The end of the year often brings increased demand for quick and effective income tax planning strategies, as clients look to their financial advisors for ideas on how to reduce their tax liabilities. The financial services industry is full of products, tools, and resources to assist advisors and their clients in this endeavor. With so many options and strategies available, however, advisors must be able to recognize when a particular product can produce the greatest benefit for their clients’ specific situations.

Do you have clients who are in search of a simple and effective means to reduce their tax liability? Do you have clients who include, or wish to include, charitable planning in their overall financial plan? If so, one strategy that may be particularly effective as the year comes to a close is a pooled income fund.

What is a pooled income fund?

A pooled income fund is a tax-exempt charitable trust, operated by a charity, which provides donors with an immediate tax deduction and an income stream for life. It is similar to a charitable remainder trust in that it is a split-interest trust with both charitable and noncharitable beneficiaries.

The noncharitable beneficiary (the donor) contributes assets to the pooled income fund and in return receives a proportional interest in the fund. The charity then commingles the contributed assets with contributions from other donors. Typically, the assets are sold immediately, and the proceeds are reinvested in various managed portfolios. The donor (or designated income beneficiary) then receives an annual payment based upon the earnings of the pooled investments. Upon the death of the income beneficiary, the remainder of the donor’s share is passed to a charity.

What are the benefits of a pooled income fund?
There are several benefits associated with a pooled income fund.

  • Charitable income tax deduction: The donor will receive a charitable income tax deduction equal to the present value of the charity’s remainder interest.
  • Avoidance of capital gain: Donations of highly appreciated assets are ideal because the donor does not realize capital gains upon the fund’s sale of the contributed assets.
  • Realization of lifetime income: The donor (or the named income beneficiary) will receive a payment of income at least annually for the remainder of the income beneficiary’s life.
  • Reduction of the gross estate: Assets contributed to the fund will be effectively removed from the donor’s estate, therefore reducing the estate taxes payable upon the donor’s death.
  • No fees required to establish or administer the fund: Unlike a charitable remainder trust, the donor does not have to pay upfront legal fees to establish the fund or perform ongoing administration.
  • Charity support: Upon the death of the income beneficiary, the remaining share of the donor’s contribution is passed to donor-recommended qualifying charities.

What types of assets are acceptable for contribution to a pooled income fund?

Acceptable contributions to pooled income funds are determined by the charity that has established and currently administers the fund. It is common for many funds, such as Fidelity’s or Eaton Vance’s Pooled Income Fund, to limit their acceptable contributions to cash, individual securities, mutual fund shares, or publicly traded bonds. There are funds, however, that expand their list of acceptable contributions beyond cash and common securities. One example of this type of fund is the Life Income Funds of America (LIFA) pooled income fund, which broadens its list of acceptable contributions to include whole and partial interests in real estate. The LIFA fund lists the following as acceptable real estate contributions:

  • Apartment buildings
  • Industrial properties
  • Land
  • Office buildings
  • Rental propertes
  • Residential real estate
  • Retail centers
  • Vacation homes

All contributions of real estate are subject to review and approval prior to acceptance by the LIFA pooled income fund. All donations of real estate interests must have been owned by the donor for at least one year and must have a minimum contribution value of $150,000.

More options

For clients who wish to meet charitable goals while addressing issues such as tax planning, retirement income, and simplification, a pooled income fund may be worth considering. The ability to contribute real estate to a pooled income fund also provides a possible solution to clients for whom charitable intent is not the primary factor.

For instance, clients who have accumulated real estate throughout their lives are consistently searching for advantageous methods for monetizing property. While the continued rental income has been an attractive benefit, such a client may want to exit the property management business. A pooled income fund can replace the rental income while providing a current-year tax benefit. Because the fund accepts partial interests, the contribution can be tailored to achieve the most beneficial tax benefits in the year of sale of the entire interest.

Real estate owners are generally familiar with three common methods of planning with real estate: the outright sale of the property, a Section 1031 like-kind exchange, or contribution of the property to a charitable remainder trust. A fourth option, the pooled income fund, can be added to the list.

Planning considerations

The pooled income fund is certainly not for every client, but it is an option to consider when you have a client with highly appreciated assets, a need for a tax deduction, and any semblance of charitable intent.

Gavin Morrissey, JD, is the director of advanced planning at Commonwealth Financial Network, in San Diego, California. He can be reached at gmorrissey@commonwealth.com.