How do you do well by doing good?
People like Bill Gates and Ted Turner grab headlines for giving money away. A lot of people you will never hear about are doing the same thing. Why do they do this?
There is a big incentive for wealthy people to give it away. They save a bundle in taxes -- both income tax and estate taxes -- while increasing their personal income and making some favorite charity very happy. One of the estate planning vehicles that makes this possible is the charitable remainder trust (CRT).
Larry Hanslits of
H Group & Financial Network
in Portland, Ore., has been the planning architect for numerous charitable remainder trusts. "They all play off the same theme, but in the hands of a skilled estate planner the benefits can be extremely impressive," he says. Investors who put their assets into CRTs:
- Eliminate the 20% capital gains tax on the sale of appreciated assets when they're sold by the trust.
- Receive an immediate federal income tax deduction for gifts to the trust; accordingly, 39.6% of the value of the charitable deduction becomes a bottom-line tax savings (assuming the contributing investor is in the top tax bracket).
- Create an income stream for life that is greater than if the asset was held or sold.
- Diversify an investment portfolio without having to pay a tax penalty to do so.
- Shelter significant amounts of principal from the claims of potential creditors.
- Avoid a 55% federal estate tax on the value of assets transferred to the trust. And instead of giving the government a lot of money investors can create a significant benefit for their favorite charity.
Let's look at an example of how CRTs can work. Assume you have a stock portfolio worth $800,000 that began 20 years ago with an investment of $150,000 (and you have other assets that put you in the top income and estate tax brackets).
So, $150,000 is your tax basis in the portfolio. Since the portfolio in this example is made up of growth stocks you are only receiving about 2% in dividends. That is about $16,000 of income. You feel locked in because you do not want to pay the 20% capital gains tax of about $130,000 if you liquidate the portfolio. To make matters worse, when you die, federal estate taxes will take about $440,000 (the 55% mentioned earlier).
Instead of doing nothing and living on the 2%, you decide to put the $800,000 in a charitable remainder trust; naming your favorite charity as beneficiary. The trust might pay you an income stream of, say, 8% of the $800,000 (the trust can pay anywhere from 5% to 50%). That is $64,000 annually, or $48,000 more than you were getting in dividends. (This income is taxable, by the way).
What makes this possible is the fact that the trust can sell all the stock and pay no income tax. Two other significant things also happen: You get a charitable tax deduction, thus reducing your tax bill. And when you die your estate will not pay any estate taxes because you no longer own the stock.
But while all that sounds great, you all of a sudden realize you have disinherited your kids, who were the beneficiaries of your estate. Even after paying estate taxes, they would have gotten
. So, to prevent your favorite charity from getting hate mail from your kids, you can replace the money that would have gone to your beneficiaries with some life insurance. Estate planners call this strategy a wealth replacement trust.
You create an irrevocable life insurance trust (ILIT) so the life insurance proceeds are not only income tax-free, but estate tax-free. Your kids, in my example, will then get the money tax-free.
There is still one not-so-little detail to work out. You need to decide how much life insurance you need and how to pay the premium. Some want to replace the whole $800,000 while others would merely replace what the beneficiaries would have received after estate taxes -- about $400,000.
The money to pay the premium usually comes from two sources that previously did not exist: savings from the tax deduction and from the increased income. The numbers for this example would look like this:
*charitable remainder trust. **irrevocable life insurance trust.
In the left hand column, I assume the stock was sold, and the after-tax amount of $670,000 was left in the estate. I realize that the money should grow, but I am just trying to simplify a very complex issue. A lot of details and a significant amount of planning are necessary to make this strategy work. If the concept applies to your situation, seek out an estate planning specialist. Do not try this on your own.
It looks like you really can do well by doing good!