Which charitable trust strategy is best for you?

October 21, 2014

If an estate owner, based on his current financial situation, is not willing or able to contribute an entire financial asset during his lifetime, a split-interest, deferred gift is something to consider.


I’m interested in a more formal charitable gifting strategy to minimize taxes, but would also like to supplement my retirement income. What options are available?

There are a number of reasons to give to charitable causes. From a purely financial standpoint, gifts to a charity during lifetime or at death will reduce the size of the gross estate, which may reduce or even eliminate the amount of estate taxes due at death. An additional benefit of lifetime gifts is that a current income tax deduction is available, within certain percentage limitations.

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If the estate owner, based on his current financial situation, is not willing or able to contribute an entire financial asset during his lifetime, a split-interest, deferred gift is something to consider. The ownership interests in an asset can be split or divided into two parts: a stream of income payable for one or more lifetimes or a term of years (the income interest) and the principal remaining after the income term (the remainder interest). When the estate owner retains the right to the income but transfers his or her rights in the remainder to a trust, it is called a charitable remainder trust.

To qualify for an income tax deduction, the trust must be a unitrust, an annuity trust, a pooled income fund, or a charitable gift annuity.

Charitable remainder unitrust. In this type of trust, the donor retains the right to a fixed percentage of the fair market value of the trust assets, with the trust assets being revalued annually. If the value of the assets increases, so does the annual payout, and vice versa.

Charitable remainder annuity trust. This trust is similar to the unitrust but instead pays a fixed dollar amount each year.

Pooled income fund. Assets are transferred to a common investment fund maintained by the charity. Each donor receives annually a share of the income from the fund, in proportion to the contribution made. These annual payments continue for the lifetime of the donor and spouse. At death, the corpus of the donor’s gift, together with any capital gains, passes to the charity. Payments will increase or decrease with the investment performance of the fund.

Charitable gift annuity. The donor transfers the asset directly to the charity, in exchange for the charity’s agreement to pay a fixed lifetime annuity.

The amount of the income tax deduction is dependent upon the percentage of the income interest and the period over which it will be paid (usually the life of the donor and his or her spouse). This calculation is determined from the mortality tables published by the government.

On the other end of the charitable gifting spectrum are those individuals who want the charity to receive only the income and not the asset itself. A charitable income or lead trust is the reverse of the charitable remainder trust. The income interest is assigned to the charity, usually for a period of years, and then the remainder generally passes to the donor’s heirs. The amount of the estate tax deduction and the amount left for the heirs will depend upon the number of years income is to be paid to the charity, the size of the annual payments, and the investment results achieved by the trustee.

There are many factors to consider prior to implementing any type of charitable trust strategy. To determine whether it makes sense for your particular situation, be sure to consult with your tax and estate-planning advisers.

 

Next: What bond investors can do to reduce risk

 

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With all the talk of rising interest rates, what should bond investors focus on to reduce their risk?

Investors should always consider ways to manage risk in their fixed-income portfolios, especially with concerns of rising interest rates. Here are a few guiding principles:

Hold shorter term issues. This approach may help reduce volatility while enhancing liquidity. Also, fixed-income investors who hold investment-grade bonds must consider their exposure to changes in interest rates. Bond prices move in the opposite direction of interest rate changes-and the longer a bond’s maturity, the greater its price change.

Stay broadly diversified. Holding many bond issues and avoiding concentration in a particular industry, sector, or issue type can help reduce the impact of a few non-performing bonds. If default rates rise, investors with a well-diversified bond portfolio should be less exposed.

Focus on quality and use market pricing to confirm credit ratings. The most creditworthy bonds are those rated AAA or AA, and most of the current problems involve lower rated bonds. Although ratings are useful, recent history in the mortgage-backed securities market has shown that a bond may not be rated accurately. A bond rated AAA should trade in a similar price range to other bonds with similar characteristics and a comparable rating.

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