Like everyone else, your retired clients can have conflicting financial goals. They might want to increase the income from their savings and other assets, but don’t want to take on too much investment risk. Or perhaps they’d like to support their favorite charities but they’re concerned that making large contributions will reduce their income and bequests to heirs. Planning with charitable income gifts can help clients accommodate these seemingly incompatible goals.
The basic premise behind the gifts is that a contributed asset’s principal can be valued separately from its income. It’s like valuing a bond: discount the interest payments and maturity principal at the appropriate interest rate, add them together and you have a market value for the bond.
How it Works
Charitable income gifts take the same approach. A donor irrevocably transfers an asset to a qualified charity or trust. In return, the charity agrees to pay an income to the donor (the income beneficiary). The starting date, frequency and duration of the income payments depend on the arrangement. When the payments end—at the donor’s death, for instance—the charity keeps the remaining funds as the remainder beneficiary. (Charitable lead trusts, which are not discussed in this article, reverse the transaction: The charity gets the income and the non-charitable beneficiary receives the remainder.)
From a tax perspective, the contribution consists of two parts: the income that will flow back to the donor and the remainder that stays with the charity. The remainder can qualify as an income tax deduction for the donor. Depending on the type of donated asset, the income payments will be taxed as a mix of ordinary income, long-term capital gain and a tax-free return of principal. Additionally, these strategies can often generate income streams higher than those available with other assets.
Here’s an example of a charitable gift annuity’s numbers using the online calculator from Planned Giving Design Center LLC.* The donors, a married couple both age 65, have a highly appreciated stock position. The shares have a low cost basis and are worth $100,000, but pay no dividend. The couple seeks additional income and also wants to benefit the college they attended. They donate the shares to the college in return for a joint-and-survivor lifetime annuity. The annuity will pay an annual rate of 4.2 percent ($4,200), with payments made monthly. Using the discount rates and mortality tables applicable in late September, the annuity has a present value of $73,965 and the remainder interest—the charitable deduction portion—is worth $26,035. Multiple Options
The usual caveats about each case being client-specific apply, but this scenario illustrates the strategy’s potential benefits. Clients can generate more income from their assets and simultaneously receive a charitable deduction: the charity benefits from the contribution. For clients who fit the profile—both charitably inclined and those seeking more income—it’s a good deal. That doesn’t mean split-interest charitable gifts are a panacea, of course. The transactions are irrevocable, so the clients can’t change their minds and get their money back. Clients’ heirs might object, because the charity keeps the remainder when the income payments terminate.
Anne Ward, with Allodium Investment Consultants in Minneapolis, Minn., says these gifts typically appeal to clients who “tend to feel very secure in retirement.” They believe they’ve anticipated their personal and family financial needs and are comfortable making larger donations. In her experience, they are often philanthropic, looking at the greater good and the world beyond their inner circle. “But they don’t tend to get to that point until they feel like they have accumulated enough and that they’re going to be OK,” she says.
Donors can choose from an array of income-producing contribution strategies. The details on each are beyond the scope of this article, but the major types include charitable gift annuities (CGAs), charitable remainder annuity trusts (CRATs), charitable remainder unitrusts (CRUTs) and pooled income funds (PIFs). CRUTs are further classified as net income (NICRUTs), net income with makeup (NIMCRUTs) and flip unitrusts (FLIP-CRUTs).
Finding the Fit
There is no simple rule-of-thumb to identify which strategy will work best for a client. Each donor is unique and each strategy has its own set of rules, benefits and costs. Nonetheless, general guidelines can give donors some initial guidance as they consider the different strategies.
Contribution amount: It often doesn’t make sense to set up a trust if the gift is under $500,000, Ward notes, because the set up and operating costs can be high relative to the trust’s size. CGAs are usually more cost-efficient in those cases.