Planned Giving and Endowments
What is planned giving?Many potential donors desire to give a charitable gift but are unable to do so immediately as they need their assets in order to provide income to themselves, their spouses, or other persons. For these donors the solution may be a form of planned (or deferred) giving. With deferred giving, the charity receives full use of the gift asset at some later date.
Many types of planned giving you may already be familiar with. Some of these are described briefly below.
Bequest:
By far, the most common form of deferred giving, an outright charitable bequest is made through terms of a will. It may be either a specified amount, a percentage of a final estate, or the residual of an estate after all other specific bequests have been made.
Life Insurance Policy:
A charity may be named as beneficiary on a life insurance policy.
Retirement Plan or IRA:
A donor may designate a charity as a beneficiary of a retirement plan, IRA, or annuity, payable upon death. As a not-for-profit, the charity would not be subject to income or estate taxes on retirement plan assets, which non-charity heirs would be subject to.
Charitable Gift Annuity (CGA):
In exchange for a gift to a charity, the charity provides up to two individuals, which may include the donor, with an income for life or lives. The annuity amount is rated based on the age of the donor. At the death of the donor or donors, the remaining funds are available for use by the charity.
Charitable Remainder Trust (CRT):
Funds are irrevocably transferred to a trust, which pays an annuity to the donor or other beneficiaries for an agreed-upon term of years or for life. At the conclusion of the term, the trust distributes the remainder to the Charity. Trusts are more commonly used for larger gifts.
Charitable Lead Trust (CLT):
Funds are irrevocably transferred to a trust that provides annual income to the Charity for a life term or a term of years, with the remainder transferred back to the donor or to the donor’s designated beneficiaries. It is useful to donors who do not need income from an asset for a period of years, but wish to transfer it to others with little or no gift or estate taxation.
Planned gifts provide many benefits including the satisfaction that donors will have knowing they are helping an institution to fulfill its mission for many years to come. Another benefit is the peace of mind that the donor feels knowing that estate plans are in order and personal needs as well as those of loved ones will be met while charitable intentions will be fulfilled upon death. Additionally, many deferred gifts receive favorable tax treatment. Capital gains taxes can often be avoided or deferred, and some deferred gifts receive charitable gift deductions on your federal income tax.
What is a charitable bequest, and how does a donor execute one?
A bequest refers to the transfer of assets at death through operation of the donor’s will. The donor’s will must meet the state requirements for a valid will, which usually indicates, among other things, that he must be mentally competent, the will must be in writing, and it must be witnessed. Other instruments such as revocable trusts, transfer of jointly held property, and naming a charity as a beneficiary of a pension or other fund are other methods in which a donor may make a transfer of assets to charity at death.
A charitable bequest, to be effective, must include the correct legal name of the charity organization. To provide a charitable deduction, the charity organization must be included under the IRS rules for estate tax deductions.
There are several ways in which a bequest may be expressed:
- It may be a specific dollar amount, such as $10,000, $100,000 or $1 million.
- It may be a percentage, such as 1%, 10% or 50% of the gross estate or residual estate.
- It may direct that a specific asset, such as a stock fund, an IRA, a house, or an art collection go to the charity.
- Or it may be a contingent bequest, which is effective only after certain conditions are met. For example, the donor may say “all of my estate goes to charity if my wife predeceases me.”
- The donor may create a logical formula involving shares of the estate, or proportions.
- The donor may use a combination of methods.
Why is the donation of a retirement plan, such as an IRA a preferred bequest?
For a donor who wishes to make a bequest, a charitable gift of a qualified retirement plan or IRA assets can give the donor and heirs savings on estate and income taxes while assisting the Charity. With proper tax and legal advice such gifts are often a preferred form of bequest.
Retirement plan assets are one of the most commonly owned assets. For many individuals, a retirement plan is their single largest asset. Tax incentives make these a preferred way to save and their asset growth has been significant in the past decade. However, after death, when these assets must be passed on to heirs, they are subject to heavy taxation. By leaving such assets to a charity, significant tax savings for both the estate and the heirs can occur. It is sensible to make a gift with an asset that generates the best tax benefits.
