Your client (let’s call her Abigail) feels like she has exhausted her alternatives. She is 70 years old and wants her children to receive the value of her $250,000 securities portfolio when she dies. But she has a large estate, and her bequest could trigger estate taxes. Nor does she want to sell the portfolio and distribute the cash because of capital gains taxes (she acquired the portfolio years ago for only $25,000). Abigail also wants to leave something to charity, but not at the expense of her children. What can she do?
How about a charitable gift annuity combined with life insurance purchased by an irrevocable wealth replacement trust?
Here’s how it works:
1) Abigail donates her securities portfolio to charity.
2) The charity sells the portfolio, and starts paying Abigail an $18,000 annual life income.
3) Over Abigail’s remaining life expectancy (16 years) each payment carries some income tax advantages:
a) $1,100 tax-free return of principal.
b) $10,000 taxed as long-term capital gains.
c) $6,900 taxed as ordinary income (if Abigail lives beyond her life expectancy, payments will be 100% ordinary income).
4) Abigail receives a charitable income tax deduction of about $72,000, the value of her donation less the present value of her life income. With this deduction she may be able to reduce her income taxes for the year she makes the gift. If she cannot use the entire deduction in the first year, she can carry it forward for up to five succeeding years.
5) The charity receives a remainder interest in Abigail’s donation (although no law prevents it from spending Abigail’s entire donation immediately).
This strategy gives you two sales opportunities:
1) If Abigail lives “too long” from the charity’s point of view, the continuing annuity payments could consume the entire donation, leaving nothing for the charity. The charity can manage this risk with a single life immediate annuity purchased from a life insurance company. The charity, not the donor, would be the owner and income recipient for this annuity. Having transferred the longevity risk to a life insurance company, the charity could spend whatever was left.
2) Abigail can replace the value of her donated portfolio by creating an irrevocable wealth replacement trust to own a life insurance policy on her life. At Abigail’s death, her children would receive the proceeds of the life insurance as beneficiaries of the trust. If Abigail wanted to pay an increased premium, she could increase the death benefit, or purchase a policy with a death benefit having the potential to increase over time.
Of course, there are caveats associated with this concept:
1) If the charity defaults on its payments, Abigail is only a general creditor, even if the charity purchased a commercial annuity.
2) Charitable intent matters. If Abigail only wants to maximize her income and tax benefits, there are better choices.
3) Once Abigail makes her donation she can’t change her income stream nor switch her gift to another charity.
4) Abigail’s income from the charitable gift annuity is fixed.
Charitable gift annuities are not just for charitable giving. Consider them also as valuable estate planning tools.
