There are many ways to include a charity in your estate planning. Here are some you may want to consider.
You might be interested in a charitable remainder trust if you own investment assets that have appreciated significantly since you purchased them and you would like to enjoy the profits—but you have been hesitant to sell the assets because you would have to pay capital gains tax.
When you set up a charitable remainder trust, you transfer the appreciated asset to an irrevocable trust. You receive a charitable income tax deduction, reducing your current income taxes. The asset is also removed from your estate, so estate taxes (if applicable) are reduced when you die.
The trustee then sells the asset at full market value—paying no capital gains tax—and reinvests in income-producing assets. Typically, for the rest of your life, the trust pays you an income. Alternatively, the trust can be set up to exist for a set number of years, up to 20. When you die, the remaining trust assets will go to one or more charities you have chosen. That’s why it’s called a charitable remainder trust.
Of course, this means that your children or other beneficiaries will not receive this asset when you die. If you are concerned about this, you can use the income tax savings and part of the income you receive from the charitable remainder trust to fund an irrevocable life insurance trust. The trustee can then purchase enough life insurance to replace the full value of the gifted asset.
A charitable lead trust is, in some ways, similar to a charitable remainder trust. But with a charitable lead trust, the charity receives the income and your beneficiaries will eventually receive the principal. And because the beneficiaries must wait a while before they can receive the asset, its value is reduced for gift tax purposes. So you will pay substantially less in gift tax than if you left the asset to them outright. Also, when you transfer the asset to the trust, it is removed from your taxable estate, potentially saving estate taxes.
A charitable lead trust would be appealing if you currently do not need the income, or if you have current charitable commitments you would like to continue in the future, and you want someone other than the charity (perhaps your spouse, children or grandchildren) to eventually have the assets.
Jacqueline Kennedy Onassis included a charitable lead trust provision in her estate plan. The assets in the trust would benefit charities for 24 years, then go to her grandchildren. Unfortunately (for the charity), the trust was optional, and no assets were transferred into it. However, had her beneficiaries utilized this strategy, it would have eliminated her estate tax completely. (This strategy uses a formula to eliminate the estate tax so it works for estates of any size.)
Instead of giving your tax money to Uncle Sam and letting Congress decide how to spend it, you can set up your own charitable foundation, donate your assets to it, and keep some control over how the money is spent. (The IRS does have restrictions on how the money is used.) You can also fund it with a life insurance policy on your life.
You can set up the foundation while you are living, or it can be established after you die. To qualify, a small percentage of the trust assets must be distributed to charity each year. But you can name whomever you wish to run the foundation—including your children—and the foundation can pay them a reasonable salary. You can be very specific about which charities you want to support, or you can leave that up to the trustees of the foundation to decide (within the IRS guidelines, of course).
The tax benefits of setting up your own foundation can be substantial—you can save estate, capital gains, and ordinary income taxes:
These are quickly becoming a favorite among charitable donors, and it’s easy to understand why. A donor advised fund is established through a public charity. It’s like having your own charitable bank account. You open an account in the fund, make contributions to it, and receive an immediate charitable income tax deduction. Your contributions are invested and grow tax free. Then, over time, you recommend that grants be made from your account to qualified charities.
The gifts you make to the donor advised fund are irrevocable, and once made, the fund owns the assets. (That’s why you recommend the grants instead of making them yourself, although typically the fund honors your request.) If you give appreciated assets, there will be no capital gains tax when the assets are sold, so the fund receives the full value of your gift.
You can make contributions as often as you wish, and you can recommend grants to as many charities as you wish, often with the ability to remain anonymous if you prefer. There is professional asset management for your account and you can direct how its assets are invested. You can also name successors to continue family involvement. Usually the sponsoring charitable organization prepares the paperwork, providing both cost savings and convenience.
You may be interested in a pooled income fund if you do not have sufficient assets to contribute to a charitable remainder or lead trust, or if you would prefer to make smaller contributions over a period of time. You make these contributions directly to the charity and the charity will “pool” your contributions with others and invest them together. Your contributions then become shares of the fund (similar to a mutual fund). You or a designated beneficiary will receive a lifetime income from the fund. When the last beneficiary dies, your shares will transfer to the charity. Your gifts can be made in cash, stock, or bonds, and you will receive an income tax deduction in each year you make a contribution.
With a gift annuity, you (or whomever you name as beneficiary) will receive a guaranteed income for life in exchange for making a direct gift to a charity. The gift can be in cash, real estate, or another asset. The income will be paid in the form of an annuity, which means each payment you receive will be for the same dollar amount. Part of each payment is a return to you of your gift (the principal), so only a portion is taxable as ordinary income.
You can begin receiving the income immediately when the gift is made or the income can be delayed until a later date (usually at retirement, when your income and income tax bracket are lower). If the income is delayed, this is called a deferred gift annuity. Under this option, the income will be higher because the original investment will have time to grow. Regardless of when the income begins, you can take a charitable income tax deduction in the year you make the gift. Upon your death or the death of the last beneficiary, the charity will keep the remaining principal and any undistributed income.
This is an arrangement through which you can give a portion or all of your home, vacation home, or farm to the charity of your choice while you are living. Until your death, you continue to enjoy the property as if you still own it—you can live on it, take care of it, and keep any income it may generate. You would consider this option if you were planning to give the property to the charity after your death, but wanted to take the charitable income tax deduction while you are alive. You may also save on estate taxes by removing the property from the value of your estate.
You can give a charity the right to use property for a certain number of years as a public park, a wildlife refuge, an historic landmark, etc. Or you could give away just the mineral rights to a parcel of real estate and keep the land in your family. The tax advantages of this type of gift are generally less than others mentioned here.
You may have certain investments or valuables (for example, artwork, musical instruments, books) that you want to give to a charity—not to have them sold and the proceeds re-invested, but to have them be enjoyed as you have enjoyed them. For you to receive a charitable income tax deduction, the gift must be related to the charity’s tax-exempt purpose—for example, giving artwork, antiques, or jewelry to a museum; books to a university or library; musical instruments to a symphony; and so on.
This is often an overlooked gift. You can give an old policy to a charity, making it both the owner and beneficiary. Or you can work with a charity and have it purchase a new policy on your life (the charity should be the applicant, owner, and beneficiary). In either case, you can receive a charitable income tax deduction.
You will want to make sure the organization meets the IRS guidelines as a “qualified” charity. Otherwise, you could lose the tax advantages. The IRS publishes a list of qualified charities and their tax status, which determines the amount of the income tax deduction. The charity will also have a determination letter from the IRS which verifies its tax status.
You may want to research an organization before finalizing your gift. One source of information is CharityNavigator.org. Another is the National Charities Information Bureau. Both evaluate many local and national not-for-profit organizations.
Your attorney can help you evaluate which charitable options would be best for you and make sure the documentation is prepared properly. Check that the document contains the correct legal name and specific location of the organization that will receive the gift.
It is also a good idea to discuss a potential gift with the charitable organization while you are in the planning stages; they will be able to give you and your attorney some insight and suggestions on how a gift may be most useful to them. You may also want to designate a successor charitable beneficiary in case your first choice ceases to exist.