Planned Giving for Beginners

Planned Giving for Beginners grew out of a desire to help individuals who are new to planned giving get started. We are aware that many Crescendo users come with a variety of backgrounds and with varying levels of expertise in computers and in planned giving. In an effort to assist those who are new to planned giving and its terminology, we prepared this booklet.

Planned giving is made up of people helping other people plan their estates and their charitable giving in ways that benefit both the family and charity. Our Federal Tax Code allows for several trust and gift agreements that are used in making these planned gifts to charity and that also provide some tax benefits. Therefore, the study and practice of planned giving is twofold. It involves knowledge of people and their needs as well as knowledge of taxation and the gift agreements available to fill those needs.

The purpose of this article is to familiarize you with the area of annuities, trusts and other gift agreements. For additional information, we encourage you to attend our series of Crescendo Seminars, which include both planned giving and hands-on training. Crescendo Seminars follow this sequence:

  1. Comprehensive Seminar
  2. Advanced Seminar
  3. Zero Estate Tax Seminar
  4. Internet Marketing Seminar

We hope that you will benefit from this article and find it helpful in your planned giving efforts. We also hope that you will attend Crescendo training and experience the potential of the powerful Crescendo Software programs to illustrate the benefits of charitable tax planning to your donors.

One popular trust agreement is the Charitable Remainder Unitrust. Most of the concepts in planned giving can be explained using the unitrust as the example.

The Need

Many people purchase an asset hoping that it will increase in value. When it does, they would like to sell it and either reinvest in another growth asset or spend the proceeds. The issue that arises is that capital gains tax must be paid on the appreciation if they sell. Therefore, many people hold on to highly appreciated property rather than sell and pay the tax.

A Solution

A donor can put the asset into a unitrust. This is an irrevocable agreement. The unitrust sells the asset and reinvests, perhaps in a portfolio of stocks and bonds. The unitrust then pays a percentage of the value of the trust each year to the donor for the donor's lifetime. At the end of the donor's life, the value in the unitrust goes to a charity.

Because the charity is tax-exempt, the unitrust itself is tax-exempt and no capital gains taxes are paid when the trust sells the asset.

The Details

The asset that funds the unitrust can be stocks, bonds, real estate, personal property, or even cash.

A trustee manages the trust, does the buying and selling, and issues the income payments. The trustee can be a bank or trust company, a charity or even the donor.

A unitrust must be written to pay at least 5% per year. It is possible to write the trust so that if the unitrust doesn't earn enough to pay the specified amount in one year, it can make up the amount in another year.

Unitrusts are usually written for amounts greater than $50,000. This is because of the expense of managing the trust. One exception is a retirement unitrust plan where it is funded yearly with smaller amounts for several years.

The length that the trust lasts may vary. It can be for one or two lives (actually it can be for several lives but that usually isn't practical) or for one or two lives plus a term of up to 20 years. Or it can be for a specified number of years, up to 20.

Because the unitrust usually earns more than it pays out, the trust value grows. Because the payment from the unitrust is based upon the fair market value of the assets in the trust as revalued annually, the payment increases each year as the trust value grows. This acts as inflation protection for the donor.

At the end of the trust term (when the donor passes away) the unitrust value, or remainder, goes to charity. The donor specifies in the unitrust agreement which charities are to receive the remainder.

Because charity eventually receives a gift, the donor receives a charitable income tax deduction the year the unitrust is set up.

The Benefits

Capital gain bypass -- the unitrust sells the asset so no capital gains taxes are paid.

Life income -- the unitrust pays a percentage of the unitrust value as income for life to the donor.

Charitable deduction -- the donor receives a current income tax deduction for the current gift of a future interest.

The Deduction Calculation

Outright gift -- If a donor were to give $100,000 in cash or stocks outright to a charity, he or she would receive a $100,000 charitable income tax deduction for that gift. If the donor were in a 27% income tax bracket, the actual tax savings would be $27,000.

class="text justifyit">Deferred gift -- However, if a donor puts a $100,000 asset into a unitrust, the charity won't receive any money for several years. Since charity has to wait for the $100,000, the gift isn't worth $100,000; it's worth less the longer the charity has to wait and the more the donor receives back.

