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S AV V Y I N V E ST I N G
A G U I D E TO
WISER GIVING
October 2014
We are a generous nation. Just last year, nearly 200 million Americans made a total
of $241 billion in charitable contributions and gave an estimated $140 billion
more in non-charitable gifts.1 While altruistic gestures are often rooted in a desire
to make the world a better place, doing so without a well-considered plan can
significantly limit the reach and impact of such giving efforts.
There are many complex vehicles through which to give and understanding the tax advantages
associated with them will help you give more wisely and help expand your giving power. Whether
you plan to give hundreds, thousands, or millions, the support of a financial professional and a
basic understanding of the estate, gift, and income tax implications of gifts to charity and family
are needed to navigate the gifting terrain. This, coupled with a clearly defined giving plan, will enable
you to maximize the impact your gifts have on the world, your community, and your family.
We make a living by what we get,
but we make a life by what we give.”
Whether you plan to give
hundreds, thousands, or
millions, the support of a
financial professional and a
basic understanding of the
estate, gift, and income tax
implications of gifts to charity
and family are needed to
navigate the gifting terrain.
Winston Churchill
CREATE A GIVING PLAN
Before you can begin to maximize the effect of your generosity, you must decide what you
hope to accomplish. Begin by determining how you wish to divide your gifts between family
and charity. For family, consider how you would prefer to give during your lifetime to support
education, housing, medical and living expenses, and how much you wish to bequeath and to
whom. For charitable giving decisions, the options often become more varied and challenging.
To begin, consider the following:
• Matters of Interest: What issues and causes are most important to you and where would
you really like to make a difference? Would you like your impact to be felt at the individual,
organizational, community, or policy level?
• Geographic Focus: Do you prefer to give to organizations serving local, state, national, or
global needs?
• Level of Involvement: Do you wish to remain anonymous? If not, how would you like to be
recognized for your gifts? How involved do you want to be in the life of the organization? Do
you prefer to provide financial support, participate on boards, or have direct involvement in
the day-to-day work of the organization?
Next, articulate these ideas in a giving mission statement. Typically one to three sentences, a giving
mission statement denotes your giving goals and the methods that will be used to achieve them.
It serves as a guidepost for your decision-making and a tool to help you assess your progress.
It consists of the answers to three fundamental questions:
1. What are the major areas you want to affect through your giving and why?
2.What types of organizations do you seek to support in these areas?
3.Are there specific methods or key criteria that will guide your giving?
Deciding where to give is the next step. There is no shortage of nonprofit organizations providing
honorable services. Fortunately, they are all considered part of the public trust and must follow
strict operating guidelines, which make them relatively easy to research, evaluate, and monitor.
In selecting charities, it is critical to ensure they are qualified for tax purposes as 501(c)(3) entities
by the IRS. You can check the status of a specific charity on the IRS website at apps.irs.gov/app/eos.
Finally, decide how best to give. There are many means for giving both to charity and to family.
What follows is a description of the most common giving vehicles.
The impermanence of this present life will force
you to leave all wealth behind, but by giving it
away, you can take it with you as good karma.”
The Dalai Lama
MEANS OF CHARITABLE GIVING
There is no shortage of
nonprofit organizations
providing honorable services.
In selecting charities, it is
critical to ensure they are
qualified for tax purposes as
501(c)(3) entities by the IRS.
Charitable solutions generally fall into two categories: Outright donations; and those that also
provide income to the donor. Those providing income are known as split-interest vehicles and
are often used as part of the retirement and estate planning process. The most broadly applicable
of these vehicles are charitable gift annuities, charitable remainder trusts, and pooled income funds.
Charitable Gift Annuity
A charitable gift annuity is a contract under which a charity—in return for a transfer of cash,
marketable securities, or other assets from you—agrees to pay a fixed amount of money to you
and one more individual if you choose, for your lifetime(s). Such payments include the earnings
on the reserve account and a part of the principal in the reserve account. The ratio of these
parts, that is, the parts that are principal and earnings, depends upon your age(s).