Case Study: Gift of an IRA
A donor has qualified retirement plan assets worth $1.5 million and other assets worth $2.5 million. She wants to give $1.5 million of her total $4 million estate to charity and the balance to heirs. A comparison of the two options of contributing the retirement plan or other assets is shown below. Note that these calculations do not take into consideration additional state taxes on inheritances in many states:
| Gift of Gift of Retirement Plan | Other Assets | |
| Gross Estate | $4,000,000 | $4,000,000 |
| Gift to charity | 1,500,000 | 1,500,000 |
| Adjusted Gross Estate | 2,500,000 | 2,500,000 |
| Estate Tax Exclusion Amount (2004) | 1,500,000 | 1,500,000 |
| Taxable Portion of Estate | 1,000,000 | 1,000,000 |
| Estate Taxes Due (2004) | 345,800 | 345,800 |
| Balance to Heirs | 654,200 | 654,200 |
| Income Taxes Due on Retirement Plan | | |
| Distributions (lump sum at 35.0%) | 0 | 228,970 |
| Net After-Tax Balance to Heirs | 654,200 | 425,230 |
The benefits of using a CRT as the beneficiary of a decedent’s retirement plan:
A donor may choose to establish a Charitable Remainder Trust at death that could be funded with retirement plan funds. This testamentary trust allows the decedent to name beneficiaries who could receive all of the net income from the trust during their lifetimes or for a term of years. At their death or at the end of the term, the designated charity receives the unused balance of the assets. The income tax on the unused balance of the retirement account is not only deferred, it is eliminated. The CRT also can be structured so that the income is generated over multiple generations; thus the amount paid to the heir beneficiaries may equal or exceed the amount that would have been received directly from the IRA.
As with other charitable gifts, the estate would receive the benefit of the charitable deduction from the donation. If the non-charitable beneficiary is the account holder’s spouse, then the account holder’s estate will also be entitled to an estate tax marital deduction on the spouse’s CRT income interest.
Either a CRUT or a CRAT may be established with a testamentary trust.
An account holder may want to provide for children through an IRA or qualified retirement plan. Use of a CRT may be more advantageous than an outright bequest of the fund income or other asset to a child for several reasons. First, a bequest to a CRT creates an estate tax charitable deduction, which will act to reduce estate taxes. Additionally, the transfer of the IRA to the CRT does not trigger immediate income taxation. Income is taxed to the beneficiary of the CRT as it is received.
Although the IRA eventually passes to the Charity and the assets are lost to the family forever, the immediate reduction in income and estate taxes preserves more of the original principal. This additional principal will generate additional income for the non-charitable beneficiary. A part of this income may be used to replace the assets lost to the family by obtaining life insurance. The structure is particularly beneficial to those with charitable bequest intentions.
What is a charitable lead trust, and how may it be useful to donors?
A Charitable Lead Trust (CLT) is a current irrevocable transfer of cash, securities, or other property to a trust that meets the IRS rules to qualify as a CLT. It operates in the reverse of a CRT, in that it provides income to the charitable beneficiary for a life term or a term of years, with the remainder transferred back to the donor or to the donor’s designated non-charitable beneficiaries. It is useful to donors who do not need income from an asset for a period of years, but wish to transfer it to others with little or no gift or estate taxation.
The elements of a lead trust are the transfer of a guaranteed income interest to charity, with an annual distribution for a term of years or lives. The remainder at the end of the term reverts to the grantor or to other individuals named by the grantor. CLTs are generally governed by the private foundation rules on self-dealing, and have certain restrictions on investments.
There are two types of CLTs–grantor and non-grantor trusts–with differing tax implications. In the grantor trust, in which the remainder reverts to the grantor, the grantor receives both income tax and transfer tax charitable deductions. The maximum income tax deduction is thirty percent of the donor’s AGI for cash and twenty percent for appreciated securities, with unused portions of the deduction carried over for five future years. For a grantor trust, the trust income received by the charity is includible each year in the donor’s income.
Non-grantor trusts, in which the remainder goes to other individuals designated by the grantor, do not provide an income tax charitable deduction, but they do provide a gift or estate tax deduction. The annual trust income going to the charity is not included in the grantor’s income. Careful planning is needed to determine whether a grantor or non-grantor trust is more appropriate for the donor’s particular situation.
CLTs may provide a guaranteed annuity amount (CLAT) or an annually revalued unitrust amount (CLUT) to the charity. There are no minimums or maximums. A CLUT may accept additional contributions to the trust, while a CLAT may not. The term of the trust, if based on lives, must be based on the lives of individual beneficiaries alive at the time the trust is created. If based on a term of years, there is no minimum term, and the maximum term is determined only by state laws regarding operation of trusts.
