From Groceries To Golf Tees

From Groceries To Golf Tees

Income Planning Opportunities in the Current Market
Article posted in Investing on 26 April 2004| 1 comments
audience: National Publication | last updated: 18 May 2011


When it comes to giving practical advice on integrating creatively structured planned gifts into donors' financial and estate planning, Jim Normandin of Memorial Medical Center Foundation Long Beach is at the top of his game. In this article, he identifies assets that may be prime candidates for charitable remainder trusts and charitable gift annuities.

by James F. Normandin

2003 closed on a positive note for investors. For the first time in several years, your clients could look to growing values in their retirement portfolios. Happy Day! Most of the pundits say that 2004 offers more of the same. This is great stuff for those 40 and 50 year old clients building estates. Low interest rates for the acquisition of real property and now, hopefully, a continued appreciation in equity securities for those 401K accounts.

On the flip side, your 70 year old clients face the continued challenge of realizing significant income from their holdings. Tough job you have here.  There just aren't any conservative debt instruments offering 6% or 7% yields. Laddering treasuries will get you about 2.25% these days, assuming a five year ladder. The same ladder in investment grade corporate bonds approaches 3.0%...less than exciting. Diversified real estate investment trusts may bring yields of 5% to 5.5% and global bond funds slightly more but there are risks here. Pricing on REIT shares have been bid up over the past few years and the currency risks on global bonds may negate their higher yields.

What to do????

The Unitrust Approach: 5% or 6% Distributions From A Total Return Portfolio

For today's retiree, the key to adequate cash flow may rest in ignoring yields and taking a total return approach to managing the nest egg. In other words, instead of trying to live on today's shrinking yields, invest in a mix of equity and fixed instruments with the plan to withdraw 5% or so of the balance each year regardless of performance.

It may surprise you how, even in the grip of severe market turbulence, this strategy seems to offer reasonable cash flow while protecting the source.

Consider the last five years, one good year in '99, three real downers and finally some recovery in 2003.

Being simplistic, let's just take a $100,000 portfolio where 50% of the holdings were placed in bonds and the other 50% were held in domestic equities. To mirror those two positions we will use the Lehman Brothers Aggregate Bond index for the fixed side and the Russell 3000 domestic equity index for the equity side.

1999 2000 2001 2002 2003
Leh Bros. Agg -0.8% +10.1%  +10.3%  + 8.4%  + 4.1%
Russell 3000 +20.9% - 7.5% -11.5% -21.6% +31.1% 

Well, our crude math tells us that if we total these returns over the past five years we come up with a total on the bond index of +33.6% and +11.5 on the equity side. Assuming a 50/50 mixture, that's a 22.55% return for the five year period.

Now then, a 5% annual distribution or 25% for the five year period leaves our retiree with an account balance down just 2.5%. Of course, our approach is too simplistic. A unitrust would pay 5% each year based on the adjusted balance in the account, so we went back and took annual net earnings (or losses) recalculated the account balance, made 5% distributions on that balance, etc.  Interestingly, here were the distributions calculated:

1999 - $5,502.50
2000 - $5,357.49
2001 - $5,010.73
2002 - $4,543.62
2003 - $5,076.64

Our account balance at the end of 2003, immediately after the current distribution and before any 2004 growth was $96,456.14, down 3.54% over the 5 year period.

Not impressed? Think about the five year period we are talking about. We had the tech bubble and a Nasdaq that lost 70% of its value, the 9-11 destruction in our nation's financial capital and the beginning of the war on terror, corporate accounting scandals and bankruptcy filings by the likes of Enron, mutual fund malfeasance, growing deficits, and a bothersome level of unemployment.

Speaking of Unitrusts: Think Charitably When Taking Profits

Many of your age 70 and over clients are holding highly appreciated capital assets in the form of real estate and, more recently, publicly traded securities. Certainly, the appreciation in real estate values has been nothing short of spectacular over the past 36 months.  No doubt you've witnessed the double digit growth in residential real property pricing propelled by record low interest rates. In many cases, properties have doubled their market valuations in the past 36 months.