Gift Annuity: Two birds, one stone
Benefitting others in the near term and yourself over the long term
David, who just turned 60, is contemplating early retirement. He has also been contemplating making a
generous contribution to his alma mater. In assessing his financial options, he decides that rather than
sell stock and pay taxes on the capital gains, he will set up a plan whereby he provides a charitable
asset for his alma mater, gets an upfront charitable deduction, and has a guaranteed revenue stream
for the rest of his life.
David Gives
Stock with a fair market value of
$100,000 and a tax basis of $50,000
David Gets
A guaranteed annual annuity of
$5,200 per year, in three pieces:
LIFETIME INCOME STREAM
1. Ordinary
income
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The issuing institution guarantees the income, as it becomes a legal obligation of the charity.
However, close attention to the credit worthiness of the charity is important as you will be reliant
on the charity to provide income for the rest of your life. The benefits include a large charitable
deduction in the year of the gift plus a lifetime stream of taxable income. The charitable deduction
is equal to the net present value of funds estimated to remain for the charity at your death, as
calculated by IRS formulas with an assumed factor for your longevity.
Generally, this vehicle works best if you want simplicity, desire fixed income payments, wish to
benefit no more than one other individual, and have cash, appreciated securities, or real estate
to donate.
Charitable Remainder Trusts
A charitable remainder trust (CRT) is an irrevocable trust that you would typically fund with highly
appreciated assets. The CRT is structured so that there is a current beneficiary—either yourself
or a named individual—and a remainder beneficiary, which is an IRS-qualified 501(c)(3) charity, such
as a private foundation. The CRT makes annual distributions to you in either a fixed amount or
as a percentage of the value of the trust. These are paid for a period of years that can either be
for your life or for a set period you choose, not to exceed 20 years. The remaining value of the
CRT is then distributed to the charity.
Charitable Remainder Trust
How supporting the arts can double as a sound personal investment
Frank and Linda own stock worth $1 million, which they originally purchased for $500,000. They wish
to diversify their holdings, yet also want to mitigate capital gains tax. They decide that the best way
to do this is to place the stock in a charitable remainder unitrust and then have the trust sell the stock.
Fund a $1
million
charitable
remainder
trust
Receive $336,000 charitable
income tax deduction
1st payment:
$50,000
Remainder
Beneficiary
Because the annual distribution is keyed to the fair
market value of the trust each year, Frank and Linda
will either enjoy the benefits or detriments of the
trust investments from year to year depending on
whether the value of those investments increases
or decreases.*
The trust pays no income or capital gains tax on the sale of the stock and pays Frank and Linda 5% of the
trust’s net fair market value annually during their lifetimes. Frank and Linda name their local art museum as
the remainder beneficiary. The unitrust arrangement provides them with a charitable income tax deduction
of approximately $336,000 in the year of the trust’s creation. Frank and Linda’s first annual payment
is roughly $50,000.
*A more risk-averse couple might consider structuring their remainder trust as an annuity trust instead of a charitable trust. Doing so would provide for a consistent
payment from year to year regardless of investment performance.
The tax benefits of a CRT include a potential charitable deduction in the year of the transfer
equal to the amount that will remain for charity, as estimated according to IRS prescribed calculations based on an assumed factor for your longevity. In addition, a CRT is exempt from tax on
its investment income. Thus, a trustee of the CRT can sell appreciated assets and reinvest the full
proceeds, allowing you to diversify from a concentrated position in a tax-efficient manner. If you
choose to contribute to a CRT under your Will, an estate tax savings is produced, not subject to
any percentage limitations, with the value of the remainder interest passing to the charity. Finally,
a CRT can be an effective strategy for planning your retirement as the trust can provide income
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ated assets, reinvest the proceeds, defer payment of tax and delay distribution to you until you
reach age 65 and are, presumably, in a lower tax bracket.
If you do not mind delaying charitable gifting, desire an income stream, have cash, appreciated
securities, or real estate to donate, and may want multiple income recipients, a CRT may be a
good gifting option.