The Factors Involved

The length of the trust -- a specified term of years or lives. Life expectancy tables are used to determine the statistical probability of when charity will receive the money.

The older the donor, the shorter the term, the sooner charity receives the money, the higher the deduction.

The percent income payout to the donor -- the more the donor takes in income from the trust, the less there is for charity, the smaller the deduction.

The Applicable Federal Rate (AFR, Rate of the Month) -- the IRS Tables used to calculate the probabilities are based on an assumed annual investment return of the trust for the life of the trust. This rate is published monthly by the IRS. The higher the rate, the higher the deduction because the trust is assumed to be growing at a higher rate, leaving more for charity at the end of the term.

The regulations state that any of three rates can be used: The current month, the prior month or the second prior month. The highest rate is usually chosen.

Unitrust Variations

Some creative uses for unitrusts fill unique needs.

Education unitrust -- a unitrust that lasts for 5 or 6 years can be used to provide income to a college student during college years. This is most often used by grandparents for grandchildren.

The benefits are income for the student, bypass of capital gain and a charitable deduction for the donor.

Retirement unitrust -- a unitrust can be used to provide income after retirement. Rather than paying income soon after the trust is funded, the trust is invested in growth stocks that pay little or no income, creating an income deficit that can be made up during retirement. Once the donor reaches retirement age, the trust is reinvested in bonds to produce income. Income is paid to the donor for life.

The benefits are: income that is deferred until retirement, bypass of capital gain, a charitable tax deduction and more flexibility than many pension plans.

Unitrust and insurance trust -- a unitrust can be used in conjunction with an insurance trust to benefit heirs and avoid significant estate taxes. A donor may fund a unitrust and then use the income tax saving, unitrust income or both to pay for a life insurance policy. When the donor passes away, the unitrust goes to charity and the insurance goes to the family. The entire amount of the insurance trust passes to family without estate tax.

The benefits are: 1) The unitrust -- income to buy insurance, bypass of capital gain and charitable deduction.; 2) The insurance trust -- insurance value passed to heirs without estate tax.

Testamentary unitrust -- a unitrust can be established by will to benefit heirs.

The benefits are: providing income to family and saving estate taxes with an estate tax deduction.

Another type of trust agreement is the Charitable Remainder Annuity Trust.

The Need

Many older donors prefer to have a fixed payout rather than a percentage payout, which can vary year to year, as in the unitrust.

A Solution

An annuity trust issimilar to a unitrust, etc. but instead of receiving a percentage of the trust value, the donor receives a fixed dollar amount each year for the life of the trust.

The Details

This trust is most often used by people in their late 70's or 80's since there is no inflation protection in a fixed payout.

Since it is theoretically possible to exhaust the trust principal by paying a fixed amount regardless of the trust earnings, the trust must pass the "5% Probability Test" to be allowed. This checks the age of the donor, the amount in the trust and the Rate of the Month and determines if statistically 95% of the time the trust principal will not be exhausted.

The charitable deduction is generally higher for an annuity trust than for a unitrust because any growth in the trust is passed on to charity.

The Benefits

Capital gain bypass -- the trust sells the asset, so no capital gains taxes are paid.

Life income -- the annuity trust pays fixed income for life to the donor.

Charitable deduction -- the donor receives a current income tax deduction for the current gift of a future interest.

A charitable bequest may be specified by will or living trust. This transfer may save estate taxes. A bequest may be a specific asset, a dollar amount or a percentage of the estate.

Lead trusts provide income to charities for a term of years and then return the asset to family.

The Need

Donors with large estates would like to pass as much to family as possible and pay as little gift or estate tax as possible.

A Solution

A donor funds a lead trust that pays income to a charity for the donor's life or a specified term of years. At the end of the term, the proceeds in the trust are transferred to family.

