CIG Wealth Management Update: Tax-Advantaged Giving Strategies
This year — clearly a highly unusual one in so many ways — there is even more need to carefully review philanthropic options that also have tax advantages.
As we enter the holiday season, many naturally turn their thoughts to charitable giving and yet, for the first time in nearly two decades, only half of U.S. households donated to a charity, according to a study from 2021 that is published every other year by Indiana University’s Lilly Family School of Philanthropy[i]. In the wake of the COVID-19 pandemic unemployment and food insecurity soared. In 2021, 53 million people turned to food banks and community programs for help putting food on the table, according to Feeding America[ii].
Taxpayers have until the end of the year to meet IRS deadlines, take advantage of tax rates that are locked in and qualify for charitable vehicles that are currently in place. There are two strategies they may want to consider: charitable lead annuity trusts and donor-advised funds. Note: these strategies tend to work best for those who can afford to designate a proportion of their income to charity on an ongoing basis.
An Under-the-Radar Option
A charitable lead annuity trust is a philanthropic option that’s a bit under the radar. It can be a good fit for those who have recently received a large influx of cash from, for example, selling a business or investment. It’s also an option for those who haven’t been able to deduct as much they’d like from their taxes.
The trust allows a donor to give cash, stock or real estate to a trust while offsetting income tax in the current year and potentially future estate taxes.
Even Jacqueline Kennedy Onassis included a charitable lead trust in her will, perhaps attracted by this benefit: Whatever assets are left in the fund at the end of the fixed term go to the donor’s beneficiaries tax-free.
A huge reason charitable givers should think about this kind of trust now: the lower the starting interest rate, determined by Section 7520 of the IRS code, the more the donor and his or her beneficiaries may benefit.
No Double Dipping
An upfront tax deduction and the ability to reduce estate and gift taxes — as well as the potential to pass on assets to heirs — make charitable lead trusts potentially very appealing.
But there are caveats. The funds in the trust are subject to investment management risk. After the initial tax deduction, donors can’t take any more deductions. No double dipping. Also, any capital gains or losses inside the trust flow back to the donor.
Charitable lead annuity trust are very complex vehicles. In addition to consulting with attorneys and accountants, it’s critical to work with a financial adviser to make sure any use of the trust is part of a holistic plan that aligns with your overall goals and interests.
Calling the Shots
Donor-advised funds (DAFs) are another attractive option for those who may have had a windfall this year or a bump in income. DAFs are a viable alternative to writing a check directly to a qualified organization or, for those with substantial wealth, starting a private charitable foundation.
Nonprofit divisions of financial service companies and other third parties, such as a community or church group, administer and legally control donor-advised funds. But as the name implies, individuals or families who set up the funds retain the ability to suggest or advise on where the funds should go.
The donors retain the ability to suggest or advise the donor on fund distributions.
Donors designate which IRS-designated 501(c)(3) charities receive money from the fund. They can change which organizations receive money and how much they get as often as they want.
What’s more, DAFs can be more attractive than family foundations because donors don’t have to worry about legal and administrative fees and can start one with as little as $5,000.
Any gift for the fund is an immediate tax deduction and the donor isn’t required to distribute it immediately. If you’re unhappy with the way one charity is operating, you can switch the distribution to one you like better. The donor calls the shots.
The tax benefits of a donor-advised fund are similar to contributions to religious institutions, colleges or public charities. Taxpayers who itemize can write off their cash donations up to 50% of the adjusted gross income. Those donating stock, real estate or any other asset that has appreciated can write off up to 30% of adjusted gross income. The unused amount can be carried forward up to five more years to be used as a deduction against income.
DAFs can serve as an appealing tax strategy for someone holding highly appreciated stock. If you were lucky enough to buy 100 shares of Apple (AAPL), 1.80% in 2008, for example, you can claim the current price of the stock as your tax-deductible donation. Meanwhile, the fund sells the stock and keeps the proceeds, but you don’t have to pay capital gains tax. In that way, you optimize your financial liabilities and make a powerful gift to charity at the same time.
People do need to keep in mind that once a donation is made to a DAF, it’s a completed gift. There’s no going back.