Generally, pooled income
funds are beneficial if you
wish to make small gifts to
charity while still receiving
income from the gifts.
Pooled Income Funds
A pooled income fund is similar in many respects to a CRT, with the main differences being that
you participate with other donors, and the charitable beneficiary assumes the administrative duties
of managing the trust in exchange for an annual fee. You may be eligible to take an immediate,
partial tax deduction, based on your life expectancy and the anticipated income stream. However,
you must pay income tax on the income you receive from the pooled income fund each year.
The charity pools contributions from multiple donors, invests the proceeds, and makes annual,
taxable payments to you and other donors for life based on your contributions and certain actuarial
factors. Contributions are typically tax deductible, based on the money projected to pass on
to the charity. As with a CRT, it often makes the most sense to contribute appreciated stocks,
bonds, and mutual funds. You and other donors recommend charitable beneficiaries to receive
the balance in the fund after the death of the last beneficiary. Generally, pooled income funds
are beneficial if you wish to make small gifts to charity while still receiving income from the gifts.
OUTRIGHT CHARITABLE DONATIONS
As noted previously, there are additional ways to make donations that do not produce income for the
donor. The most broadly used of these include donor-advised funds and community foundations.
A donor-advised fund can
be a good giving vehicle if
you want simplicity in grant
making, are comfortable serving
in only an advisory role, want
higher charitable deduction
income limitations, and wish
to support multiple charities.
Donor-Advised Funds
A donor-advised fund is a program of a public charity that allows you to make irrevocable contributions to the charity, become eligible to take an immediate tax deduction, and then make
recommendations for distributing the funds to qualified nonprofit organizations. Donor-advised
funds often can accept many types of assets, will allow you to name successors to continue
family involvement, and afford you the right to remain anonymous.
As for tax considerations, you may be eligible to take a tax deduction of up to 30% of your adjusted
gross income for contributions of securities, and up to 50% for cash contributions. You may also
be able to eliminate capital gains tax for gifts of long-term appreciated securities.
A donor-advised fund can be a good giving vehicle if you want simplicity in grant making, are comfortable serving in only an advisory role, want higher charitable deduction income limitations,
and wish to support multiple charities.
Community Foundations
A community foundation is a permanent, nonprofit, charitable organization for public benefit. It is
supported by local donors and governed by a board of private citizens who speak for the needs and
well-being of the community. They accept many types of assets, offer multiple types of funds—
frequently including donor-advised funds, and will often afford you the right to remain anonymous.
These foundations are organized to channel gifts from donors to a variety of charitable organizations in a local community. Individuals, families, businesses, and organizations create permanent charitable funds that help their region meet the challenges of changing times. The community foundation generally invests and administers these funds.
You can potentially take an immediate tax deduction—up to 50% of adjusted gross income
for cash or 30% for appreciated assets—and may also be able to eliminate capital gains tax for
gifts of long-term appreciated securities.
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I want to give my kids enough so that they feel
that they can do anything, but not so much that
they can do nothing.”
Warren Buffett
An estate plan that incorporates
giving to non-charitable
beneficiaries, such as family
members and other heirs,
can help preserve assets and
possibly reduce estate and
gift taxes.
MEANS OF GIVING TO FAMILY
Often when people think of gifting, they think only of charities. However, an estate plan that
incorporates giving to non-charitable beneficiaries, such as family members and other heirs, can
help preserve assets and possibly reduce estate and gift taxes.
Gift Tax Exclusion Gifting
Each year, you may give any number of people up to $14,000 each (for 2014) in cash or assets—$28,000
if your spouse joins in making the gift—free of any gift tax. The recipient(s) is(are) also free of tax
liability for such gifts. Gifts exceeding the annual gift tax exclusion are subject to a gift tax.
Note that current law allows you an unlimited exclusion for certain tuition and medical payments
made on behalf of others. To qualify for this exclusion, you must make the payments directly to
the educational institution or medical facility. Payments for medical insurance also qualify for the
medical exclusion. However, payments for dormitory fees, books, supplies, and similar school
expenses do not qualify for the tuition exclusion.
