More On Tax Planningfrom The Advisor's Professional Library
- Health Insurance: Health and Medical Savings Accounts A Health Savings Account is a trust created exclusively for the purpose of paying qualified medical expenses of an account beneficiary. Although they are popular, they are not without their pitfalls and the regulations can be complicated. Learn more about how to avoid federal taxation on the accumulation and distributions of HSA.
- Precious Metal Taxation Precious metals can be used to better diversify a portfolio but can be volatile. The tax implications of investing in these types of assets vary depending upon the situation.
When panic about the economy hit a crescendo in November of last year and then again in March of this year, it wasn't just for-profit firms that were under pressure. Nonprofits and the donors that support them were also panicked over the future course of philanthropic giving. But no matter what the economy does, donors are going to continue to shovel hundreds of billions of dollars into the social sector and wealth managers need to position themselves to help their clients give well.
It is widely assumed that when the economy seizes up and asset prices fall, that donors stop giving. But history shows this isn't true. While the current economic situation is unique in many ways, it is still informative to know that when the dotcom bubble burst and the Nasdaq fell 78% from 2000 to 2002, annual charitable giving actually rose 11%, from $211 billion to $234 billion.
This dynamic holds because while large foundations give a percentage of their assets, individual donors tend to give a percentage of their income. With income far more stable than asset prices and the increasing need for social services during recessions, individual donors simply do not walk away from their charitable commitments.
The fact is that while big foundations might get the media coverage, individual charitable giving simply dwarfs institutional giving. Foundation grants account for only 13% of total charitable giving in the United States, according to the most recent Giving USA survey, while donations from individuals make up 82% of the annual total. (Corporations give the rest.)
But while individuals make the bulk of charitable donations, the way they make their gifts could be done a lot more effectively. This is where wealth managers can add tremendous value for their clients who give at high levels.
Every time one of your clients writes a check to charity, he or she is incurring phantom taxes. By integrating philanthropic services into your wealth management offering, you can capture these phantom taxes and return them to your client or help your client give even more to charity.
When your clients give cash to a nonprofit, even though they take an income tax deduction for the gift, they are inadvertently foregoing an opportunity to reduce their capital gains tax, estate tax, and gift tax. This missed opportunity to reduce taxes generates a tax bill in the future that does not need to occur. These taxes represent a phantom tax on donors who choose not to structure their gifts in the most efficient manner.
Let's look at the simple example of a client making a gift of stock rather than a gift of cash. When a donor writes a check for $10,000, he reduces his federal tax bill by $3,500 (assuming he is in the top federal tax bracket). If instead he gives stock worth $10,000, which he bought for $5,000 years earlier, he will get the same income tax deduction and avoid paying $750 in capital gains tax, for a total of $4,250 in reduced taxes. In each case, he has parted with $10,000, but by giving stock, he has reduced his after-tax cost of giving from $6,500 to $5,750, a 12% drop. (Considering state taxes would make the example even more compelling.)
Making gifts of appreciated assets instead of writing checks is the simplest tool in the philanthropic toolbox. But it is one that most of your clients do not take advantage of. According to The 2008 Bank of America Study of High Net Worth Philanthropy, 98.2% of high net worth individuals give to charity each year. Individuals who make more than $200,000 a year give on average between 9% and 14% of their income. But if you compare these high levels of giving to the number of requests you get from your clients to transfer appreciated assets to the nonprofits they support, you'll find a huge gap and a need for more proactive philanthropic planning.
One way to gain the skills to advise your clients on financially savvy ways to execute their philanthropy is to complete the Chartered Advisor in Philanthropy (CAP) program. The CAP program is offered by The American College, it's called The American College: Chartered Advisor in Philanthropy program which also offers the Certified Financial Planner (CFP) designation. While still a rare designation, the CAP program has emerged as the leading "credential" for philanthropic advising.
The CAP program is an excellent entry point into philanthropic planning for financial professionals. But keep in mind that much of the course work focuses on tax planning strategies as opposed to "impact" focused strategy. Impact is to philanthropy what "alpha" is to wealth management. It describes the extent to which a charitable gift generates social benefit. Just as anyone can buy a stock, anyone can make a charitable gift. But that doesn't mean they are a great investor or philanthropist. Helping clients maximize their impact through robust philanthropic strategy is beyond the domain of wealth management, but keep in mind that tax planning is never the prime motivation of charitable giving. The best advice for a client who is giving only for the tax break is to tell them to keep their money. Not even the fanciest charitable tax planning can leave a client in a better financial position than if they simply held onto their money.
So now that you understand the advantages of encouraging your clients to make charitable gifts using appreciated assets, here is a summary of a few common planning vehicles to tide you over until you complete your Chartered Advisor in Philanthropy program:
Private Foundations: Many advisors make the incorrect assumption that private foundations are only for the ultra wealthy. But the fact is that 60% of foundations have less than $1 million in assets. Rather than using the amount of assets a client intends to commit as the deciding factor when selecting a philanthropic vehicle, the focus should be on what the client wants to achieve. Private foundations allow clients to completely control their philanthropy and name a board to help decide how to use the money. Beyond making charitable grants, foundations can also make loans to nonprofits, employ staff members, offer educational scholarships, and have complete control over how they invest their assets.
Donor Advised Funds: Donor advised funds are like charitable brokerage accounts. Your client gets an income-tax deduction when they fund the account and they are free to send money out of the account to the nonprofits of their choice. Donor advised funds (DAFs) are offered by community foundations and by national organizations like the Fidelity Charitable Gift Fund and Schwab Charitable. While donor advised funds can only be used to make grants to nonprofits, they can be opened with as little as $5,000. Policies vary from provider to provider regarding whether clients can request that their advisor manage the assets or whether they are limited to a set of investment options offered by the fund.
Charitable Remainder Trusts: Charitable remainder trusts allow your client to set up a trust where an income payment is paid to them or the beneficiary they assign while the principal in the trust goes to the charity of their choice upon the termination of the trust. Your client gets an income-tax deduction for the principal portion and may be able to defer taxation on any gains realized in the trust (such as those triggered if a highly appreciated asset is contributed to the trust). Charitable remainder trusts are a good choice for a client who intends to leave a large charitable bequest in their will. By locking in that commitment via a trust, your client will get an income-tax deduction today.
Charitable Lead Trusts: Charitable lead trusts are almost the reverse of a remainder trust. The annual income payments go to charity and the principal is given to your client's heirs or returned to your client upon the trust termination. Charitable lead trusts are often structured to pass assets on to heirs during your client's lifetime with significantly reduced or eliminated gift taxes. Charitable lead trusts are particularly attractive right now since they benefit from the low interest rate environment and because they are usually funded with assets that are not highly appreciated.
Philanthropic planning can be a key differentiator for your wealth management practice. As the Baby Boomers retire, they will also be entering their "peak giving years". Will you be ready to serve them?