Despite the recession, people are giving and giving generously. In this article from the June 2009 issue of the Journal of Financial Planning, financial writer and gift planning specialist Jim Grote explores the types of gifts that are being made in today's environment.
by Jim Grote, CFP®
In defiance of an S&P index down 38.5
percent in 2008 (its worst annual performance since a 47 percent drop in 1931), über-philanthropist Bill Gates has redoubled his charitable giving efforts. The 2009 Annual Letter from the Gates Foundation not only boasts a mere 20 percent decrease in foundation assets for 2008, but announces an increase in foundation giving for 2009.
Says Gates, "During the past five years, as the foundation was growing, we spent a bit over 5 percent of its assets each year in addition to the gift from Warren [Buffett]. Our spending in 2008 was $3.3 billion. In 2009, instead of reducing this amount, we are choosing to increase it to $3.8 billion, which is about 7 percent of our assets."
Financial planners might contemplate Gates's assertiveness and redouble their own charitable consulting efforts. Historical evidence shows recessions do not portend the end of philanthropy. During the last economic debacle—with the S&P 500 index down 9 percent in 2000, 12 percent in 2001, and 22 percent in 2002—charitable giving actually increased; only showing an inflation-adjusted decline of –0.5 percent in 2002.
According to Phil Cubeta, CLU, ChFC, CAP, the Sally B. and William B. Wallace Chair of Philanthropy at the American College in Bryn Mawr, Pennsylvania, there is no better time for donors and advisers alike to be thinking about philanthropy. Charitable needs are greater than ever, and many giving strategies remain viable under the current economic conditions.
Charitable lead trusts (CLT) lead the pack of favorite giving techniques among experts interviewed by the Journal. Sean Stannard-Stockton, CFA, CAP, director of tactical philanthropy for Ensemble Capital Management in Burlingame, California, and philanthropic columnist for the Financial Times, believes that if your client wants to pass wealth to heirs and has charitable intent, now is the ideal time to suggest a CLT.
Says Stannard-Stockton, "This is the tool now. It is poised to explode in popularity." For estate planning purposes, your clients want valuations as low as possible. In February 2009, the applicable federal rate (AFR) hit the historic low of 2 percent, making 2009 the best time in generations to pass wealth on to the next generation.
Turney Berry, J.D., a partner with Wyatt, Tarrant & Combs LLP in Louisville, Kentucky, and head of the Charitable Committee for the American College of Trust and Estate Councils, explains the significance of these low AFRs in reducing gift taxes. A $1 million 20-year term charitable lead annuity trust (CLAT) with a 5 percent annual annuity (payable at the end of each quarter) would have resulted in a gift value for tax purposes of $678,055 if established in February 2008 when the AFR was 4.2 percent. If established in February 2009 when the AFR was 2 percent, the gift value would have increased to $823,706.
Unlike the charitable remainder trust (CRT) which creates current income for the donor and a deferred gift to charity, CLTs create current gifts to charity and a deferred gift to either the donor (in the case of a grantor CLT) or the donor's heirs (in the case of a non-grantor or family CLT). For more detail on the various types of CLTs (and potential tax traps) see Jon Gallo's discussion, "When Interest Rates are Low, Charitable Lead Trusts Become More Valuable," in the April 2009 issue of the Journal.
Berry likes to add a twist to the non-grantor CLT with a back loaded "shark-fin" CLAT making a balloon payment to charity in the last year of the trust. (This trust is also sometimes referred to as the variable CLAT or VCLAT.) The IRS issued model CLAT forms in June 2007 allowing these trusts to vary their annuity payments, thus making the balloon payment alternative possible.
Recently Berry has created shark-fin trusts in the $1 million to $2 million range for several clients. He notes, "We've tended to create these for clients who own a large amount of a particular publicly traded stock they want to pass on to their children. With stock prices artificially depressed (within a long-term horizon), now is an ideal time to fund these trusts."
Berry's goal is for clients to avoid gift taxes altogether. For example, a donor puts $1 million into a 20-year term non-grantor shark-fin CLAT, with only $1,000 a year going to charity for the first 19 years and a balloon payment of $1,485,947 in the 20th year of the trust (equal to the present value at 2 percent of $1 million in 20 years).