It is important to note that there is a lifetime gift tax exemption tied to the annual gift tax exclusion.
The total amount you gift during your lifetime that is free of gift tax will be used to reduce the
amount you can bequeath without being subject to estate taxes. For example, if you give away
$3,000,000 during your lifetime, your federal estate tax exemption will be reduced $2,340,000
(based on 2014 limits). In other words, $3,000,000 in lifetime gifts is subtracted from the 2014
federal estate tax exemption of $5,340,000, leaving only $2,340,000 of the exemption.
However, even if you have fully utilized your lifetime gift tax exemption equivalent amount, you
are still able to take advantage of the annual gift tax exclusion amount. Furthermore, gifting to
family members may provide additional tax benefits if taxable income can be shifted to family
members with lower marginal tax rates than the donor.
Each year, you may give any
number of people up to
$14,000 each (for 2014) in cash
or assets—$28,000 if your
spouse joins in making the
gift—free of any gift tax.
Grandparent-Owned Life Insurance
If you are a grandparent, you can make sizeable gifts of cash using life insurance. Relatively small
premiums can translate into large amounts of life insurance that can be earmarked for your
grandchildren with the proceeds being distributed free of tax. Furthermore, grandparent-owned
life insurance allows for you to place conditions on the gift and revoke the policy if such conditions
are not met by the beneficiary, without penalty. Specifically, the policy may be cancelled with no
surrender penalty after 10 years.
For example, consider a couple both age 70 and in good health. They purchase $250,000 of Survivorship Universal Life and name their grandchildren or a trust for the grandchildren as beneficiary.
Assume the annual premium on the policy is $4,929 and both pass away at their joint life expectancy
of 93. The resulting rate of return on the premiums paid producing the $250,000 proceeds in 23
years would be 6.13% tax-free.2
Special Options for Gifting To Minors
Transferring assets to minors can help to ensure that your children and grandchildren have the
financial resources needed to go to college, buy their first home, start a business, or begin their
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own investment and estate planning. However, many people are uncomfortable giving large
sums of cash or assets to their children or grandchildren outright. The following are a two of
the main methods for gifting to minors:
UGMA/UTMA Accounts
Unified Gifts to Minors Act accounts or Uniform Transfers to Minors Act accounts provide that
a custodian hold the property which can be used for the support, health, maintenance, and/or
education of a child until attaining the age of majority—usually 18 or 21, depending on the state.
At the age of majority, the child is entitled to the assets in the account.
You can front-load a 529
plan by gifting up to $70,000
($140,000 if you gift-split
with your spouse) in the first
year, tax-free as long as the
contribution is treated as a
series of five equal annual gift
tax exclusion gifts.
UGMA and UTMA accounts are similar in many ways. Both are managed by custodians, and both
allow parents, grandparents, relatives, and friends to make irrevocable transfers in any amount to
the account. In addition, if you, acting as custodian, die before the funds are turned over to the
child, the account may be taxable as part of the donor’s estate. The two account types differ in
the type of assets you can transfer to them. UTMA law allows virtually any kind of asset, including
real estate, to be transferred to a minor, whereas UGMA law limits gifts/transfers to bank deposits,
securities (including mutual funds), and insurance policies.
For tax purposes, gifts made to UGMA and UTMA accounts are considered present interest gifts
and are eligible for the annual gift tax exclusion. In addition, there is a minor income tax benefit
in that the first $1,000 of the account’s unearned income (interest, dividends, or capital gains)
is exempt from federal income tax if the child is under age 18 at the end of the tax year. The
second $1,000 of unearned income is taxed at the child’s rate. Any unearned income over $2,000
is taxed at the higher of your or your child’s marginal tax rate.