The Details

This trust is "upside down" from a remainder trust. A lead trust pays to charity and passes the remainder to family instead of paying to family first and then passing the remainder to charity.

The highest charitable deduction is obtained by using the lowest Rate of the Month, which also is the opposite of a remainder trust.

The tax deduction for giving income to charity offsets some of the gift or estate tax due.

There is no income tax deduction with a family lead trust.

The Benefits

Estate or gift tax deduction -- allows a transfer of more property to family by minimizing gift or estate tax.

Pass appreciation to family -- if the lead trust uses an annuity formula for income payments to charity, it pays a fixed amount to charity. Therefore any growth in the trust is passed to family.

A Variation

Testamentary lead trust -- a lead trust may be established by will.

The benefits are: providing income to charity for a term of years, passing appreciated assets on to family, and saving estate taxes with an estate tax deduction.

The Need

An older donor may want to contribute an amount to charity and receive a fixed payment for life.

A Solution

A gift annuity contract is an agreement between the charity and the donor. It promises a fixed payment to the donor for life.

The Details

A gift annuity may be funded with appreciated property or cash.

A gift annuity is part outright gift to charity and part annuity. It is approximately a 50/50 split.

The fixed annuity amount a donor can receive is usually an amount determined by the American Council on Gift Annuities, a voluntary association of charities which recommends uniform rates. The older the donor, the higher the annuity. The rate is as high as 12% per year for persons 90 or older.

Since the donor is receiving back some of his own money as income, part of the income is tax-free. This is an attractive feature of a gift annuity to many donors.

The Benefits

Partial bypass of capital gain -- only part is gifted to charity and the rest is returned as an annuity.

Annual annuity payment -- part of income is tax free.

Charitable deduction -- the donor receives a current income tax deduction for the current gift of a future interest.

Gift Annuity Variations

Deferred payment gift annuity -- younger donors may contribute to a deferred payment gift annuity and choose to wait until retirement to receive income.

The benefits are: income deferred until retirement, partial tax free income, charitable deduction.

Gift annuity for home -- it is possible to fund a gift annuity with the remainder value from a home. This is usually done with donors in their 70's and 80's.

The benefits are: the donor can live in the home for life and receive an annual annuity.

This plan does not involve a trust or contract, but this plan can be a good idea for donors who do not want a trust or annuity.

The Need

A donor may wish to sell some appreciated property and give a portion to charity. However capital gains taxes would have to be paid on the appreciation.

A Solution

The donor first deeds the gift portion to charity, then the property is sold. The capital gains tax is bypassed on the portion gifted to charity.

The Benefits

The donor is able to make a gift to charity and personally retain more of the proceeds. This often leads to a larger gift.

The donor receives an income tax deduction that can help offset the capital gains tax that must be paid on the donor's retained portion.

The Need

An older donor may like to donate the family home at death, but would be interested in some kind of current benefit.

A Solution

A life reserved or life estate contract specifies that the donor may live in the home for life and at death the home is transferred to charity. And for that, the donor receives an income tax deduction.

The Details

This is usually for donors in their 70's and 80's.

This is generally done when the donor has at least $100,000 in other assets available.

The donor is responsible for normal maintenance, upkeep and insurance of the home.

The tax deduction is based on a formula which takes into consideration the value of the land, the value of the building and the age of the donor.

The Benefits

Charitable income tax deduction for the remainder value of the home. This is the value today to the charity for having to wait for the home.

A pooled income fund works sort of like a group unitrust.

The Need

Many donors would like to donate to a charitable trust and receive tax and income benefits, but don't have enough to fund a unitrust.

A Solution

A pooled income fund combines the assets from several donors into one pooled fund and pays income for the donors' lives.

The Details

Since donors contribute to the same fund at different times, the fund yield instead of the Rate of the Month is used to calculate the charitable deduction.

The Benefits

Capital gain bypass -- the pooled income fund sells the asset so no capital gains taxes are paid.

Life income -- the fund pays a percentage of the fund value as income for life to the donor.

Charitable deduction -- the donor receives a current income tax deduction for the current gift of a future interest.