At a modest 7 percent growth rate, the trust in the above example will grow to $3,869,684 by the end of its term. Even after the balloon payment to charity, the heirs receive $2,383,737 free of gift tax in year 20. Berry reminds financial advisers that the donor's money manager still manages the assets, only now within the shell of the trust.
For those preferring less tax detail than attorneys Gallo and Berry provide, remember two simple facts. First, with a CRT, your client gives away the tree (corpus) and retains the fruit (income), while with a CLT, your client gives away the fruit while retaining the tree. In tough economic times, giving away the fruit may make more sense than giving away the tree.
Second, CRTs and CLTs are only good deals if your client wants to give money to charity. Berry says, "If you want to do something for charity, it is virtually impossible to do it without some kind of charitable intent." Stannard-Stockton agrees, "If you want to maximize your personal wealth, don't give your money away. Don't give away a dollar to save 50 cents."
That said, the CLT has remarkable advantages for money manager, donor, and charity alike (see Lani Starkey's two-part article on CLTs in the Journal of Gift Planning, 2008). If the donor in the above example had put $1 million into an endowment for a charity, odds are the donor's financial planner would have lost management of the assets. With a CLT, the adviser continues to manage the assets in the trust as opposed to losing the assets to the charity's money manager.
For the donor, a CLT beats an endowment or a donor-advised fund because the donor receives the corpus back after a set period. "CLTs are an ideal way to create temporary endowments," notes Cubeta. And, he adds, they provide immediate rather than deferred income to charity, a big advantage in the current economy.
Charles Collier, senior philanthropic adviser at Harvard University and author of Wealth in Families, reiterates this point: "With endowments taking such a big hit, universities, like other nonprofits, have a need for immediate over deferred gifts. Many universities are working diligently to get their major donors to make larger unrestricted gifts."
An additional advantage from the charity's perspective is that payments to charity from a CLT are legally binding, while payments from a multi-year pledge are not.
For the very reasons that CLTs are attractive, CRTs should be approached with caution. Financial planners should note that one trust's meat is another trust's poison. The up-front income tax deduction for CRTs has dropped in tandem with applicable federal rates (AFRs). Moreover, low capital gains taxes (as low as 15 percent for investment securities) have lessened the traditional strategy of deferring gains by funding CRTs with highly appreciated property.
According to studies by Marc Hoffman, editor-in-chief of the online Planned Giving Design Center, the use of CRTs is particularly sensitive to capital gains rates. High capital gains rates (and high AFRs, in the case of the annuity version) make CRTs cheaper on an after-tax cost basis, and therefore more valuable. Low rates make them less attractive.
However, tangible personal property remains subject to the top capital gains tax rate of 28 percent. This is property, excluding land and improvements (buildings and permanent structures), that can be physically touched. Examples include antiques, artwork, precious gems and metals, stamp and coin collections, as well as motor vehicles.
According to Hoffman, collectibles are one of the most overlooked assets for funding CRTs. By funding CRTs with collectibles or other tangible personal property appreciated assets, donors can defer gains on the sale, receive a current income tax charitable deduction (based on the lesser of the fair market value or basis), and retain a life or term of years income stream that is based on an undiminished principal base.
The funding of CRTs with collectibles has become a boom business for Phillip Adcock, assistant vice-president for development at the University of Alabama in Tuscaloosa. Adcock says, "I've had more unusual gifts in the last several months than at any time during my career." These gifts include stamp collections as well as one of the largest collections of African-American art in the world. But one recent gift stands out.
Adcock remembers feeling skeptical when an alumnus in his late 60s (without a history of major gifts) showed up at the development office late one Friday afternoon wanting to donate a used car. Adcock was suspicious. The alumnus had bought the car from a professor for $1,500 decades ago while attending the University of Alabama. The car still had his student parking decal on the window!
