top 10 charitable planning strategies for financial advisors

Top 10 Charitable Planning Strategies for

Financial Advisors

Russell James, J.D., Ph.D., CFP®Texas Tech University

Dept. of Personal Financial Planning

Never give cash

Give retirement RMD first and more

at death

Take deductions today for transfers

tomorrow

Match Deductions with Roth

conversions

Buy life insurance with new

tax deductions

Earn more income by avoiding capital

gains tax Prevent your

clients from dying (ever) Grow tax free Make your wealthy

clients want to save MoreBe in a growing market for good clients

1. Never give cash

Donor Charity$100k Cash

Donor Charity

Income tax deduction ($100,000 x 39.6%)

$39,600+

Avoid capital gains tax($90,000 x 23.8%)

$21,240

Income tax deduction ($100,000 x 39.6%)

$39,600

$100k Stock

Donor Charity$100k low basis stock

$100kcash

immediately buy identical stock(100% basis)

The Charitable Swap

No “wash sale” rule because this is gain property, not loss

property

Donor

Charities

$100kcash

The Charitable SwapSimplified

Donor Advised

Fund

$

$

$

$100k low basis stock

immediately buy identical stock(100% basis)

Donor

Charities

$100kcash

A FREE tax benefit you lose every time you give cash

Donor Advised

Fund

$

$

$

$100k low basis stock

immediately buy identical stock(100% basis)

Did you pay capital gains taxes last year?Did you make cash gifts to charity?If so,

You need a new financial planner.

John Competitor, CFP®Financial Planning Services for the Charitably MindedYour.Competition@EatingYourLunch.com

Never give cash

Give retirement RMD first and more

at death

Take deductions today for transfers

tomorrow

Match Deductions with Roth

conversions

Buy life insurance with new

tax deductions

Earn more income by avoiding capital

gains tax Prevent your

clients from dying (ever) Grow tax free Make your wealthy

clients want to save MoreBe in a growing market for good clients

2. Give retirement RMD first and more at death

Life stages of a retirement account

Early distribution (before 59 ½)

Regular distribution (59 ½ to 70 ½)

Required minimum distribution (after 70 ½)

Giving after 70 ½

After age 70 ½ participants must take required minimum distributions (account balance / remaining life expectancy) or pay 50% penalty

$10,000

$10,000 incomeIRA

Giving after 70 ½ If the income is not needed, a charitable gift deduction might offset the income

(if itemizing and no income giving limitations exceeded and no pease limitation effects and no negative effects from increased AGI and not in the wrong state)

$10,000

$10,000 incomeIRA $10,000 deduction

$10,000

Giving after 70 ½

In some years, congress has allowed a Qualified Charitable Distribution (QCD), eliminating both the income and deduction

$10,000

$0 income

IRA$0 deduction

Qualified Charitable Distribution (QCD)

$10,000

$0 income

IRA$0 deduction$100,000

per person maximum

Participant 70 ½ or older

No private foundations, donor

advised funds, charitable trusts, or

charitable gift annuities

IRAs or IRA rollovers only; no

401(k), 403(b), SEP, SIMPLE,

pension or profit sharing plans

Retirement plan assets

inherited by non-charitable beneficiaries

are reduced by income tax

Does it matter which goes

where?

A client with a $1MM IRA and a $1MM house wants to leave

one to her child and one to

charity

IRA(child); House(charity)$1,000,000 House$1,000,000 to charity

$1,000,000 IRA -$396,000 (39.6% federal

income tax) $604,000 to child

-$110,000 (11% Oregon state income tax)

$494,000 to child

IRA(charity); House(child)$1,000,000 IRA$1,000,000 to charity

$1,000,000 House -$0 (no income tax)$1,000,000 to child

Retirement plan charitable beneficiaries

• A public charity• A private family

foundation• A charitable

remainder trust

• Not Charitable Lead Trusts (because they aren’t tax exempt)

• Avoid naming estate as beneficiary with instructions in estate documents (estate itself may have to pay income taxes)