529 College Savings Plans
Also known as Qualified State Tuition Programs, 529 Plans are state-sponsored investment programs
designed to help save for a child’s higher education. Each state develops its own program. You
can front-load a 529 plan by gifting up to $70,000 ($140,000 if you gift-split with your spouse)
in the first year, tax-free as long as the contribution is treated as a series of five equal annual gift
tax exclusion gifts. If, however, you should die within five years of the gift, the pro-rated portion
for the years after death will be included in your estate for estate tax purposes.
ADDITIONAL GIFTING MEANS
For very high net worth individuals and families with taxable estates, there are additional charitable
vehicles to consider, including charitable lead trusts, private foundations, and supporting organizations. In addition, non-charitable vehicles such as irrevocable life insurance trusts (ILITs), grantor
retained annuity trusts (GRATs), and intentionally defective grantor trusts (IDGTs) are some of
the many sophisticated gifting mechanisms for taxable or complex estates.
For more information on these options and means of fully leveraging them, contact a Wintrust
Wealth Management professional.
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GIFTING TRAPS TO AVOID
If you want to minimize or avoid taxes, your gifts must be properly structured. All your efforts
may be for naught if you should fall into any of these common traps:
The kiddie tax rules: Beware of the kiddie tax rules when transferring income−producing property
to children under age 14. Unearned income above a specified amount is taxed at your marginal
tax rate.
Gifts of retained interests or powers: Beware of making gifts of property in which you retain
some financial interest (e.g., life estates, right of reversion, right of revocation) or powers (e.g.,
power of appointment). This property may be includable in your estate for estate tax purposes.
For example, if you transfer ownership of your home to your child on the condition that you are
allowed to live in the home for the rest of your life, then you have retained a financial interest in
the home, which may be includable in your estate for estate tax purposes.
Delays in making a gift of life insurance: Do not delay in making a gift of a life insurance policy
on your life. Transfers of policies on your life may be includable in your taxable estate if made
within three years of your death.
Payments for tuition or medical care made to the donee: Do not make payments for tuition or
medical care to the donee. You must make the payments directly to the educational institution
or medical care provider in order to qualify the gift as tax exempt.
Overlooking gift-splitting: Do not forget the gift−splitting privilege for spouses who qualify,
which can double the annual gift tax exclusion.
Overlooking the tax−exclusive nature of lifetime gift: Do not assume that lifetime gifts and
transfers made at death result in the same tax effect. Remember that the tax−exclusive nature of
lifetime gifts results in overall tax savings because the tax is removed from your estate.
There are many creative ways
to maximize your giving power.
Determining the best for you
is a function of your unique
tax situation and charitable
inclinations.
Gifting in community property states: If you are married and live in a community property state
(AZ, CA, ID, LA, NV, NM, TX, WA, or WI), gifts of community property you make to third persons
may be limited by state law. For example, you may need the express or implied consent of your
spouse, or you may be limited by the amount you can give each donee. The IRS may consider
transfers made by your attorney−in−fact (agent or representative) to be revocable transfers. That
means that those gifts may be includable in your estate for estate tax purposes. If you want your
attorney−in−fact to make gifts on your behalf, make sure that you give express written authority
in a power of attorney.
STRATEGIES
There are many creative ways to maximize your giving power. Determining the best for you is
a function of your unique tax situation and charitable inclinations. Here are five common strategies
for you to consider before you meet with your financial professional.
1. Donate Long-Term Appreciated Securities
Dependent upon your adjusted gross income (AGI) and filing status, you may now face a 20% capital gains tax rate as well as the new 3.8% Medicare surtax on net investment income. Accordingly,
a charitable contribution of long-term appreciated securities—such as stocks, bonds, or mutual
funds that have realized significant appreciation over at least a one-year period—is one of the
most tax-efficient of all ways to give.
When you donate such securities, no capital gains are realized on the transaction, so the charities to which you donate receive a larger gift. Further, you may be eligible to take an income tax
charitable deduction for the full fair market value of the donated securities—up to a maximum
of 30% of your adjusted gross income for contributions to public charities. Any amounts in excess
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of the 30% limit can be carried forward for up to five years. Not surprisingly, this method of giving
has become increasingly popular in recent years.
