Clients can open their hearts and still circle their financial wagons: Charitable donations, properly structured, can protect wealth.
“I have several clients who’ve done estate tax planning and satisfied what they want to give to their children into trusts. Most of those clients [then] gravitate to allocating the balance of their estate to charity,” said Clay Stevens, director of strategic planning at Aspiriant.
Techniques can incorporate charitable giving into a client’s estate plan while protecting wealth, but much depends on the family’s goals for wealth preservation, added Adrienne Hart, head of philanthropic advisory at Rockefeller Capital Management.
Effective charitable tools to preserve wealth include private foundations, a donor advised funds (DAF) or such split-interest trusts as charitable lead trusts and charitable remainder trusts. The latter trusts allow clients to donate to charities and individuals while also receiving a charitable deduction for a portion or all of the assets contributed, Hart said.
DAFs can also work well with a “bunching” strategy of giving, grouping years’ donations in any given year so that a taxpayer’s itemized deductions may be used as one year’s standard deduction. Such a strategy works well in a high-income tax year where the taxpayer is in a higher marginal tax bracket.
Private foundations, often a top option for establishing a charitable legacy, have weaknesses. “Creating a private foundation involves creating an entity under state law and being under the jurisdiction of the state attorney general, as well as some rather complicated tax filings,” said Mary Kay Foss, a CPA in Walnut Creek, Calif. “The tax forms are available for public inspection and may lead to numerous solicitations from charities wanting donations from the foundation. The tax deduction may be limited with a private foundation, as well.”
Clients who want to give away their money only after enjoying it face one big financial wrinkle: no income tax deduction for giving assets at death.
“To the extent the client has appreciated assets (especially appreciated marketable securities), we’ll have them gift to charity each year to the extent the client can use the deduction to offset other income,” Stevens said. “There are income limitations on how much one can deduct in any one year, so we want to manage around that number and gift more in years the client has higher adjusted gross income.”
For clients worried about accidentally giving away too much, to the point that impacts their lifestyle, “we can consider a charitable remainder trust to convert their appreciated assets into an annuity payment to the clients over their lifetime,” Stevens added. “This is a tax-exempt entity so it allows liquidation of the appreciated assets without immediate income tax.”
Giving appreciated assets to charity is an effective donation strategy, but clients sometimes misunderstand that capital gains on the assets are just deferred and eventually passed to the beneficiary, not eliminated altogether. Tax treatment also differs depending on how long the client held the asset. “If the appreciated securities are held for less than a year, only the cost of the securities qualifies as a charitable deduction,” Foss said.