Bad retirement plan death beneficiaries

Charities are not “designated beneficiaries”, so could accelerate RMD’s for other beneficiaries. Solutions:• Separate IRAs into a 100% charitable and

100% non-charitable account before death (+ RMDs can be taken from either to match desired plans)

• Beneficiaries can separate accounts by end of year following participant death1

• Payout charity share before September 30 of year following participant death.2

• If spouse is beneficiary, simply roll that share into spouse’s IRA

Simple solutions to a potential trap

1. Treas. Reg. sec. 1.401(a)(9)-8 Q&A 2(a) 2. Treas. Reg. sec. 1.401(a)(9)-4 Q&A 4(a)

Never give cash

Give retirement RMD first and more

at death

Take deductions today for transfers

tomorrow

Match Deductions with Roth

conversions

Buy life insurance with new

tax deductions

Earn more income by avoiding capital

gains tax Prevent your

clients from dying (ever) Grow tax free Make your wealthy

clients want to save MoreBe in a growing market for good clients

3. Take deductions today for transfers tomorrow

A remainder interest in a home or farm gives the right to own the property after a set time or after the death of a person

OK, you can have my

stuff now.

Charles A. Donor

Charitable deduction for remainder interest deed in $1,000,000 of farmland by age 59 donor

1.0% (Jan 13)

$804,79011.6% (May 89)

$156,840

Leaving land to charityby will

• Revocable• $0 income tax deduction

• Impacts charity after death

Leaving land to charityby remainder deed

• Irrevocable• $804,790 immediate income

tax deduction• Impacts charity after death

or immediately if charity sells remainder interest• Immediately increases cash

assets available for investments (AUM)

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Charitable Remainder Trusts generate an immediate tax deduction, even

though donor can manage assets and receive income for life

Never give cash

Give retirement RMD first and more

at death

Take deductions today for transfers

tomorrow

Match Deductions with Roth

conversions

Buy life insurance with new

tax deductions

Earn more income by avoiding capital

gains tax Prevent your

clients from dying (ever) Grow tax free Make your wealthy

clients want to save MoreBe in a growing market for good clients

4. Match Deductions with Roth conversions

Roth conversions and charitable planning can work together to match

Income Deductions

$1MM in standard IRA (withdraws

are taxable)

Conversion creates $1MM in immediate

taxable income

Roth Conversion

$1MM in Roth IRA (withdraws

are tax free)

TaxableTax Free

Where can I find offsetting deductions?

Where can I find offsetting deductions?

Put money into a• Charitable remainder trust• Charitable lead trust

(grantor)• Charitable gift annuity• Donor advised fund• Private foundationOr give a remainder interest in a residence or farmland to a charity

Charitable deductions may be limited (with five year carryover) to 20%, 30%, or 50% of income depending on gift and recipient

If I have unused deductions, how can I pull future income into current year?

If I have unused deductions, how can I pull future income into current year?

With a Roth conversion

$1MM in standard IRA (withdraws

are taxable)

Conversion creates $1MM in immediate

taxable income

Roth Conversion

$1MM in Roth IRA (withdraws

are tax free)

TaxableTax Free

Roth conversions and charitable planning can work together to match

Income Deductions

Never give cash

Give retirement RMD first and more

at death

Take deductions today for transfers

tomorrow

Match Deductions with Roth

conversions

Buy life insurance with new

tax deductions

Earn more income by avoiding capital

gains tax Prevent your

clients from dying (ever) Grow tax free Make your wealthy

clients want to save MoreBe in a growing market for good clients

5. Buy life insurance with new tax deductions

Charitable planning devices such as Charitable Gift Annuities, Gifts of Remainder Interests in Homes and Farms, and Charitable Remainder Trusts produce amazing tax advantages, reducing income taxes, capital gain taxes, and estate taxes

But, they also reduce heirs’ inheritance

Heir Charity Donor

Life insurance can diminish this concern

Tax Free Life Insurance

Can it pay to be charitable?