How Much in Benefits?
The tax benefit depends on your effective tax rate. For philanthropic options like DAFs, the benefit is not necessarily how much more you get in tax savings today, but the control you maintain over your donation.
And in the case of a charitable lead trust, it’s the ability to potentially retain some of your money down the road in the form of a tax-free payment to an heir or a beneficiary when the term of the trust runs out.
For both these strategies, financial advisers play a crucial role.
They will — or should — have a comprehensive plan for you and can identify whether the strategy is appropriate. Does it make sense for you or not?
Advisory firms will walk you through the financial planning process to make sure the tax or philanthropic option is truly viable.
You never want a complex strategy involving significant assets to be a one-off, where you’re just trying to get an edge on your taxes. You have to know how it affects the other pieces of your overall plan.
[i] https://scholarworks.iupui.edu/bitstream/handle/1805/26934/philanthropy-crisis-nov21.pdf?sequence=1&isAllowed=y
[ii] https://www.feedingamerica.org/hunger-in-america
CIG Capital Advisors and its affiliates do not provide tax, legal or accounting advice. This material being presented is for informational purposes only and is not intended to provide, nor be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
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CIG in the News: MarketWatch, “Three ways to maximize your wealth”
With rising taxes and inflation likely on the horizon, what are you doing to adjust your wealth management plan? CIG Capital Advisors’ managing principal Osman Minkara outlines a three-bucket strategy to help you prepare in MarketWatch.
CIG in the News: Marketwatch, “How to cut tax bills with smart charitable giving strategies”
As we enter the holiday season, plans for charitable giving are moving to the forefront. This year, the pandemic has reduced giving opportunities while simultaneously increasing need, causing donors to carefully review philanthropic options that include tax advantages. CIG Capital Advisors’ Senior Wealth Managers Eldin Foco and Martin Swiecki outline two strategies to consider in MarketWatch:
How to cut tax bills with smart charitable giving strategies
As we enter the holiday season, many naturally turn their thoughts to charitable giving. This year —clearly a highly unusual one in so many ways — there is even more need to carefully review philanthropic options that also have tax advantages. Click here to read more.
Physicians may consider a CLAT (Charitable Lead Annuity Trust) as a tax-saving strategy
The combination of a low key interest rate and a large influx of cash some physician-owners may experience, after, for instance, selling his or her private practice, could make a CLAT (Charitable Lead Annuity Trust) a desirable vehicle for tax- and legacy-planning purposes.
An illustrative case* involves a hypothetical physician-owner selling his practice and sheltering $500,000 of the proceeds in a CLAT. You can see, in the flow chart below, that the one-time contribution of $500,000 to the CLAT allows for an annual gift to the charity of his choice of $26,117 over the next 20 years, and then an eventual tax-free gift at the end of those 20 years of $864,158 to the beneficiary of his choice:
This is, of course, a hypothetical example not indicative of any particular client, with a 7% annualized growth rate assumption over 20 years. What makes this strategy relative is that it relies on a favorable IRS 7520 rate to take advantage of an arbitrage opportunity. Right now, the IRS 7520 rate is extremely low, but those rates do fluctuate, as you can see in the table below:
An IRS 7520 interest rate of 3.6% vs. 0.42% can impact the trust’s remainder value by almost $400,000 ($479,518 using December 2018’s rate vs. $864,158 using August 2020’s rate), as in our case study of the $500,000 CLAT.
Please contact our wealth management team in order to properly evaluate if this strategy is right for you and begin the financial planning process. Please speak to your tax professional to understand the cost and tax implications of your particular giving situation.
*All case studies and references are hypothetical examples developed by the CIG Capital Advisors team and the values shown are not intended to represent those of a client or known person. Assumes annualized growth rate of 7%.
Financial Resilience Amid Disruption: Your Tax Strategy
Policies around tax and some types of debt have changed during the pandemic, and some individuals may be able to take advantage of the new circumstances:
Lower Interest Rates: Interest rates are lower than they have been in several years, allowing some borrowers to refinance or take out a new loan or mortgage. If you currently have a mortgage or investment properties, restructuring the debt on these properties could yield large savings.