The table below illustrates potential tax savings for a couple with an AGI of $500,000, filing jointly, making a direct donation of a long-term appreciated security—with cost basis of $20,000, and
long-term capital gains of $30,000.3
A charitable contribution
of long-term appreciated
securities—such as stocks,
bonds, or mutual funds that
have realized significant
appreciation over at least a
one-year period—is one of
the most tax-efficient of all
ways to give.
Donating Cash vs. Donating Stock
Donate Stock:
Donate Cash:
Contribute securities Sell securities and
directly to charity donate proceeds
Current fair market value of securities
$50,000
$50,000
Capital gains and Medicare surtax paid 4 (23.8%)
$0
$7,140
Charitable contribution/deduction5
$50,000
$42,860
Value of charitable deduction
less capital gains taxes paid4
$19,800
$9,833
While you can donate long-term appreciated stock or mutual fund shares directly to any qualified
charity, donating to a charity that sponsors a donor-advised fund program has an added advantage:
You are generally eligible for all of the immediate tax benefits associated with your donation,
plus you gain the flexibility to support many charitable causes over time with one contribution.
Additionally, the administrative burden many smaller charities face when asked to receive and
liquidate shares of a security is removed.
2.Charitable Offset Roth Conversion Strategy
In the aftermath of The American Taxpayer Relief Act of 2012, the ability of most taxpayers to
transfer assets to a Roth IRA was greatly expanded to include assets in 401(k), 403(b), 457(b), and
thrift savings plans. However, doing so comes with tax consequences in that the amount you convert
is subject to income taxes. One possible strategy to reduce the tax cost of a Roth conversion is
to make an offsetting charitable donation.
For example, consider a charitably inclined couple that makes annual donations and plans to continue
doing so in the future. Further, they have $270,000 in an eligible rollover IRA, taxable income
before the conversion of $180,000, and $400,000 in a taxable brokerage account—which could
be used to pay the taxes on the conversion or make a charitable donation. They believe they
may be in a higher tax bracket in the coming years and would like to convert their Roth IRA now
while they are in a lower bracket. By doing so, their AGI would be $450,000 after
the conversion and they could potentially
Offset of Roth Conversion Taxes
deduct up to $225,000 (50% of $450,000) of
a charitable cash contribution, or $135,000
Roth Account
Roth Account
(30% of AGI) of a charitable donation of
securities, which could significantly reduce
$270,000
$270,000
the tax impact of the conversion.6
As the chart to the right shows, if the couple
makes a $90,000 charitable donation in
the same year of the conversion, the total
estimated tax burden of converting their
IRA would be reduced by $30,733. Total
taxes on both income and Roth conversion
would be $95,113 with the charitable deduction, compared to $125,846 without it.
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$90,000
$87,981
Without
Charitable Deduction
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$57,248
With
Charitable Deduction
TO CHARITY
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Note that the overall limitation on itemized deductions, other limitations, the federal alternative
minimum tax, and state and local tax deductions are not taken into account.7
Furthermore, if the $90,000 donated to charity included securities with long-term appreciation,
gifting the securities further avoids taxes capital gains.8 In this case the effective after-tax cost of
a charitable contribution would be significantly reduced.
3.Build Flexibility into Your Estate Plan
One way to build flexibility into your estate plan is to name a donor-advised fund as one of the
beneficiaries of your charitable trusts. By donating to a donor-advised trust you separate tax
planning from charitable gift decisions. You donate cash or appreciated securities to an account
held at a brokerage firm or with a charity that functions like an escrow account for your charitable
gifts. You get the potential charitable deduction in the year the wealth is donated to the donoradvised trust and then can subsequently advise the fund to disperse gifts to the charities of your
choice at your preferred pace.
Naming a donor-advised fund as the beneficiary of a charitable trust gives you and your heirs
the ability to:
By directing withdrawals
from IRAs or employersponsored plans such as
401(k)s and 403(b)s to a
charity you reduce AGI, and
hence, both federal and state
tax liability on current income.
