizations. We may not expect to benefit personally from our actions, but we nevertheless find meaning in sharing what we have with others.
But “finding meaning” and “feeling good” aren’t the only benefits of charitable giving. There are tremendous personal advantages, which not only allow you to accomplish your charitable objectives, but reduce the amount of estate taxes, ordinary income taxes and capital gains taxes you will owe; provide you or someone you care about with a lifetime income; and, with proper planning, still leave a substantial portion of your assets to your heirs.
In other words, charitable giving — in addition to satisfying a natural inclination to help others — can be an effective estate planning, retirement planning or even business succession planning strategy.
After a lifetime of hard work and careful planning, do you really want to be that generous to the government? You don’t have to be. A charitable giving strategy essentially allows you to decide how resources you would otherwise pay to the government will be spent and will direct them to the organizations and causes you care about most.
There are a number of charitable giving strategies that could work, depending upon your circumstances, needs and objectives. Among others, these strategies can range from simply donating funds or property directly to a favorite charity, to naming the charity as the beneficiary of your life insurance policy, to setting up a Charitable Remainder Trust (CRT).
Let’s consider charitable gifts of life insurance and CRTs.
Charitable Gifts of Life Insurance
In its simplest execution, using life insurance to benefit a favorite charity is fairly straightforward: You apply for (and retain ownership of) a policy, name the charity as beneficiary and begin paying the premiums. As long as you retain ownership of the policy, the premiums are not income tax deductible. However, upon your death, the charity receives the proceeds from the policy free of federal income and estate taxes, and free from the costs, delays and publicity of probate. Furthermore, there are no trusts to set up and administer.
You can also donate an existing life insurance policy to a favorite charity, or simply have a charity apply for and own a new policy on your life. For example, you may own a policy that you no longer require for its original purpose. In such a case, you can transfer ownership of that policy to a charity of your choice and immediately reap two immediate benefits: an income tax deduction and future premiums paid will be income tax deductible, subject to limitation.
Charitable Remainder Trusts (CRTs)
A CRT is a tax-advantaged “split-interest” trust that can provide you or someone else you choose with benefits, and a charity you select with benefits down the road. Thus, there are two beneficiaries: the “income beneficiary,” which is the person or persons — including yourself — who will benefit from the trust during the term of the trust; and the charity, which will benefit at the end of the term of the trust. The CRT term can be based upon your (or someone else’s) life expectancy, or simply upon a term of years not exceeding 20.
You can donate a wide variety of assets to a CRT, including cash, personal property, real estate, publicly traded stocks and securities, an interest in an IRA or qualified retirement plan or, in some cases, even a closely held business interest you wish to sell. Your donated assets are typically sold by the trust, and the sales proceeds are reinvested and managed by the trust, which, in turn, pays you (or someone else you choose) income for a period of time you select. At the end of the trust term, the charity receives the remainder interest. Be cautioned, however, that a CRT is irrevocable.
The benefits of setting up a CRT are many. First, you can obtain an immediate income tax deduction, which is based on the net present value of the charity’s remainder interest. The IRS limits the income deduction you may take in any given year to a percentage of your adjusted gross income for that year. However, it will allow you to carry forward your deduction, if necessary, for up to five additional years.
The second benefit of a CRT is a reduction in the amount of estate taxes your heirs will owe at your death. What’s more, the amount of the estate tax deduction is unlimited — every dollar that passes to the charity is a dollar on which your heirs will not have to pay taxes. CRTs also allow you to avoid capital gains taxes.
And finally, as mentioned, a CRT allows you to generate income for yourself, your family or anyone you choose for a period of time that you select.
But what about your heirs?
Despite the tax, non-tax and “feel good” advantages of donating assets to charity, you may be hesitant to give away a valuable asset that you might otherwise want to leave to your children or other heirs. If such feelings have kept you from implementing a charitable giving strategy, consider a Wealth Replacement Trust. That trust uses life insurance with an Irrevocable Life Insurance Trust (ILIT) to help you achieve your tax, non-tax and charitable objectives without having to reduce the amount of wealth left to heirs.
Here’s how it works: Income generated from the CRT (or the tax savings that resulted from establishing the CRT) is used to purchase a life insurance policy on your life (or joint lives of you and your spouse), with a face amount equal to the value of the asset(s) you are donating to charity. The policy is owned by the ILIT, which keeps it out of your estate. The proceeds at death are paid to the ILIT free from income or estate taxes. ILIT funds are then managed for the trust beneficiaries.
Charitable giving can also be an important component of your estate, retirement or business succession plan. When executed properly, it can help you provide lifetime income to yourself or others; reduce your current and future tax liability; and leave your heirs a substantial legacy.
Michael DeFillipo has 14 years of experience in the insurance industry. He holds Life Accident and Health, Series 65, 63, 6 and 7Licenses and received his Chartered Life Underwriter (CLU®) designation from The American College of Financial Services.