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The Charitable Planning Balancing Act

The Charitable Planning Balancing Act


In recent years, there’s been no shortage of discussions on the importance of advisors raising the topic of charitable giving with clients, as they contemplate their estate and financial plans. 

In my experience, these discussions take many forms. In some cases, philanthropically inclined clients will quickly take the lead and have definite ideas about how they want to structure the charitable element of their plans. In these cases, the “gift” comes first and the “plan” tends to follow.

In other instances, advisors drive the conversation, and it’s primarily directed at ways to minimize taxes, increase income, diversify investments or incorporate other factors that primarily focus on harnessing all possible planning advantages for the donor. In this case, we might say the “plan” is central with the “gift” occurring as a somewhat secondary consideration.

In practice, both of these situations exist. Advisors will always be challenged to help clients balance what can be multiple layers of intertwined personal and philanthropic motivations. In fact, helping clients reconcile seemingly conflicting desires in the charitable arena can be one of the more rewarding aspects of personal financial and estate planning.


Impact of Tax Changes

Recent reductions in estate and gift taxes, combined with increased taxes on ordinary income and capital gains, have in many cases changed the dynamics familiar to many planners. For a large number of clients, the inevitability of estate taxes in the past tended to dominate their planning, even those of relatively modest means. In some cases, for example, estate plans would direct that all or a large percentage of funds in excess of estate tax exemptions be transferred to charities. For many decedents, leaving those types of provisions unaddressed may have resulted in the unintended reduction or elimination of charitable dispositions that the client desired for nontax reasons.

Over the past decade, as the economy faltered and the tax environment shifted, many charities discovered the powerful leverage that nontax motivators can have in prompting larger gifts as a component of their donors’ estate plans. As asset values plummeted during the Great Recession, many campaigns found that large goals weren’t obtainable under traditional gift crediting standards. Campaigns thus increasingly began to include “endowment components,” “future gift funds” and other designations that amounted to giving current gift recognition for future gifts.

These gifts typically fell into two categories. Some campaigns only gave credit for irrevocable deferred gifts, such as charitable remainder trusts, charitable gift annuities, pooled income funds, remainders following life estates in real property and so on. In other cases, campaigns gave credit for revocable gifts to be received in the future, such as bequests via wills, living trusts, remainders of retirement plans and life insurance proceeds. It wasn’t uncommon for these gifts to comprise 30 percent or more of the totals of campaigns, including many campaigns with goals in the $100 million and greater range.

From the charities’ perspectives, they were able to squeak through and achieve what may have appeared to be otherwise unattainable goals. They declared victory and began planning the next round of campaigns that are now beginning at a time when asset values have rebounded past pre-recession levels.  

Despite economic recovery for many, the impact of the negative wealth effect of the period following the 2008 meltdown still lingers. Concurrently, the first baby boomers are now approaching age 70. Many of them are facing the prospect of a very long period of retirement at a time when elderly parents and underemployed millennials are adding to financial pressures.  

This situation doesn’t mean that large charitable gifts will grind to a halt for all except the uber wealthy. It does mean, however, that many even relatively wealthy baby boomers may be increasingly reluctant to make large outright gifts with “no strings attached.” Instead, in many cases, they’ll make gifts that help increase their financial security and/or address temporary impediments that, in their minds, would otherwise make it impossible to give.


Win-Win Situations

Clients motivated by multiple considerations to make larger gifts, and charities that are increasingly interested in the present value of those gifts and the cash flow they provide, will present challenges to planners as they strive to help donors maintain or enhance their financial security while they also provide for a gift that the charitable recipient will value and recognize.

The days of charities giving full credit in a campaign for a $1 million, 6 percent charitable remainder unitrust (CRUT) for the lives of a 55-year-old baby boomer couple may be over. The financial officers of charities are increasingly involved in the gift crediting process; they’ll “do the math,” and credit for gifts will be based on their present value.  

If such a trust earns an 8 percent total return over its anticipated 35-year period, the corpus should grow to $2 million. If the charity discounts that amount to present value using an 8 percent opportunity cost, the gift will be valued at $135,000. Could it be that the Treasury has also “done the math,” and that’s why this gift results in a charitable income tax deduction of just $165,000?

From the donors’ standpoints, they’ll enjoy a tax-free trading environment for an estimated 35 years, and much of their income will be taxed favorably under the tier structure of income reporting that applies to charitable remainder trusts.


Balancing Interests

The task will increasingly be to work with clients and their charitable interests to craft gifts that help meet financial challenges younger individuals face, while not requiring a charity to wait until donors pass away to reap any benefit.

In the above instance, there are several ways to enhance the value of this gift for campaign crediting purposes. One approach is to create two trusts, each funded with $500,000. The first trust would make payments for 15 years until the couple retired at age 70, and the charity would receive the balance of that trust, estimated to be worth $673,000 at that time. The present value of the 15-year CRUT is about $212,000. When added to the $68,000 present value of the other trust that lasts for the remainder of the donors’ lifetimes, the total gift value is now just under $280,000.  

While the donors will only have the income from both trusts for the first 15 years, that’s the time when they anticipate needing the additional income for educational expenses, weddings, etc. They expect the mandatory withdrawals they’ll begin taking from their retirement plans at age 70 will more than offset the lost income at the time the first trust ends.

Another possibility to provide income to the couple from the entire amount funding the trust for the remainder of their lives is to carve out an income interest for the charitable recipient equal to 20 percent of the income distributed each year. The first year the donors would receive $48,000 and the charity $12,000. By Year 35, the donors’ income interest would amount to $96,000, and the charity would receive $24,000. Over the period of the trust, the donors would receive income totaling $2.5 million and the charity about $624,000. The present value of the charity’s income interest is $175,000. When added to the $135,000 present value of the trust remainder, the total value of the gift is $310,000.

Donors may be interested in the latter alternative if they’re more interested in receiving a larger income in their later years after retirement and would like to be credited with a larger gift today.

Under these examples, we see a $1 million, 6 percent CRUT for the life of a 55-year-old couple with a gift value for charitable credit purposes ranging from $135,000 to $310,000, depending on how the charity and the donors divide the income and trust corpus over time.

There are any number of ways to structure split-interest gifts depending on the age of donors, their level of donative intent, the type of property used to fund a trust and many other factors.  

At a time when numerous surveys reveal that the majority of affluent individuals say they’d like to include charitable gifts as part of their financial and estate plans, it’s increasingly vital that all parties work together to achieve an outcome that may better balance the needs of the donor and the charity.

TAGS: Philanthropy
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