EDITOR'S NOTE: This article was originally published in the December 2011 issue of Kiplinger's Retirement Report. To subscribe, click here.
Given a shaky economy, tumultuous markets and shifting tax laws, those inclined toward charitable giving may feel like simply giving up. But before throwing in the philanthropic towel, seniors should examine the full range of charitable-giving options.
In some charitable vehicles, today's rock-bottom interest rates and forecasted higher future tax rates are creating attractive opportunities for donors. You can support nonprofits while generating lifetime income or passing money to the next generation tax-free.
For donors who are looking to leave money to their kids, certain charitable trusts, for example, become more attractive when a key interest rate is relatively low -- and today that rate is at a record low. Other vehicles, such as charitable gift annuities, support nonprofit organizations while also providing donors with a stream of lifetime income far exceeding the paltry yields currently available from money-market funds.
Many donors are forging ahead with philanthropy despite the uncertain times. Total charitable giving climbed 3.8% in 2010 from a year earlier, according to Giving USA, which tracks philanthropic trends. And more than 70% of donors plan to maintain or boost their charitable giving this year relative to last year, according to an October survey by Fidelity Charitable.
While financial advisers acknowledge that the ups and downs of markets and tax rates can make it tough to plan charitable gifts, they warn donors against inertia. With the unified exemption for the estate tax and lifetime gift tax now set at $5 million, donations that reduce the size of a taxable estate may not seem a top priority for many retirees. But barring legislative action, those exemptions return to $1 million in 2013, and the top estate tax rate climbs to 55%, from 35% today. "The law is changing all the time, and that makes some people catatonic," says Jonathan Blattmachr, director at Eagle River Advisors, a New York City wealth-management firm.
Another wrinkle for philanthropists came in June, when the IRS announced that 275,000 organizations lost their tax-exempt status because they failed to file required annual reports. Without tax-exempt status, a group can no longer receive tax-deductible contributions. While larger charities generally weren't affected, "if you've been giving to smaller charities, I'd certainly look to see if they're on the list," says Eileen Heisman, president of National Philanthropic Trust, which offers donor-advised funds that support charities. The list is available at www.irs.gov/charities.
Despite such hurdles, "people give to charity because they want to give," says Kim Laughton, acting president of Schwab Charitable, a donor-advised fund. Of course, they also want to get the most bang for their charitable buck. Here's how to choose the best vehicle, whether you're looking for steady income, a smaller tax bill, a legacy for your heirs -- or the simple joy of giving.
Giving Directly to Charity
One of the best ways to give directly to charity may disappear at the end of 2011. Until the end of December, people over age 70 1/2 can transfer up to $100,000 from a traditional IRA directly to charity. You won't get a tax deduction for the charitable contribution, but you get something better: The money doesn't show up in your taxable income in the first place, and the amount still counts toward your required minimum distribution.
If you don't need your RMD for living expenses and plan to make a gift that's sizable relative to your income, the qualified charitable distribution from the IRA may be "the best way to give to charity," says Gregory Singer, director of research at Bernstein Global Wealth Management, in New York City. Cash gifts to public charities are generally deductible only up to 50% of your adjusted gross income. So if you'd like to give $20,000 to charity but have less than $40,000 in taxable income, you can't deduct the full amount in the year of the gift. But you could send a $20,000 payout from your IRA directly to the charity.
For seniors holding highly appreciated securities in taxable accounts, it pays to consider donating those shares instead of cash. In addition to getting the deduction for the charitable gift, you avoid paying the capital-gains tax -- typically 15% -- when you sell the shares. Let's say you have $200,000 worth of stock that you bought many years ago for $20,000. If you sell the stock, you'll likely owe $27,000 in capital-gains tax on the $180,000 gain, leaving you only $173,000 to give to charity. But if you simply donated the shares, the charity would get the full $200,000.
Schwab's Laughton says she reviews her own portfolio at the end of each year and donates some of the most appreciated stock to her donor-advised fund. She then repurchases those shares, so the look of her portfolio doesn't change much, but "at least I got the most value for my charitable contribution," she says.
If you're not sure which charities you'd like to support, you don't have to delay your gifts. With a donor-advised fund, you turn over assets to a fund administered by a sponsoring organization, often the charitable arm of a financial-services firm or a community foundation. You get an immediate tax deduction, and you can make recommendations on how the fund should parcel out gifts to specific charities over time.
Donor-advised funds are attracting contributions thanks to their relatively low costs and simplicity. At Fidelity Charitable, the largest U.S. donor-advised fund program, contributions in the first nine months of this year climbed 23% from the same period last year, to $748 million. While account minimums vary, some major providers, such as Schwab and Fidelity, require only $5,000 to get started. Donor-advised funds don't require donors to keep up with tax filing or dole out a certain percentage of assets to charity each year.
Yet donor-advised funds are far from foolproof, and there are important differences among the major providers. Some, such as Schwab Charitable, don't allow direct grants to organizations based outside the U.S. One program that will work with donors to make such grants is National Philanthropic Trust.
While donors recommend grants from the funds, they give up control of the money. Fund administrators tend to follow donors' recommendations for grants to legitimate nonprofits, but recent court rulings suggest that they can also just ignore them.
One case decided in Nevada Supreme Court earlier this year illustrates the potential pitfalls in these vehicles. The case involved a donor's $2.5 million contribution to Friends of Fiji, a California-based donor-advised fund. The donor, Ray Styles, claimed in court filings that "not one dollar" of his contribution was directed to the charities that he recommended. Instead, he contended, Friends of Fiji used the money "for its own purposes," such as paying salaries to the organization's directors and officers.
