Legacy planning is one of the most neglected parts of financial and estate planning.
That’s too bad, because good choices about leaving a legacy can have powerful effects.
Too often, estate planners and individuals focus only on the tax effects of potential giving strategies.
But focusing more on non-tax effects and making shrewd choices can significantly enhance your legacy and the benefits you and others receive.
There are many ways to make legacy gifts and transfers.
The strategies are very flexible and can have very different results.
You can leverage the benefits of your gifts, enhancing the financial security of you and your heirs while being philanthropic.
Estate planners often refer to these strategies as planned gifts or planned giving. Most people give primarily through their wills or living trusts.
Lifetime giving strategies can generate the trifecta of current income tax benefits for you, income for you or your loved ones, and gifts to charity.
The first issue is whether to give during your lifetime or wait to give through your estate. Once your financial security is set, it’s a good idea to consider some lifetime giving.
You might receive tangible or intangible benefits (such as seeing how your gifts help others). You also can structure lifetime gifts to increase your family’s after-tax wealth.
For those reasons, economist Meir Statman says people should consider lifetime giving, or as he puts it, give with a warm hand instead of a cold hand.
But if you want to focus on the tax benefits of giving, consider this: Few people receive tax benefits for gifts made through their estates, because most estates are exempt from the federal estate tax.
Making gifts during your life, however, can generate income tax benefits. When you’d like to benefit one or more charities with some of your lifetime savings, either through your estate or during your lifetime, review these strategies with your estate planner to determine the best moves for you.
A bequest is a gift in your will or living trust that takes effect after you pass. You hold and control the assets during your lifetime. Yet, there are different ways to make bequests, and your choice can make a big difference to the charity and your other beneficiaries.
A specific bequest can be either a stated dollar amount or a particular asset.
For example, your will could state that you leave $50,000 to a particular charity or to each of several named charities. Or you could leave a certain number of shares of a stock or mutual fund, or even a parcel of real estate.
It is simple and straightforward, and probably the most common way posthumous gifts are made.
You need to think carefully how you phrase and set specific bequests, because there are a few risks.
Suppose last year you updated your will to state that a certain charity should receive a fixed dollar amount that, at the time, was about 10% of your estate.
Recently, with stock indexes down 20% or more, the value of your estate might be lower and the charity would receive a higher percentage of your estate.
Your heirs would receive less than you planned, and it could be significantly less.
The point is that when you make a specific bequest to charity of particular property or a particular amount of money, the results could be very different from what you intended because of fluctuations in the value of your estate and of particular assets.
An alternative is the residuary bequest.
The residuary is the part of your estate left after specific bequests have been filled.
Suppose you have a $5 million estate and decide a minimum of $4 million should pass to your family.
The will includes specific bequests of at least $4 million to family members, and more if the estate increases in value.
Any remaining amount is the residuary estate. If the value of your estate declines, there might be little or no residuary estate.
A residuary bequest can be of the full residuary estate or a percentage of it. It also can be of specific property you expect to be in the residuary estate.
The amount that goes to charity will depend on your estate’s value when you pass away.
Charities might receive nothing, or they might receive considerably more than you anticipated when drafting the will. Instead of making only specific or residual bequests, some people add a safeguard to their plans.
One safeguard is to say charitable gifts will be made only if the estate is worth at least a minimum amount.
Another safeguard is to cap charitable gifts at a percentage of the estate or dollar amount, regardless of the other terms of the will.
For example, a will can say that a charity will receive $50,000 or 10% of the estate, whichever is less. The will also can add that charitable gifts won’t be made at all if the estate is worth less than a stated amount.
These safeguards ensure there will be a minimum inheritance for your loved ones and prevent you from having to update the plan each time asset values change.
Before deciding to make specific bequests, consider the other strategies discussed below. You might find one or more of them provide more benefits for you, your family, and the charity.
Bequests of cash or property from your probate estate often are not the most tax efficient way to make charitable gifts.
That’s especially true when you own appreciated assets. Your family and other beneficiaries receive tax breaks when they inherit appreciated property.
The beneficiary increases the basis to its current fair market value. No capital gains tax is due on the appreciation that occurred while you owned the property.
The property can be sold immediately, and no capital gains taxes will be due.
A better way to give to charity often is to name a charity as beneficiary of your traditional IRA or employer retirement plan.
If your loved ones inherit as beneficiaries of these accounts, they’ll owe taxes on distributions just as you would have. In most cases, the distributions are treated as ordinary income and taxed at the recipient’s regular tax rate.
(If your estate is subject to the federal estate tax, retirement accounts will be included in the taxable estate.)
Your loved ones really inherit only the after-tax value of retirement accounts while they inherit the full value of other assets, especially appreciated assets.
Charities are tax-exempt.
When they are named beneficiaries of traditional IRAs or retirement plans, they take the distributions tax free.
The estate also avoids income and estate taxes on those amounts. The full amount of the retirement account benefits the charity. But if your family inherits the retirement account, they benefit only from the after-tax amount.
Everyone is better off 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 designate that the charity receives only a percentage of the retirement account or a specific dollar amount.
You can make charitable gifts by buying permanent life insurance and naming a charity as beneficiary.
Your estate isn’t affected by the charitable gift and can be left intact to your heirs. At the same time, you’re providing a guaranteed gift to charity. In addition, the amount of the gift is likely to exceed the premiums paid on the policy.
You’ve left the charity more than you could have by giving it part of your estate through your will. 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 or benefits from employer plans.
As your obligations to dependents decline and your estate increases, the life insurance no longer is as important as it was. Some people let the policies lapse or cash them.
Another option is to name 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.
When you want guaranteed lifetime income and 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, which is the gift to charity. The present value of that gift, calculated using information provided by the IRS, qualifies for a current income tax deduction.
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 defer the payouts and receive a higher income that begins in a few years.
Most charities determine the income using the rates set by the American Council on Gift Annuities.
Recently, the payout rates at key ages were 4.8% at age 65; 5.3% at age 70; 6.0% at age 75; and 7.0% at age 80.
For example, Max Profits is 68 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 recent interest rates, Max will receive a $9,495 charitable contribution deduction in the year he deposits the money with the charity. (This amount changes monthly with interest rate changes.)
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 produce income and a current income tax deduction, consider the charitable remainder trust (CRT).
Suppose Max Profits has $500,000 in stocks. He’s held the stocks for a number of years, so his tax basis in them is $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 pass, 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’s 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 varies with current interest rates and the ages of Max and Rosie. The older they are, the higher the deduction.
The CRT provides the most benefits when it’s funded with appreciated investment assets but also can make sense when funded with cash.
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. IRS regulations limit the payout rates on the trusts.
Many charities will serve as the trustee, administering the trust and filing tax returns, and have staff that will invest the trust with the rest of their assets. Often, a charity will provide these services for no fee or very low fees.