2 Popular Estate Planning Tools That Help Charities
Estate planning with charitable giving in mind
It's an attractive offer. Help a favorite charity and also receive income for the rest of your life with a charitable gift annuity.
You've seen the ads from AARP and Consumer Reports; gotten mailings from your alma mater and the nonprofit you donate to each year.
What is a charitable gift annuity?
Sometimes called "Life Income Plans," almost all larger nonprofits advertise these charitable gift annuities as a way to benefit an organization whose work you want to support and as a way to invest safely with a predictable return.
But should you take the bait? These kinds of annuities are not for everyone, but they can be attractive to people nearing retirement who have healthy savings or investments and an altruistic mindset.
How gift annuities work
You give a gift of cash, securities or other assets to a charity. It goes into an annuity that pays out a guaranteed interest rate of around 5-9% per year to the beneficiary (you and your spouse usually). At your death, the nonprofit gets to keep whatever is left of the original sum.
The American Council on Gift Annuities sets the rates that guide annuity payments. These are set so that the nonprofit ends up with about half of the donor's initial contribution.
Charitable annuities commonly pay out at a certain age, usually 50 and above. A portion of the annuity payments are tax-free, and you can take an upfront income tax deduction for the gift.
You can also pay taxable gains on appreciated stocks or property over your life expectancy rather than paying capital gains tax immediately the way you would if you sold that property for other purposes.
What to watch out for
Gift annuities involve an irrevocable transfer of assets. You can't get your gift back once you fund an annuity. You are also stuck with the rate of interest when you fund the annuity. It won't go up when interest rates or inflation rise.
On the other hand, the interest rate won't go down either, and you get to support a beloved institution or cause.
Donors can receive payments immediately (although many nonprofits don't allow payments until you are over 55) or defer payments until a later date. The older you are, the higher the rate. What you receive will also depend on whether you secure a gift annuity just for yourself or include your spouse.
If you postpone annuity payments, a tax deduction can still be taken when you make the donation, and the gift can appreciate without being taxed.
You can check the ACGA website to see what rates are currently recommended.
Gift annuities are usually funded with a minimum contribution of at least $5,000-$10,000. Charitable gift annuities may or may not pay as well as commercial annuities, depending on the current interest rate climate.
Annuities are backed by the charity's assets, so you should thoroughly vet the institution's financial strength before funding an annuity. Ask organizations about their total asset levels and for records of any defaulted annuities. Gift annuity defaults, due to insolvency, are rare, however.
You should consult your financial adviser, accountant, or attorney to make sure a gift annuity works best for you.
What is a charitable lead trust?
A charitable lead trust is a philanthropic and estate planning tool.
A donor can transfer assets, such as cash, stocks, and artwork, to a trust for a set term of years. Each year, payments are made from the trust to the donor's designated charity.
It is called a lead trust because the charity is entitled to the lead (or first) interest in the trust asset, and the noncharitable beneficiary receives the remainder (or second-in-line) interest.
Once the trust's term expires, what is left goes to the donor's heirs free of federal gift and estate taxes. Obviously, using this tool has significant benefits for a donor and his heirs, but it is also a way to support a favorite nonprofit, such as your alma mater, to further research into a particular disease, or to support a human rights organization.
The IRS sets the rate that assets are expected to grow in the trust. This rate is called the "hurdle" rate by estate planners because any gains beyond it can usually pass to the heirs tax-free.
The rate is adjusted monthly by the IRS but remains locked in for the length of the trust.
Two types of charitable lead trusts
Charitable lead trusts are of two types: charitable lead annuity trusts and charitable lead unitrusts. In the first type, the donor sets a fixed annual gift for the charities named. In the unitrust, the charities receive a percentage of the trust's value each year. This means that those benefits will fluctuate based on the trust's investment returns or losses.
Annuity trusts are the most popular because the charitable payments are fixed. In the unitrust, assets grow, and the percentage going to charity uses up more and more money, thus leaving less for the heirs.
How taxes work with a charitable lead trust
A donor who establishes either type of trust can take an upfront income-tax deduction based on the trust's payments to charity. The donor may opt to forgo that deduction, however, because it requires the donor to pay taxes on the trust's investment gains.
Downsides to a charitable lead trust
Charitable lead trusts are irrevocable. Once you put assets or cash in, they cannot be taken out. If the trust's assets go down in value, the amount left for heirs could be less because the trust must make its charitable payment no matter what the market is doing.
The money going to the heirs is a taxable gift and lowers your estate-tax exemption.
Market timing is crucial when setting up a Charitable Lead Trust. Consult an estate planner to make sure it is in your best interest and that of your heirs.
This article is just for informational purposes. It is not intended to be legal advice. Check other sources, such as the IRS, and consult with legal counsel or an accountant.