How you can help charity and also help yourself
If you wish to give to charity, a gift can be made during life or as a transfer after death. Gifts can be either given outright or put into a trust with terms designated by you. With proper planning, both lifetime and after-death gifts can be used to benefit you and your estate as well as the charity.
Gifts to charity that are given with no strings attached are generally tax deductible from both income tax and estate tax assessments. But there are alternatives that allow for the gift to provide for you or your beneficiaries while still supporting the charity.
There are several types of wealth replacement trusts that can be useful for situations in which a person has an asset that has increased greatly in value since its original purchase. For example, perhaps you bought a parcel of land for investment purposes many years ago for $100,000. It is now worth $500,000 and you would like to sell it, but you are concerned about having to pay capital gains tax on the profit. At 20%, the tax would consume a sizable portion of your profits.
One form of wealth replacement trust is called a charitable remainder trust. You give the asset (in this case, the land) to your favorite charity. Since charities do not have to pay capital gains tax, the charity sells the land for its current fair market value of $500,000 and invests the entire proceeds. You receive a fixed dollar amount every year, at a minimum of 5% of the value of the trust. In this case, you would receive $25,000 per year for the rest of your life. Assuming the principal is invested well and yields an annual return of at least 5%, when you die the original principal of $500,000 will remain, and will be owned by the charity. Thus, you have made an important gift to charity and also established a guaranteed income for yourself for the rest of your life. There will also be a substantial deduction on the amount of estate tax due from your estate.
Perhaps you don't need the guaranteed income now, but would like your asset to benefit charity and also provide something for your beneficiaries. A charitable lead trust operates similarly to the charitable remainder trust, except the charity begins receiving the interest or dividends immediately, and continues to receive a regular income from the trust during your life. When you die, the principle of the trust account goes to a beneficiary of your choosing. As with a charitable remainder trust, a considerable advantage is that your estate will be able to deduct the value of the trust income from the estate tax bill.
A third type of wealth replacement trust is the pooled income trust, which operates similarly to a mutual fund. The charity receives contributions from a number of donors and pools the donations to form one big trust. The charity then invests the money and pays interest to the contributors based on the amount of their donations. This trust allows people to donate appreciated assets which are not producing much income, and simultaneously With the pooled income trust, the charity sets up the trust and manages the paperwork. This type of trust is easier and less expensive to set up for the donor, but does not have the same flexibility (as far as personalizing the terms of the trust) as the other types of wealth replacement trusts.
Wealth replacement trusts are not only for the wealthy. They can benefit anyone who has an asset that has greatly appreciated in value since it was acquired, especially if it is a non-income producing asset or if it produces a very low yearly income. There are several different types of wealth replacement trusts but they all operate on the same principle. They all must be irrevocable in order to qualify. They all involve the gift of an asset to charity and some form of retained interest by the contributor. They are all helpful in providing ongoing income and avoiding taxes.
Deborah A. Malkin
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