The donor, familiar with the structure of CRTs, was selling a business and wanted extra income for his retirement. It turns out the car was a 1950 Ferrari (serial #0046M) with a Zagato body—very rare. With the help of the donor's attorney, they put the car in a NIMCRUT (charitable remainder unitrust with net income make-up provisions). The car sold for more than $1 million, kicking out a 6 percent income to the donor for life in addition to a $280,000 saving in capital gains tax. (Note: Since the trust sold the car, the car is considered an "unrelated use" gift by the IRS. As a result, the income tax deduction for the gift to the trust was based on the lesser of fair market value or adjusted cost basis—in this case, the net present value of $1,500.)
Another overlooked asset for funding CRTs is privately-held businesses. As Stannard-Stockton notes, "Privately-held assets may be in a market niche where valuations are not currently down. For example, one entrepreneur I know runs a law firm specializing in mortgage default law. His business is booming!"
For entrepreneurs, gifting privately held stock may be the perfect way to help charity and reduce their taxes. Stannard-Stockton warns planners that, if a private company donates stock to a public charity, there cannot be a pre-arranged sale between the charity and, for example, the donor's children.
While charities prefer immediate gifts to deferred gifts, Hoffman argues that bequest giving is the simplest and most efficient way to give larger gifts during economic downturns. While outright gifts can be limited by a donor's need for annual income, bequests do not have that disadvantage. Furthermore, Hoffman notes that bequest giving increased dramatically during the Great Depression while outright giving declined.
In research gathered by attorney Robert Sharpe Jr., of the Sharpe Group in Memphis, Tennessee, "The percentage of major gifts represented by bequests and deferred gifts peaked at some 70 percent during the depths of the Depression in 1933. As the economy gradually recovered, the percentage represented by bequests and deferred gifts gradually dropped."
By 1945, that percentage was less than 10 percent. In comparison, bequests accounted for 7.6 percent of the $306 billion in private philanthropic giving in 2007 according to the Giving USA Foundation.
Odds are that bequests will be making a comeback in the current recession. Therefore, it is more important than ever to bequeath the right assets to charity. As Cubeta argues, "IRA and other qualified plan assets are the most heavily taxed assets in existence. They are subject to a double tax, first to an estate tax on the owner and then to an income tax on the heirs. If you want to give to charity there's no better gift than qualified assets."
Of course, donors need not wait till they are deceased to unload some of these tax time bombs. Through the end of 2009, donors over the age of 70½ can gift up to $100,000 directly from qualified assets to charity.
Even with interest rates at their current low levels, Berry believes charitable gift annuities offer an attractive alternative to bequests. Berry, who wrote the gift annuity regulatory legislation for the state of Kentucky, gives the example of a donor in her 80s with a jumbo CD. If she has a $100,000 bequest to her church in her will and is only making 2 percent on her certificate of deposit, why not set up a gift annuity for her church and make 7 percent plus?
From the charity's point of view, gift annuities (which cannot be changed) are a surer source of revenue than bequests (which can be changed through a simple codicil). "With the mobility of our society," Berry says, "people move and change their churches (and the bequests in their will) all the time. Gift annuities lock in the gift for charity and provide a guaranteed retirement income for the donor."
Collier concurs. Harvard and other universities are marketing charitable gift annuities because the annuity (like the CLT mentioned earlier) locks in the gift to the institution. Hoffman adds, "Because gift annuities are backed by the assets of the issuing charity, donors and their advisers would be wise to evaluate the financial worthiness of issuing organizations just as they would any commercial issuer."
Another alternative to bequests involves gifting a remainder interest in a house or farm to charity. When clients complain that all their assets are depreciated, the remainder interest in a house or farm may be a fine gift option.
For example, explains Berry, say a 70 year-old couple has a Florida condo that was worth $1 million and now has a fair market value of only $500,000. They can gift a remainder interest in their condo to charity and retain the right to use it for the duration of their joint lives. They continue to pay taxes and maintenance on the property, but receive an income tax deduction of approximately $335,000 in the year of the gift. The children then buy the remainder interest in the condo from the charity for $335,000. The condo becomes theirs when the parents die with no gift tax issues.
