December, the month of gift-giving and good cheer, has long been the time when clients dispense their largesse to secure a year-end tax-deduction. And a growing number of these charitable contributions are not the one-time variety, but planned gifts that, funded with life insurance, form part of a comprehensive wealth transfer plan.
“There is a new awareness of the opportunities that have arisen in the charitable giving arena,” says Teresa Cherry, a certified financial planner and principal at Wealth Design Network, Chicago, Ill. “There is a greater interest among donors to explore ways of giving that achieve legacy planning objectives and tax savings.”
The latter can indeed be substantial. When donors contribute assets to a charitable trust, they can receive a charitable tax deduction for (typically) 20% of their adjusted gross income, a deduction they can carry forward for 5 years. The donor can additionally defer and/or avoid long-term capital gains tax on assets sold by the trust to generate income for the charity and non-charitable beneficiaries. And, structured properly, the vehicle can zero out their estate tax.
The tax advantages, combined with the less tangible but often equally rewarding experience of giving, are fueling a surge in donations. According to the Giving USA Foundation, charitable contributions in 2005 topped $260 billion, a nearly 5% gain from the $245 billion recorded in 2004. At $199 billion, individual donations accounted for the lion’s share of the total. Donations by foundations, charitable bequests and corporations totaled $30 billion, $17 billion and $14 billion, respectively.
To be sure, a still substantial percentage of these gifts are one-time contributions, many of them made during charities’ capital campaigns. The challenge for advisors, says Cherry, is to identify clients’ charitable inclinations and channel them into a comprehensive plan that fulfills long-term goals. High among these are securing a comfortable retirement income, passing on an inheritance to children and grandchildren, minimizing income and estate taxes and, if the client is a business owner, engineering a graceful exit from the firm.
The charitable component of an all-inclusive wealth transfer plan starts with the discovery or fact-finding process. R. Clifford Berg, a chartered financial consultant at Financial House, Centreville, Del., and a member of the board of directors of the Society of Financial Service Professionals, Newtown Square, Pa., says he reviews clients’ tax returns to identify organizations to which they had previously contributed one-time gifts. Still more can be learned, he adds, by asking clients questions about the reasons underpinning their contributable donations.
Are they motivated to give primarily because of the tax advantages afforded by charitable gifts or from a desire to advance a cause? With which organizations are they actively involved in the non-profit community? Are they looking to generate a greater income stream on highly appreciated assets than they can currently?
Often, sources say, philanthropic intentions hinge on a combination of factors–including the element of surprise. Sources point out that many clients who have established an estate plan are ignorant of the fact that Uncle Sam might still be entitled to part of their accumulated wealth.
“After the estate planning, there will potentially be an exposure subject to the death tax when mom and dad die based on certain exclusions,” says Aubrey Morrow, host of MoneyTalkRadio.com and president of Financial Designs Ltd., San Diego, Calif. “In a recent case, I told 2 clients of mine–a Jehovah’s Witnesses couple who held $11 million in real estate–that without advanced planning, they would elect by default the IRS ‘charity,’ as opposed to a charity of their choice. That hit them like a ton of bricks.”
And it spurred them to establish a planned gift for their church. But wherever the client’s interest may lie–be it proselytizing to the unconverted, saving the environment or offering succor to populations suffering from disease and hunger–clients need to bring their charitable inclinations into focus if they’re to have a meaningful impact.
To that end, says Cherry, advisors can help them formulate a philanthropic mission statement. Clients also need to identify charities that can make the best use of their money–a task that may require the assistance of a consultant who can properly research organizations of interest.
Clients need to decide, too, on which assets to gift. Generally, sources say, these encompass highly appreciated assets that, absent a charitable plan, would be subject to not only estate tax, but also long-term capital gains tax that would result from the property’s sale.
Such assets commonly include closely held businesses, equity portfolios and real estate. They may also extend to antiques, artworks and collectibles. Example: a 17th century sofa worth $1.7 million that a client of Morrow’s, an antique store owner, had acquired.
