Thinking About Charitable Giving All Year

Many people leave money on the table when they think seriously about charitable giving only at year-end. Think about charitable giving all year and focus on how to give instead of how much. You’re likely to generate higher immediate tax benefits plus income or other benefits.

I’m not talking about the small checks you might write to various causes. When you make larger gifts or plan to through your estate, consider the best way to make the gifts. Here are some strategies that can help leverage your charitable gifts and deliver other benefits.

Consider appreciated investments. Instead of simply writing a check, consider transferring some appreciated stocks, mutual funds, or other securities. When the security was held for more than one year, you deduct the fair market value as of the date of the gift. Neither you nor the charity pays capital gains taxes on the appreciation. So, the greater the gain you have in the security, the larger the pay off.

The strategy doesn’t even require a change in your asset allocation. The wash-sale rules don’t apply to charitable gifts. So after making the transfer, the cash you were going to give to the charity can be used to repurchase the securities. If you were planning to sell the securities anyway, giving them delivers a better result than selling them.

Use donor-advised funds. You transfer money or securities to the fund. It’s set up as a charitable fund, so you receive a tax deduction when you make the transfer. Then, you designate, or advise, the fund which charities receive money from your donation over time. The major advantage is you make the contribution and take the deduction when you have money or need a write off. You take time, even years, to decide which charities receive the benefit.

Donor-advised funds are sponsored by major firms such as Schwab, Fidelity, and Vanguard. They also are sponsored by communities and major charities.

Remainder interest. This strategy doesn’t really cost you anything now, but you take a tax deduction today and the charity receives the benefit in the future. The remainder interest typically is used with real estate, especially a second home, farm, or undeveloped property. You change the deed to allow you (or you and your spouse) to act as owner for the rest of your life. After that, the charity receives full title to the property. It can sell it or use it.

You receive a charitable contribution deduction when you rewrite the deed. The amount depends on the value of the property, current interest rates, and your life expectancy. The older you are, the greater the percentage of the property’s value you can deduct.

The lower interest rates are, the greater your deduction is. With today’s interest rates so low, it’s a good time to consider creating a remainder interest in property for charity.

A related strategy is to give a conservation easement. The easement is given to a qualified non-profit group and provides that some feature of the property can’t be changed. For example, undeveloped land might have to remain undeveloped or an historic property might have to retain its façade or other essential features.

The IRS doesn’t like these strategies. You have to carefully document how the amount of the deduction was determined. Use an experienced tax advisor, because an audit is likely.

Supplement with life insurance. You might be able to use these strategies to also increase the wealth your heirs receive.

Suppose you have a second home and leave it to a charity through the remainder interest. This generates a tax deduction, and you take some or all of the tax savings from the deduction to fund an irrevocable life insurance trust that purchases a life insurance policy. Your children benefit from the trust. The trust avoids both estate and income taxes.

Charitable annuities. You can generate a tax deduction now and income for life. Give money or property to a charity in return for a promise to pay you monthly income. You’ll receive lower payments than you would from a commercial annuity. But you receive a charitable contribution deduction the year you purchase the annuity for what’s basically the difference. Your age and current interest rates determine the amount of the deduction.

If the charity falls on tough times, you are only a general creditor of the charity. You don’t own a separate contract. So, you want to enter a charitable annuity agreement only with a large, well-established charity that’s been offering annuities for a long time. There’s no need to shop around among charities. Almost all of them agree to pay the same rates on annuities.

Charitable trusts. By giving now through trusts you might generate more benefits for you and your loved ones.

In a Charitable Remainder Trust you give appreciated securities or other property with a lot of embedded capital gains to the trust. The trust pays you income for life. The income can be a fixed amount or a percentage of the trust’s value each year. After your passing, the amount left in the trust goes to the charity.

You receive a tax deduction when the trust is created. The amount depends on the value of the property, current interest rates and your age. The older you are, the higher the deduction. The lower interest rates are, the lower your deduction. Neither you nor the charity pays taxes on their appreciation. In addition, the property is out of your estate for taxes and probate.

A charitable lead trust is almost the opposite. The trust pays income to the charity for a period of years designated by you. After that, the property reverts to you or beneficiaries named by you. The longer the period the charity receives income, the greater your tax deduction. Also, the lower interest rates are the greater your deduction.

Giving your IRA. Suppose you have adequate assets outside your IRA to fund your retirement. Leaving a traditional IRA to your heirs isn’t a tax-efficient move, especially if you plan to leave the IRA to loved ones. One strategy we’ve discussed in the past is to convert the IRA to a Roth IRA.

Here’s another strategy. Take money out of your IRA and give all or most of it to a charitable remainder annuity trust. You’ll owe taxes on the distribution from the IRA, but you’ll also receive a deduction for the present value of the charity’s remainder interest. The amount of the income offset by the deduction will depend on your age and current interest rates.

The trust will pay you annual income. You can use that income to pay premiums on life insurance or make gifts to an irrevocable life insurance trust. Eventually your heirs receive a substantial life insurance payout and the charity receives a tidy sum from the trust. Because life insurance is tax-free and IRA distributions are not, your heirs are likely to have much more after-tax wealth than if they inherited the IRA.

There are many variations you can make to this strategy. Almost all of them are likely to leave both charity and your heirs better off than simply holding the IRA for life.

RW May 2012.