Berry has had several clients use this technique with farms in the heart of the bluegrass state, but he cautions clients considering this strategy: "The charity has the right to refuse to sell the property to the donor's children and also has the right to up the price."
For financial planners seeking to boost their charitable tax law I.Q., Cubeta and Hoffman offer two very different options. Through the Chartered Adviser in Philanthropy (CAP) certificate granted by the American College, Cubeta trains financial advisers and fund-raising professionals to guide their clients through a disciplined charitable planning process.
Established in 2004, today 371 professionals have received the CAP certification. Cubeta quips, "For financial planners the CAP certification is a great way to leverage their CFP certification. And for donors," he adds, "philanthropy is a great way to think beyond their family, their business, and their dog!"
Planners without the time to invest in another certification might browse through Hoffman's Planned Giving Design Center LLC (http://www.pgdc.com/). This site provides published articles from top notch journals and leading experts to help advisers become more comfortable with gift planning techniques and the ever changing tax rules that govern their use. "We're a content aggregator," says Hoffman. "We give our readers a taste of the contents of these publications at no cost. Our goal is to help financial advisers help their charitably inclined clients give wisely."
Currently 70 nonprofit organizations (especially community foundations, universities, and hospital foundations) subsidize the site for the benefit of more than 25,000 registered members. Hoffman, a former fund-raiser himself, notes the trend behind this approach. Most donors are not comfortable sharing all of their financial information with nonprofit fund-raisers who are asking them for money. Instead they are increasingly seeking philanthropic planning advice from their legal, tax, and financial advisers. Organizations can then talk about their core values, mission, and funding needs. Hoffman's site brings all the parties together.
Stannard-Stockton's financial planning practice has benefited significantly from an emphasis on philanthropy. His firm grew 30 percent in new assets under management in 2008, most of which were philanthropic assets within a variety of trusts and foundations. Unfortunately, Stannard-Stockton notes, consumer confidence has now bottomed out and this spending freeze includes philanthropic expenditures. "I'm seeing clients who traditionally gave $250,000 a year cut their annual gifts to $200,000."
Similarly, Berry notices clients putting the brakes on charitable giving, though not from consumer malaise, but more in anticipation of higher taxes. He labels this phenomenon, "politically deferred giving," and knows several individuals purposefully delaying their giving in order to lower their anticipated future tax increase. As Berry explains, "This strategy makes sense. Following the simple logic of regression to the mean, current low tax rates have only one way to move—up."
With the odds of higher tax rates in the future, Hoffman advises financial planners to start brushing up on their knowledge of CRTs. He says, "As capital gains tax rates rise, these vehicles will inevitably come back in favor." Just to whet the appetite of tax savvy planners, Hoffman adds, "It wasn't that long ago (2007) that Barron Hilton funded a $1.2 billion charitable remainder unitrust (CRUT) with his interest in Hilton Hotels Corporation and Harrah's Entertainment." A nice AUM in anyone's book!
Collier offers some parting advice for financial planners struggling under current market conditions. "In my view, financial planners should have more personal contact with clients during these down times. This is a perfect opportunity to hold events for select clients."
He is convinced, however, that the average person of wealth is tired of investment seminars. But, this is an opportune time for planners to put on seminars about family philanthropy, family governance, and family business succession. Says Collier, "These issues are important and not going away. The togetherness of small gatherings lowers clients' anxiety during this downturn. The seminars I hold for Harvard alumni and for private banks, 'Practices of Flourishing Families,' are more in demand now than ever before."
With the right balance of personal communication and select giving vehicles, advisers can enhance their clients' philanthropic plans, whatever the movement in financial markets and the fluctuation in tax rates.
Jim Grote, CFP®, is a financial writer whose articles have also appeared in Bloomberg Wealth Manager, Family Business Review, Financial Advisor, Morningstar Advisor.com, and Planned Giving Today. He can be reached at jimgrote@hotmail.com .
Reprinted with permission by the Financial Planning Association, Journal of Financial Planning, June 2009, Jim Grote, Shark-Fin CLATs vs. the Bears - Charitable Giving in Down Times. For more information on the Financial Planning Association, please visit www.fpanet.org or call 1-800-322-4237.