Charitable Deductions: Lower IRS 7520 rates for charitable trusts means that when gifting assets (cash or securities) to a Grantor Charitable Lead Annuity Trust, the IRS requires you to gift all the assets you contributed to the trust plus the interest. The interest rate used is the IRS 7520 rate. This rate is fixed for the life of the trust and sets the amount that needs to be distributed every year for the life of the trust. The difference between the fixed distribution and the growth within the trust will be passed to the beneficiary of the trust. The lower the 7520 rate, the greater potential for growth. For a CLAT with an initial value of $200,000, the below 7520 rates would yield the corresponding tax-free transfers to the remainder beneficiary:
Values are not intended to represent those of a client or known person.
Charitable Lead Annuity Trust (CLAT) is a plausible option to offset tax liabilities, gift annually, and set aside tax-free assets for a designated beneficiary in the future.
- Transfer
of cash/securities to trust in first year
- Immediate
deduction for gift to trust offsets…
- Increased level of income
- Realized Capital Gains
- Annually
gift for a set term from the trust to…
- Public Charity,
- Family foundation, or
- Donor Advised Fund
- Remaining balance at end of term is transferred to Remainder Beneficiary as a tax-free asset
- Immediate
deduction for gift to trust offsets…
Waiver for RMD in 2020: In March, required minimum distributions for retirement accounts were waived for 2020. An example of how a hypothetical person over age 70 could save on taxes by not taking RMD in 2020:
Assumes effective combined federal and state tax rate of 30% for hypothetical purposes. Values are not intended to represent
those of a client or known person.
Increased 401k/403b Loan Limits: Previously, penalty-free early withdrawals was the lesser of $50,000 or 50% of vested balance. Now, penalties don’t kick in until the lesser of $100,000 or 100% of vested balance, allowing savers to borrow more from their retirement accounts without penalty.
Opportunity for Roth Conversion: In a down market, with depressed values of pre-tax IRA accounts, it could be a good time to convert the account to a Roth IRA, where the funds can grow tax-free:
hypothetical purposes. Values are not intended to represent those of a client or known person.
This allows the saver to pay taxes on the lower account value this year, and once converted the money can grow, hypothetically, tax-free:
To take advantage of these or any other tax strategies, please schedule an intitial complimentary consultation at www.calendly.com/mswieckicig.
Charitable trusts and the difference between a charitable lead trust and a charitable remainder trust
For many of us, philanthropy can provide great personal satisfaction. However, when properly planned for, charitable giving can provide financial benefits both today (as an income tax deduction and/or capital gains tax shelter) and in the future (when the amount of taxes your estate may owe when you die can be reduced).
There are many ways to give to charity. A common vehicle for many families is a charitable trust, where a charity is named as the sole beneficiary. You may name a non-charitable beneficiary as well, splitting the beneficial interest (this is referred to as making a partial charitable gift). The most common types of trusts used to make partial gifts to charity are the charitable lead trust and the charitable remainder trust.
What is a charitable lead trust?
A charitable lead trust pays income to a charity for a certain period of years, and then the trust principal passes back to you, your family members, or other heirs. The trust is known as a charitable lead trust because the charity gets the first, or lead, interest. A charitable lead trust can be an excellent estate planning vehicle if you own assets that you expect will substantially appreciate in value. If created properly, a charitable lead trust allows you to keep an asset in the family and still enjoy some tax benefits.
SOURCE: Broadridge Investor Communication Solutions, Inc. Copyright 2017
What is a charitable remainder trust?
A charitable remainder trust is the mirror image of the charitable lead trust. Trust income is payable to you, your family members, or other heirs for a period of years, then the principal goes to your favorite charity. A charitable remainder trust can be beneficial because it provides you with a stream of current income — a desirable feature if there won’t be enough income from other sources.
SOURCE: Broadridge Investor Communication Solutions, Inc. Copyright 2017
Note: There are expenses and fees associated with the creation of a trust. Please speak to your financial and/or tax professional to understand the cost and tax implications of your particular giving situation.
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