Priscilla wants to sell a $1,000,000 non-income producing zero-basis asset then spend the interest income of 5% while leaving principal for heirs. Her combined state and federal tax rates are:

capital gains (23.8%) income (39.6%) estate (40%)

Sale$1,000,000 asset -$238,000 capital gains tax

Client uses $38,100/year ($762,000 X 5% return)

Heirs receive $457,000 ($762,000-$304,800 est. tax)

CRUT$1,000,000 asset $0 capital gains tax$1,000,000 in 5% unitrust pays $50,000 annually + a charitable tax deduction of $300,000 worth $120,000

+ ILITClient pays $120,000 initially and $10,000 annually for a $400,000 ILIT-owned policy (including post-crummey gift taxes)

Client uses $40,000/year

Charity receives $1,000,000 remainder

Heirs receive $400,000 (tax free from ILIT)

John, age 59, at 39.6% income tax rate, owns $100,000 of farmland which he would like to use for the rest of his life then leave to charity, but he also wants to benefit his heirs.

Giving the remainder interest to charity creates a deduction of $80,479 worth $32,869. Suppose this will purchase a paid-up policy of about $50,000+.

John keeps lifetime use of farmCharity gets 100% of farm at deathHeirs get $50,000+ (estate tax free)

Never give cash

Give retirement RMD first and more

at death

Take deductions today for transfers

tomorrow

Match Deductions with Roth

conversions

Buy life insurance with new

tax deductions

Earn more income by avoiding capital

gains tax Prevent your

clients from dying (ever) Grow tax free Make your wealthy

clients want to save MoreBe in a growing market for good clients

6. Earn more income by avoiding capital gains tax

A client holds a large, highly appreciated asset that generates little income (like developable land or non-dividend paying stock). How can she convert it to income generating property?

Option 1: Sell it. Pay the capital gains tax. Earn income on the remaining amount. $1,000,000 stock

$1,000,000 gain (if zero basis)

$238,000 tax (23.8% fed + ?% state)

$762,000 left to invest AUM

Option 2: Transfer to a CRT. Earn income for life on the full amount.

$1,000,000 stock$1,000,000 gain (if $100,000 cost)

_____$0 tax (CRT pays no tax)

$1,000,000 left to invest AUM

A client holds a highly appreciated asset that generates little income (like developable land or non-dividend paying stock). How can she convert it

to income generating investments?

Simple Sale

$1,000,000 asset$1,000,000 gain (if zero basis)

$288,000 tax (23.8% fed + 5% state)

$722,000 left to invest-AUM

Or California $670,000 left Charitable Remainder Trust

$1,000,000 asset$1,000,000 gain (if $100,000 cost)

$0 tax (CRT pays no tax)

$1,000,000 left to invest-AUM

& $100,000+ tax deduction

Never give cash

Give retirement RMD first and more

at death

Take deductions today for transfers

tomorrow

Match Deductions with Roth

conversions

Buy life insurance with new

tax deductions

Earn more income by avoiding capital

gains tax Prevent your

clients from dying (ever) Grow tax free Make your wealthy

clients want to save MoreBe in a growing market for good clients

7. Prevent your clients from dying (ever)

Client death is highly inconvenient for financial planners

1. The government takes a chunk of the assets

2. The kids divide up the rest into smaller pools

• You CAN’T manage the money (because you don’t have the business relationships with each of the kids)

• You DON’T WANT to manage the money (because each remaining pool is too small)

A donor advised fund or private foundation holds money and distributes charitable grants

Multi-generational managementInheritance• Small pools after division by

1/n children and estate tax• Individual relationships with

each heir• High maintenance / personal

losses

Private Foundation/DAF• Big pool with no division

and no estate tax• Preexisting position as pool

manager• Low maintenance /

charitable org. losses

Donor Advised Fund• No minimum payout• Minimal setup &

administrative expense• Expected control of grants• Investment management

allowed with many financial institutions

• Legislatively newer

Private foundation• 5% minimum payout• Significant setup &

administrative expense• Actual control of grants• Investment management

always allowed• Legislatively stable

Advanced charitable strategies to preserve

wealth

• Lifetime and testamentary transfers to private foundation

• CRT (spigot) paying for life (if desired for consumption) then to family foundation

