Are You Losing Big Tax Savings on Your Charitable Bequests?

I was sitting with a new client the other day, reviewing a summary of his current estate plan, and I noticed that he had several substantial bequests to charities in his will. So, I asked him why he was leaving the money to charity at his death.

This surprised him. "What do you mean?" he replied.

"Wouldn't it be much more fun to see the charity use the money during your lifetime when you could experience the gratification from that?" I asked. "Also, if you give the money now you could receive a big income tax deduction. Why leave the money from that on the table?"

Sounded good to him. But he still was concerned the approach might leave him short of what he needs to live on.

So I suggested that he transfer the money that he was planning to leave to charity at his death to a charitable remainder trust now. He asked, "How does that work?"

I explained to him that with a charitable remainder trust, he would retain an income from the trust and whatever principal that is left when he dies would go to charities that he would designate in the trust. The income would be either a fixed percentage of the initial contribution to the trust, called a charitable remainder annuity trust (CRAT). Or he could designate a fixed percentage of the value of the trust as of the last day of the prior year—a charitable remainder unitrust (CRUT).

The value of using a CRAT is that he would know the amount of the income each year. Whereas with a CRUT, he would have the opportunity for the income to grow if the assets of the trust experience growth in excess of his payment.

Also, with a CRAT, if his return on the assets is not deemed large enough, he could deplete the assets of the trust since his income is not dependent on the amount of assets in the trust. Of course, he would have that same issue if he didn't put the assets in the trust, and he continued to take the same income, and his investment return didn't support that amount of income.

Alternatively, with a CRUT, the income is a percentage of the value of the account each year. So, if the account goes down, his income the following year would be adjusted accordingly by the normal operation of the trust. So, the income would not deplete the trust, although it could get very small eventually with constant underperformance.

He could also get a sizable income tax deduction upon setting up the trust. The deduction can be spread over six years if his income is not high enough to use the deduction in one year. That is extra money that he may enjoy today.

Also, he can be the trustee of the trust, so he can still control how his money is invested.

If he designates a charity as the irrevocable beneficiary and informs the charity today, he would become a major donor of the charity and be invited to all of their events. This would be good for him and the charity since he would naturally become more emotionally involved with the charity and, likely, would give his time and money to the charity in other ways.

He said to me, "I'm just not sure I'm comfortable giving up access to the money during my lifetime."

I said, "If you lost 80% of your wealth due to a financial calamity, would you spend the other 20%, or would you protect it and invest it to provide you income?"

No brainer. "Of course I would conserve it to provide an income. Otherwise I'd be broke!" he said.

My reply: "That's the money I'm talking about. The part of your estate that you're never going to spend anyway, and it will always be available to produce income."

He decided to put 10% of his investment portfolio into a charitable remainder unitrust and dedicate it to his favorite charity, with whom he now has a very close relationship. He said it's one of the most rewarding things he has ever done.

Bruce Udell has more than 40 years of experience in the financial industry. He designs solutions for wealth accumulation and enjoyment for high net worth individuals.

Disclosure: Charitable remainder trusts can be complicated. This article is for informational purposes only. The example presented is applicable to the individuals depicted and may not be representative of the experience of others. You should seek the advice of a tax professional before implementing a gift of this type.