What is a Charitable Gift Annuity?
A Charitable Gift Annuity is a vehicle for making a gift that serves as a lasting contribution to a charitable organization. It is a simple and established technique for securing a lifetime income and minimizing taxes. In its simplest form, the donor transfers cash, securities, or in some cases real estate to an established charity in exchange for the charity’s promise to pay an annuity to the donor and/or other named beneficiaries. The value of the charitable contribution is the difference between the annuity value and the value of the property transferred. In addition, a portion of each annuity payment is deemed a return of the original investment and is tax-free to the annuitant over his or her life expectancy as determined by actuarial tables. At the end of the annuity term the charity may use all of the remaining funds for its charitable purposes.
Annuity payments can begin immediately or can be deferred for a specified time period. If payments are to begin at a specified time in the future, for instance upon the donor’s retirement, and the planned start date is at least one year from the date of the gift, the arrangement is called a “deferred charitable gift annuity”. A high-earning donor may not need or want immediate additional income but might benefit from current income tax relief. A deferred gift annuity lets a donor postpone the starting date of annuity payments, increase the amount of payments once they begin, and increase the amount of their current income tax charitable deduction. Thus the deferred gift donor benefits from tax relief during high-income years and a higher income stream later on when he or she may have a greater need for annuity income.
The dollar amount or annuity rate the annuitant receives depends upon the age of the annuitant or annuitants (up to two persons). To avoid competition among charities for gift annuity donors, recommended rates have been established by the American Council on Gift Annuities, and most charities follow these rates for most gift annuities they establish. Rates effective as of July 2007 range from 6% to 11.3%. Older annuitants with shorter life expectancies receive higher income payments. An annuity established to provide income for two beneficiaries, rather than one, will provide a smaller income payment. This is because the life expectancy of two individuals is actuarially longer than that for one, even if they are the same age.
A Charitable Gift Annuity offers a number of benefits to the charity:
- it establishes an irrevocable gift;
- it can be used to make a significant one-time gift;
- it can be used to make a series of smaller, repeat gifts;
- it is easier to explain to donors and to implement than certain alternative gift vehicles; and
- the minimum gift amount usually is sufficiently low to make the gift annuity attractive to a large part of the Charity’s donor base.
What is an example of the use of a Charitable Gift Annuity?
Jack Donor has been contributing to his favorite charity for over twenty years. Jack, age seventy-two, has expressed an interest, in providing for the charity with a bequest equal to about 5% of his gross estate, which is about $1 million.
Jack currently seeks to increase his household income to help cover the expenses of his wife Jill’s illness. In his stock portfolio, he has one security with a current market value of $50,000 for which he paid $10,000 in earlier years. In recent years, these stocks have been paying him dividends of about 2% per year. He has considered selling the stocks, paying the $6,000 taxes (15%) of the $40,000 capital gains, and investing the $44,000 balance in an income producing fund, which he feels would give about 4% return rate, or $1,760 of taxable income per year.
Sarah, the planned giving officer, stops by to thank him for his continued interest in giving a bequest. While there, she shows him an illustration of how a gift annuity would work in his situation. At age seventy-two, he would receive a 6.7% annuity rate, according to the ACGA tables. In return for a $50,000 contribution, Jack would receive $3,350 per year in income for life, a nice increase over the $1,000 he currently receives from dividends or $1,780 from a taxable income fund.
But, because of the charitable deduction and the reduced capital gains taxes, the after-tax financial benefit of the gift annuity is much better. As of June of 2004, the IRS values Jack’s life income stream from the gift annuity at $29,995. The donor therefore receives a charitable tax deduction for the balance, or $20,005. The tax savings of about $6,201 (31.0% bracket) may be reinvested, which reduces the actual cost of the gift annuity to about $43,799. On this adjusted investment basis, the income of $3,350 is equivalent to a 7.6% return. Also, a $414 portion of each annual payment is received completely tax free, and $1,656 of each annual payment is taxed at the 15% capital gains rate. Thus, for comparative purposes, the after-tax equivalent rate of return is 9.0%, which is much better than the 4% he would receive from the stock fund reduced by its capital gains taxes then invested in an income portfolio.
Jack decides to establish the gift annuity. The bequest Jack has discussed will be virtually guaranteed. He may continue to include a provision on the will, reduced by the gift annuity or not reduced, which will add to this fund upon his death. Everybody benefits from the new gift annuity.
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