• Zeroed out CLT that pays charitable interest to family foundation, excess growth to children

• Multi-generational: Testamentary CRT, income to kids, then to private foundation run by grandkids

Never give cash

Give retirement RMD first and more

at death

Take deductions today for transfers

tomorrow

Match Deductions with Roth

conversions

Buy life insurance with new

tax deductions

Earn more income by avoiding capital

gains tax Prevent your

clients from dying (ever) Grow tax free Make your wealthy

clients want to save MoreBe in a growing market for good clients

8. Grow tax free

Tax Free Growth Environments• Growth inside a

donor advised fund is tax free

• Growth inside a charitable remainder trust is tax free (only distributions are taxed)

• Growth inside a private foundation is tax limited (either 2% or 1% rate)

Standard Account10% growth, 39.6% federal, 5% state

Year 1 $10,000Year 2 $10,554Year 3 $11,139Year 4 $11,756Year 5 $12,407

… …Year 18 $25,009Year 19 $26,394Year 20 $27,856

Donor Advised Fund/PF10% growth, 39.6% federal, 5% state

Year 1 $10,000Year 2 $11,000Year 3 $12,100Year 4 $13,310Year 5 $14,641

… …Year 18 $50,544Year 19 $55,599Year 20 $61,159

Never give cash

Give retirement RMD first and more

at death

Take deductions today for transfers

tomorrow

Match Deductions with Roth

conversions

Buy life insurance with new

tax deductions

Earn more income by avoiding capital

gains tax Prevent your

clients from dying (ever) Grow tax free Make your wealthy

clients want to save MoreBe in a growing market for good clients

9. Make your wealthy clients want to save More

Once my family and I are provided for, why would I keep working to build wealth?

Do the estates of people who make charitable estate plans grow differently than the general population?

After making their plan, charitable estate donors grew their estates 50%-100% faster than did others with

same initial wealth

Never give cash

Give retirement RMD first and more

at death

Take deductions today for transfers

tomorrow

Match Deductions with Roth

conversions

Buy life insurance with new

tax deductions

Earn more income by avoiding capital

gains tax Prevent your

clients from dying (ever) Grow tax free Make your wealthy

clients want to save MoreBe in a growing market for good clients

10. Be in a growing market for good clients

$2.0 milli

on < $3.5 milli

on

$3.5 milli

on < $5.0 milli

on

$5.0 milli

on < $10.0 milli

on

$10.0 milli

on < $20.0 milli

on

$20.0 milli

on or more

0%

10%

20%

30%

40%

Estates including charitable planning(IRS Statistics of Income 2008)

Estate Size

Charitable Estate Planning among US Adults Aged 55-65

3.0%

3.5%

4.0%

4.5%

5.0%

5.5%

6.0%

1996 1998 2000 2002 2004 2006

Increases in charitable planning are driven by increases in childlessness and education

VariableEstimate

(s.e.) p-valueEstimate

(s.e.) p-valueEstimate

(s.e.) p-valueYear 0.0138

(0.0032)<.0001 0.0033

(0.0034)0.3298 0.0015

(0.0036)0.664

Any children -0.6251 (0.0345)

<.0001 -0.6224 (0.0479)

<.0001

Years of Education

0.1412 (0.0048)

<.0001 ….full set of

….

control variables

Probit analysis of all respondents age 55-65 in 1996-2006 HRS. Outcome variable is the presence of charitable estate planning.

Time trend exists

Time trend disappears

when including childlessness

and education

• The trend of increased charitable estate planning is driven by changes in childlessness and education.

• This allows us to predict rapid growth of charitable estate planning in the coming decades as both of these will unalterably increase for upcoming retiree populations.

Top 10 Charitable Planning Strategies for

Financial Advisors

Russell James, J.D., Ph.D., CFP®Texas Tech University

Dept. of Personal Financial Planning