Financial Advice for Retirement, Social Security, IRAs and Estate Planning

Legacy Planning & Your Estate Plan: Part 2

When it comes to legacy planning, it’s all about the details.

Before deciding to make specific bequests or other gifts from your estate, consider these additional strategies discussed below.

Beneficiary designations

Bequests of cash or property from your estate often are not the most tax efficient way to make charitable gift. That’s especially true when appreciated assets are involved.

As I pointed out in our last issue of Retirement Watch Weekly, there are tax advantages to leaving appreciated assets to your heirs.

Under current law, when appreciated property is inherited, the beneficiary increases the basis to its current fair market value.

There will be no capital gains tax on the appreciation that occurred while you owned the property.

It’s better to look for other ways to contribute to charity.

A better way to give might be to name a charity as beneficiary of your traditional IRA or employer retirement plan.

If your loved ones are named beneficiaries of these accounts, in the future they’ll be taxed on distributions the same way you would be.

In most cases, the distributions are treated as ordinary income and taxed at the recipient’s regular tax rate.

When your estate is valuable enough to face estate taxes, the retirement account also will be subject to the estate tax.

Your loved ones really inherit only the after-tax value of retirement accounts while they inherit the full value of cash and other assets.

Charities are tax-exempt. When they inherit traditional IRAs or retirement plans, they take the distributions tax free.

There’s also no income or estate tax to the estate, regardless of the estate’s value.

Everyone comes out ahead when you name a charity as beneficiary of a retirement account instead of having the estate contribute other assets to the charity.

You don’t have to leave an entire account to the charity. You can update the beneficiary designation form so the charity receives only a percentage of the retirement account.

Life insurance

Some people buy permanent life insurance and name a charity as beneficiary.

They want to leave their estates intact to their heirs while providing a guaranteed gift to charity… and perhaps be able to leave a policy with a benefit that exceeds their premiums.

There’s another way to use life insurance to create a charitable legacy.

Many people have paid-up permanent life insurance policies they no longer need. Often, the policies were purchased years ago.

Sometimes they were purchased by or through an employer. As your obligations to dependents decline and your estate increases, the life insurance no longer is as important as it was.

In these cases, consider naming a charity as full or partial beneficiary of the policy. There’s no effect on your lifetime cash flow.

You benefit a charity at no additional cost to you and still leave your full estate to your heirs.

Charitable gift annuities 

Annuities can be a good supplement to a retirement plan. They deliver fixed, guaranteed income for life, no matter how long you live.

Your retirement can be more secure when you have guaranteed income to cover basic expenses.

When you’re charitably inclined, consider purchasing a charitable gift annuity instead of a commercial annuity.

You’ll receive a lower monthly payout with the charitable annuity, but you’ll receive a current income tax deduction for making that gift.

You deposit a lump sum with the charity, and it promises to pay you a fixed amount for life.

You can have the payments begin right away, or you can defer the payouts and receive a higher income beginning in a few years.

Most charities pay at the maximum rates determined by the American Council on Gift Annuities. Recently, the annuity rates at key ages were 4.7% at age 65; 5.1% at 70; 5.8% at 75; and 6.8% at age 80.

For example, Max Profits is 70 years old and deposits $25,000 with a charity under a charitable gift annuity contract. His annuity rate will be 5.1%.

Using IRS tables that incorporate his age and current interest rates, Max will receive a $9,495 charitable contribution deduction in the year he deposits the money with the charity.

The charity will begin paying Max $1,275 annually right away, with $975 of that being income tax free until Max has recovered his $25,000 investment.

Keep in mind that the promise to make the payments is backed only by the charity. No other entity guarantees or backstops the charity. You want to be sure the charity is financially secure.

Charitable remainder trusts

When you have cash or appreciated investments that you’d like to generate income and a current income tax deduction, consider the charitable remainder trust (CRT).

Suppose Max Profits has $500,000 of stocks. He’s held them for a number of years, so his tax basis in them is only $250,000.

If he sells them to diversify his portfolio and generate cash for his retirement expenses, he’ll pay capital gains taxes, which would be $50,000 at the maximum 20% rate.

Instead, Max forms a CRT which will pay Max and his wife, Rosie, income for life. After they have passed away, a charity will receive the remainder of the trust balance.

Max donates the securities to the trust. He owes no tax on the transfer.

The trust can sell the securities and reinvest them without paying any taxes, because it is a charitable trust. The CRT won’t be included in either Max’s or Rosie’s estate for federal estate tax purposes.

Max receives a charitable contribution deduction on his income tax return for the year he donates the securities to the trust.

The deduction is a portion of the value of the securities. And the deduction varies based on current interest rates and the ages of Max and Rosie.

The older they are, the higher the deduction.

The CRT can work with appreciated real estate in addition to securities.

Max can set up the CRT as either an annuity trust or a unitrust.

An annuity trust pays a fixed dollar amount each year. The unitrust pays a fixed percentage of the trust value each year, so it will fluctuate with changes in the value of the trust assets.

The IRS limits the unitrust payout rate to between 5% and 7% in most cases and has similar limits on the annual payout from the annuity trust.

Many larger charities have the infrastructure to make the CRT low cost and efficient. The charity will serve as the trustee, administering the trust and filing tax returns.

The charity also might have a foundation or other investment arm that can invest the trust along with the rest of its assets.

Often, the charity will perform these tasks for no fee or very low fees.

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