What techniques might be considered in effectuating a planned gift? On this question, sources say, much will depend on the client’s retirement, estate and legacy planning objectives. Underpinning most of the strategies are irrevocable split-interest trusts–vehicles that “split” the assets held in trust between individual beneficiaries and a designated charity or charities.
A charitable remainder trust, for example, will pay a percentage of trust principal to named individuals (such as a son or daughter) and distribute the balance to a charity. The CRT, which be may established during life (inter vivos) or at death (testamentary), comes in 2 basic types: the charitable remainder annuity trust, or CRAT, which pays a fixed dollar amount or a fixed percentage of the initial value of the assets transferred to the trust; and the charitable remainder unitrust, or CRUT, which pays a fixed percentage of the trust’s assets valued annually.
Less commonly used among clients, observers say, is the charitable lead trust and its permutations, the charitable lead annuity trust (CLAT) and the charitable lead unitrust (CLUT). Distinguishing the CLT from a CRT is the order of the beneficiaries: The first pays an income interest to the charity and a remainder interest to non-charitable beneficiaries.
If the assets donated to charity are to be replaced to provide an inheritance for children, grandchildren or others, then the advisor generally will recommend the client also establish an irrevocable life insurance trust (or wealth replacement trust). The ILIT will usually be funded with a second-to-die life insurance policy that pays a death benefit to named beneficiaries (such as adult children) income- and estate-tax free after both insureds (e.g., the parents) pass away.
In Morrow’s experience, however, most charitable trusts are not accompanied by an ILIT. The reason, he says, is that donors are more interested in establishing a legacy for a favorite charity than they are for family members. Or, they want to maximize the income they receive from the charitable trust–income that otherwise may be used all or in part to fund the ILIT’s premiums.
Often, too, the charitable trust can be jettisoned in favor of (or supplemented by) alternative vehicles for giving. Where the client is charitably inclined but doesn’t have highly appreciated assets, they might consider establishing a private family foundation (or a donor-advised fund for charitable contributions totaling less than $1 million) in lieu of a CRT.
Richard Plesha, a private wealth management director for The Hartford, Hartford, Conn., says 50% of the company’s wealth transfer plans typically encompass a family foundation, a 501(c)(3) organization that, under IRC rules, must contribute 5% of its value annually for charitable purposes.
“What the foundation does is instill in children and future generations a sense of social and financial responsibility,” says Plesha. “It also creates a common cause for keeping the family together over time.”
In conjunction with the foundation, he adds, Hartford also advocates the establishment of a dynasty trust, a vehicle that continues for approximately 100 years or longer and provides payments to future generations without additional estate or generation-skipping transfer taxes. To fund the trust, Hartford normally recommends purchasing a life insurance policy equal to 50% of the client’s net worth.
Simpler methods of contributing are also available to donors, including an outright gift of their life insurance policies. But Cherry cautions that contributors need to keep charities apprised of the status of these policies lest they lapse–or fall off the radar screen. She cites one charitable giving officer who, upon reviewing certain neglected files, found 4 or 5 old life policies that her non-profit knew nothing about.
If clients aren’t up to gifting a policy’s death benefit in its entirety, they might be amenable to donating a percentage. Michele Van Leer, vice president and general manager of individual insurance at SunLife Financial, Wellesley, Mass., says the company now offers on its policies a charitable giving benefit rider that will pay a 1% additional death benefit to a named charity. The feature is available on contracts carrying face amounts up to $10 million.
As part of its strategy to target the charitable giving community, SunLife also offers advisors a kit to help them form alliances with charities that are seeking planned gifts from their regular contributors. This approach, she says, can be highly effective.
“Many non-profit development directors know nothing charitable planning involving life insurance,” she says. “But they’re always looking for good ideas. By networking these people, advisors can gain entr?e into this market.”