Although a Nevada district court found that the donor-advised fund failed "to attempt in any way" to satisfy the donor's charitable goals, it ruled in the fund's favor, concluding that the donor had no right to control the funds or to require the funds be used in the way he recommended. Styles asked the Nevada Supreme Court to require that Friends of Fiji transfer the $2.5 million, plus interest, to a bona fide charity, or return that sum to him. But the court in February affirmed the lower court's decision.
Richard Fox of Dilworth Paxson in Philadelphia, who specializes in philanthropy and was an attorney for Styles, calls the case "a heartbreaker." Though the case is an outlier, it shows what can go wrong in donor-advised funds, he says. An attorney for Friends of Fiji did not respond to a request for comment.
Donors who stick with well-established donor-advised funds should be able to find a vehicle that helps meet their charitable goals, advisers say. Before you dive in, be sure you understand the program's fees, investment options and any restrictions on the types of organizations that can receive grants from the fund.
Gifts to Charity -- And Your Children
For retirees, there's little to love in today's low interest rates. But for those who are charitably inclined and would like to leave a chunk of money to their heirs, those minuscule rates do have a silver lining.
The reason: In a charitable lead annuity trust, low interest rates increase the odds that a donor can leave substantial assets to heirs free of estate or gift tax. A donor contributes money to the trust and may get an immediate tax deduction, depending on how the trust is structured. The trust pays out an annuity to a charity during the term the trust is in force. When that term ends, remaining assets can pass to the donor's family.
The amount of the remaining money that's reportable for gift- or estate-tax purposes is determined partly by the Internal Revenue Code's "section 7520" rate at the time the trust is established. Currently, the 7520 rate, which is published monthly by the IRS, is at a historic low of 1.4%. To the extent the trust's investment performance exceeds 1.4% a year, the excess growth can pass to beneficiaries free of estate tax.
Therefore, "in a low interest rate environment, a charitable lead trust becomes very attractive," says Bernstein's Singer. For every dollar that goes into the trust at today's rates, it may be possible to get a full inflation-adjusted dollar out for beneficiaries at the end of the trust term -- even accounting for payments to charity and the estate tax, Singer says. When interest rates are at more normal levels, these trusts generally offer only a 50% chance of having money left over for beneficiaries, he says.
The vehicles can cost roughly $5,000 to set up. Seniors considering them should work with a trusted attorney because some types of charitable lead trusts have sparked controversy. The so-called shark-fin charitable lead annuity trust offers relatively low charitable payouts in the trust's early years, but the amount going to charity balloons at the end of the trust's term. In one version of the shark-fin trust, most of the trust assets are used to buy a life insurance policy that provides a guaranteed amount for charity and beneficiaries.
Attorneys have debated whether the shark-fin trusts are legitimate charitable vehicles. Some contend that a trust that uses most of its assets to purchase life insurance isn't giving much to charity year to year.
Gifts That Give Back
Some charitable vehicles can offer steady income to donors or their family members. But seniors must weigh these benefits against some potential drawbacks springing from today's low interest rates.
A charitable remainder trust, for example, is essentially the opposite of a charitable lead trust. The donor can get an upfront charitable deduction for transferring assets to the trust, which pays income to the donor or other individuals during its term and gives any assets remaining at the end of the term to charity. The payouts can be a set dollar amount or a percentage of trust assets, valued each year, depending on the type of trust. Assumptions about the trust's future growth rate factor into the size of the deduction.
Susan Fulton, president of FBB Capital Partners in Bethesda, Md., set up a charitable remainder trust four years ago to help provide for her sister, who is 12 years her junior, after Fulton dies. At Fulton's death, her sister will receive an income of 7.5% of the trust's value each year. And when the sister dies, the remainder will go to Fulton's alma mater. While this trust can be a good way to provide a stream of income to someone, Fulton says, she acknowledges a downside: "It could be the college will get nothing, which is an issue."
For seniors considering charitable remainder annuity trusts, the question of how much will remain for charity may be particularly troublesome. Given today's low 7520 rate, it's assumed that the trust will only grow 1.4% a year. That makes it more likely that the annuity payments will erode the value of the trust and leave little left over for charity -- and that minimizes the charitable deduction available to donors.
Seniors who would rather avoid the complexity and expense of establishing a trust might consider charitable gift annuities. In this arrangement, you transfer assets to a charity, and the charity promises to pay you or other beneficiaries an annuity. A portion of those payments are considered a tax-free return of your gift, but you may owe income or capital-gains tax on the remaining portion, depending on whether your contribution consisted of cash or other assets.
The size of the payments depends partly on the age of the annuity recipients, and the rates are generally lower than what insurance companies offer on commercial annuities. However, bearing in mind that a chunk of the payments is a return of the gift, seniors may still find these vehicles attractive relative to the tiny payouts available on certificates of deposit. Currently, a 65-year-old couple can get a rate of 4.7%, according to the American Council on Gift Annuities, which sets gift annuity rates followed by most charities.
Seniors considering gift annuities should remember that the payments are fixed. And the income stream depends on the charity's ability to make the payments. In rocky economic times, charities can go bankrupt. You can check out a charity's IRS Form 990 tax filing and research its financial health at GuideStar.org.
Also ask the charity if it has a large, well-diversified pool of annuitants. "We've seen some plans where there's one annuitant that was 50% or 60% of the value of the plan," says Singer. If that annuitant lived to age 99, he notes, the charity might need to prop up the plan with additional funds -- and the risk is that the charity runs out of money.