• Change the charities you support from year to year without needing an attorney to revise
trust language
• Vary the amounts you donate each year
• Give family members advisory privileges over the donor-advised fund in order to further your
charitable legacy for generations to come
This strategy affords you the option to shift charitable deductions into the year most beneficial
for your tax planning.
4.Fund Gifts with Retirement Plan Withdrawals
By directing withdrawals from IRAs or employer-sponsored plans such as 401(k)s and 403(b)s to
a charity you reduce AGI, and hence, both federal and state tax liability on current income. Furthermore, you can deduct the gift for estate tax purposes and the beneficiary charity will not have
to pay income tax on the funds. A further benefit is that the donation does not affect itemized
deductions, meaning it will not subject you to greater vulnerability to limitations on deductions.
Current law allows use of this strategy if you are over the age of 701/2 and the IRA withdrawal goes
directly to an IRS-approved charity, but not to a donor-advised trust. There is one caveat to
bear in mind, however. For each donation, you will have IRA withdrawal paperwork to complete
and you will receive a check to your home address which you will be responsible for forwarding
to the charity. In light of these paperwork requirements, consider limiting this strategy to your
larger contributions.
5.Gift Retirement Plan Assets to Charity
Donating assets subject to income taxes to qualified charities is another strategy to maximize
gifting power. Retirement plan assets in particular may be one of the most tax-efficient assets to
transfer to charity. It is important to note that private foundations, supporting organizations, and
donor-advised funds do not qualify to receive tax-free distributions from IRAs.
Retirement plan assets in
particular may be one of the
most tax-efficient assets to
transfer to charity.
A tax-exempt public charity can withdraw pre-tax monies from non-Roth retirement accounts,
such as traditional IRAs and 401(k)s without paying income taxes. Note that it is best to use non-Roth
retirement accounts for this purpose given that inherited Roth assets are already tax-free to recipients, provided certain conditions are met. In addition, you can take a charitable deduction in the
amount of the donation which reduces the size of your taxable estate.
To illustrate, consider a 75-year-old widow who has a net worth of $8 million, including a $1
million traditional IRA (all pre-tax monies), real estate valued at $3 million, and long-term appreciated securities with a current market value of $4 million. She is debating whether to leave her
entire IRA to charity or divide it between her two grandchildren equally.
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Assuming that the grandchildren would withdraw all the IRA assets immediately upon inheritance,
the first $5.34 million would be exempt from federal estate taxes but the remaining $2.66 million
of the estate is taxed (at 2014 tax thresholds). Each grandchild is married, files jointly, and has
an AGI of $960,000, including the $500,000 withdrawal from the inherited IRA. If they itemize
their deductions, each grandchild should be able to claim an estate tax deduction on their own
federal income tax returns for the federal estate tax attributed to their portion of the inherited
IRA, even though the estate taxes may have been paid by the grandmother’s estate.
The estate tax deduction they could claim would be slightly reduced because their AGI puts them
in an income bracket subject to the so-called Pease limitation on itemized deductions that was
reinstated in 2013. The table below shows how federal estate and income taxes can significantly
reduce an inheritance compared to leaving the entire IRA to charity.
Donating IRA Assets to Charity vs. Family
IRA portion of
each grandchild
By naming a charity—rather
than the two grandchildren—
as the IRA beneficiary, $564,882
($282,441 times two) that
otherwise would have gone to
taxes goes to charity instead.
IRA
to charity
Amount of IRA
$500,000
$1 million
Less: Income tax on IRA withdrawal
(39.6% x $500,000)
$198,000
$0
Less: Estate tax on inherited IRA9
$126,225
$0
Plus: Value of tax savings of “IRD deduction”
(39.6% x $174,833)10
$69,234
n/a
Value of each grandchild’s portion of IRA after
federal income and estate taxes11
$245,009
n/a
Total after-tax gift
$490,018
$1 million
By naming a charity—rather than the two grandchildren—as the IRA beneficiary, $564,882 ($282,441
times two) that otherwise would have gone to taxes goes to charity instead. In turn, by leaving
other long-term appreciated property, like stock and real estate to her children, they will likely
be able to get a stepped-up basis at her death, reducing the capital gains tax they would have to
pay on the assets if they decided to sell them.
