If you’re unclear about the options, benefits, and even the process of strategic charitable planning, you’re not alone. Many financial professionals have been led to believe that charitable planning is only beneficial for philanthropic individuals who have significant wealth. A great number of financial professionals, however, are becoming increasingly aware that charitable planned giving can be beneficial for everyone.
For example, would you consider talking with your clients about charitable planned giving if you knew you could help them:
• Take advantage of benefits outlined in the IRS code that many assume are only available to the wealthy;
• Reduce their income tax bill;
• Identify potentially problematic and/or overlooked assets that are best suited for planned giving;
• Reduce capital gain on appreciated assets;
• Provide lifetime income or a period of years income for themselves and/or a loved one; and
• Make a difference in the lives of others through charitable planned giving?
Most advisors answer yes; however, helping their clients determine how and when charitable planned giving is most advantageous can sometimes prove challenging.
Let’s take a look at a conversation between a financial professional and a client during an annual review to gain a better understanding of charitable planned giving and its benefits.
Advisor: “Mr. and Mrs. James, I understand you paid more than $9,000 in income taxes last year. If there was the potential to cut that amount in half next year, would you want to look into it?”
Mr. James: “Absolutely!”
Advisor: “Many people are unaware that there are nearly $2 trillion of annuities in force. An even more interesting statistic, however, is that approximately 90% of these annuities will be passed on to beneficiaries such as the annuitant’s children without having been annuitized.”
Mrs. James: “That makes sense, because we plan on passing our annuity to our children.”
Advisor: “One thing you may not realize is that an annuity is an IRD asset, which means it is subject to double taxation when passed to your children.”
Mr. James: “How so?”
Advisor: “Let me give you an example: if an annuity is purchased for $100,000 and two years later it is passed on to the children, having grown to a value of $110,000, then the children will have to pay income taxes on the $10,000 of growth. Of course, the value and the tax burden could be much higher if the annuity had a longer growth period. And as I mentioned, the monies could even be taxed twice if estate taxes apply.”
Mr. James: “So what’s the solution?”
Advisor: “There are certain nonprofit organizations that will allow you to transfer ownership of your annuity for a charitable planned giving program. Although the transfer will create a taxable event for the gain, you will receive an immediate income tax deduction, which many times reduces or eliminates the applicable taxable gain. The programs can be tailored to provide lifetime income or income for a specified period of years. This not only resolves the issue of passing a taxable event to your children, but the income tax deduction also lowers your taxable income for the current year with a five-year carry forward, if needed. Some programs have helped individuals cut their income taxes in half.”
Mr. James: “Sounds great so far. How does it work and what happens to my annuity?”
Advisor: “When you transfer ownership of your annuity to the nonprofit, they will provide you with a new contract that includes lifetime income or income for a specified period of years. The process is that simple, and you can still choose to defer the income until you want or need it. Once the income is started, it continues for a lifetime or for the period of years you’ve specified. If an unexpected death occurs and the income doesn’t start during your lifetime, your named beneficiary will receive the income based upon the program and options you chose.”
Mrs. James: “I’m starting to like this idea, but I thought you said our current annuity was a good decision.”
Advisor: “What you have is good if it is meeting your current needs.”
There are a few common reasons why people choose to proceed with this strategy, and none of them are a result of a wrong decision when they purchased their annuity. In most cases, they are able to take advantage of all these benefits:
1. They don’t want to pass a potential tax bill on to their children.
2. They would like to reduce their current tax bill and possibly put those tax savings back into their pockets.
3. They determine this is an effective way to support a charitable cause.
The scenario above is just one example of how a charitable planned giving strategy could benefit your clients. Now let’s review some of the highlights of each strategy.
Charitable Installment Bargain Sale
This program is a combination of a Charitable Bargain Sale1 and Installment Sale2. By using this program, clients can transfer a variety of assets such as annuities, real estate, and securities to a nonprofit organization and receive tax-favored income for a specified period of years. The income can begin immediately or can be deferred. The income is fixed for the specified period of years or increases each year the payments are deferred. Following the death of the original beneficiary, other beneficiaries (which may be heirs or charitable organizations) will receive the remaining payments. In addition, individuals will receive an immediate income tax deduction and capital gain reduction on appreciated assets, while reducing applicable estate tax liability.
Charitable Gift Annuity (CGA)
Another charitable planned giving strategy to consider is the widely recognized CGA3. A CGA offers lifetime income for the client and if desired, the life of the client’s loved one. The income may be immediate or can be deferred. The CGA can be funded with a variety of assets, such as annuities, real estate, securities, and cash. In addition, individuals will receive an immediate income tax deduction and capital gain reduction on appreciated assets, while reducing applicable estate tax liability.
A thorough understanding of these types of charitable planned giving programs and the tax and income benefits associated with them will undoubtedly make the financial professional more helpful in meeting needs of his or her clients. Strategic charitable planned giving can mean that a “hand out” for a worthy charity will also be a “hand up” for your clients’ financial future.
Jim Wolter is the vice president for development for the National Community Foundation (NCF), the development division of New Life International, a Christian non-profit organization. He started out as an independent life and health insurance agent nearly 20 years ago and was a top producer in benefit planning for business owners and small groups. Now Mr. Wolter works with agents all over the country, helping them build charitable planning into their practices.
Footnotes:
1. IRC § 1011.b and § 170
2. IRC § 453
3. IRC §501(m)(5)