If her goal is to maximize the after-tax assets left to charity and her grandchildren, she is clearly
better off giving her IRA to charity, and leaving her children and grandchildren other property.
CLOSING
Clearly, the legal and tax landscape associated with giving—both charitably and to family—is complex
and the options myriad. Tax-efficient charitable giving gets complicated quickly and the mechanics of charitable giving are worthy of careful planning attention. Furthermore, as changes in your
life, your family, and your priorities materialize, your charitable giving plan should change as well.
Beneficiary assignments should be reviewed on an annual basis to be sure they reflect the passing
of loved ones, changes in marital status, and changes in your gifting priorities in accordance with
your giving mission statement.
Your Financial Advisor can work closely with you and your legal and/or tax advisors to establish a
sound charitable giving plan and help you make the most of your giving power.
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1. Giving USA 2014 report, Giving USA Foundation; irs.gov SOI tax stats
2. Leaders Partners, Inc.
3. This is a hypothetical example for illustrative purposes only. State and local taxes, the federal alternative minimum-tax and limitations to itemized deductions applicable to taxpayers in higher-income brackets are not taken into account.
Please consult your tax advisor regarding your specific legal and tax situation. Information herein is not legal or tax advice.
4. Assumes donor is in the 39.6% federal income tax bracket, and that all realized gains are subject to the maximum federal long-term capital gain tax rate of 20% and the Medicare surtax of 3.8%. This does not take into account state or local
taxes, if any.
5. Availability of certain federal income tax deductions may depend on whether you itemize deductions. Charitable contributions of capital gain property held for more than one year are usually deductible at fair market value. Deductions for
capital gain property held for one year or less are usually limited to cost basis.
6. This does not take into account any limitations on itemized deductions or personal exemptions for taxpayers in higher tax brackets.
7. This is a simplified hypothetical example for illustrative purposes only. Tax results can vary greatly depending on an individual’s tax situation. Other strategies may provide more flexibility and similar savings, including utilizing other deductions and/or converting your assets to a Roth account over several years. Please consult with your tax adviser.
8. The 50% limit on cash contributions and 30% limit on security contributions to 501(c)(3) public charities is an aggregate limit as a percentage of a taxpayer’s adjusted gross income (AGI). Gifts to charity are irrevocable and nonrefundable.
9. Estate taxes were estimated using the 2014 schedule for the first $1,000,000 of taxable estate assets beyond the basic exclusion of $5.34 million and 40% for taxable estate assets over $1 million, for total federal estate taxes of $1,009,800 on
the whole $8 million estate. It was further assumed the estate taxes were paid proportionately from the more liquid estate assets — the IRA ($1M) and securities ($3M). $1,009,800/$4M = 25.2% effective rate on assets used to pay federal estate
taxes.
10. Income tax deduction for federal estate tax, permitted under I.R.C. Sec. 691(c) (the “IRD deduction”) adjusted for limitations on itemized deductions. To claim the estate tax deduction, the taxpayer must itemize deductions and take it in the
same year he is required to report the income in respect of a decedent (IRD). This example assumes the estate had no IRD other than the IRA and had no expenses in respect of a decedent. The estate tax without income or expenses in respect
of a decedent was estimated to be $620,534, for a deductible estate tax of $389,266 ($1,009,800 - $620,534). The deduction for each grandchild was $194,633 before the “haircut” of $19,800.
11. This is a hypothetical example for illustrative purposes only. It assumes both grandchildren are in highest federal income tax bracket of 39.6%, claim itemized deductions and pay a portion of the decedent’s estate taxes from the IRA. It does
not take into account state and local income or estate taxes, the federal alternative minimum tax or other limitations and adjustments beyond the Pease limitation on deductions.
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A GUIDE TO WISER GIVING
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