More Asset Classes Show Growth

Recovery in the stock markets is a more recent phenomena. Consider a few of the many holdings that are up over 100% in just the last 12 months:

Rambus +335% Sandisk Corp +294%  Juniper Networks +250%
Nortel +214% Plantronics +172% William Lyon Homes +163%
Yahoo +161% Broadcom +141% Genetech +138%
7-Eleven +119%  NCR  +114% TommyHilfiger +109%
Cisco  +106% Nordstrom  +104% Capital One +102%
Intel  +101%

Beyond these asset classes, hard assets have had a good run. Gold and copper are up substantially over the past few months...all of which leads us to suggest the timing may be right for your senior client to lock-in some gains and convert some of this capital to a dependable income.

Enter the Charitable Remainder Unitrust

When it comes to converting capital assets to a lifetime stream of income, the Charitable Remainder Unitrust ("CRUT") offers unique benefits. A capital asset sold by the trustee of a CRUT avoids the initial capital gains tax hit. Therefore, income is calculated and paid on the full value of the asset of any sales costs but before taxes. Think about it. Your client may be sitting on their position simply because they cannot bring themselves to pay the tax.

With a CRUT, they can sell that $700,000 real estate parcel or $100,000 position in Genetech stock and draw 5% or 6% income on the full amount less sales costs.

What of the capital gain?  Well, the income from the unitrust will carry a pro-rata share of that capital gain over the income recipient's life expectancy, spreading out the taxation much like an installment sale...a much less "taxing" experience.   

Additionally, your client receives an income tax deduction in the year of transfer for the present value of the remainder interest passing to charity. Under today's formulas, that $100,000 of Genetech transferred by a 70 year old who retains lifetime income would generate a charitable income tax deduction of $53,631 (assuming a 5% payout) or $47,990 (assuming a 6% payout).

Many planners will use that tax deduction for the tax effective sale of additional assets on an outright basis (e.g., $100,000 Genetech inside the CRT and another $100,000 outside).  OR better yet, offset a large withdrawal from a qualified plan where the deduction is used against ordinary income rather than the more favorably taxed capital gain.

Unitrust Design: Choices to Meet Client Needs


Our previous example (50% bond/50% equity), with a full 5% distribution on the annually recalculated portfolio value, is a standard form of unitrust.  This design is well suited to the client who requires a regular and significant income from the portfolio.

Net Income

Here is a unitrust format that tends to accumulate any portfolio appreciation within the unitrust and distribute only the income (defined as interest, dividends, rents and royalties).  Typically this trust would call for the payout of a fixed percentage of portfolio value, e.g.  5%, or the income whichever is less.

This design would provide less income in the current low yield environment but preserve the donor's trust corpus for the future.


Here is a unitrust that begins as a net income unitrust, paying out only the portfolio yields annually. Then, at some future date or following a triggering event, it becomes a standard unitrust, paying out its full stated percentage (e.g., 6% annually).

This design is ideal for the income beneficiary who wishes little current income from the trust but desires to see the corpus grow tax-deferred and then "turn on the faucet" at some future date...retirement, etc.

Annuitizing or Cannibalizing the Asset: Another Approach to Income When Yields Fall

Rather than taking on more risk to boost a retiree's cash flow in today's market, how about taking a particular asset and simply planning to consume it over a period of time? The combination of principal and interest makes for higher cash flow and the lack of income taxation on the asset's basis makes for more net income. As to the latter, consider how a charitable gift annuity works for your 70 year old client.

First, we'll take the client with a $100,000 CD currently yielding 2.2% or $2,200 per year. Of course, that income is fully taxable at ordinary income tax rates.

Moving the $100,000 to a charitable gift annuity would increase the payout to 6.5% (based on ACGA suggested rates), fixed for the annuitant's lifetime. Further, for the next 16 years (our annuitant's life expectancy) or until 2020, 62% of that income will be a tax-free return of the donor's basis.

The numbers look like this:

  $2,470 taxable annually
+$4,030 tax free annually
Total   $6,500 annually

Not incidentally, unlike tax-exempt bond interest, this tax free income is not considered in arriving at "modified adjusted gross income" for the purpose of taxing this senior's social security income.

Finally, the transfer of these funds to a charitable gift annuity results in a charitable income tax deduction of $35,938, which can be used against up to 50% of the transferor's adjusted gross income in the year of transfer, with any surplus carried forward.

All things considered, for the client in a 35% tax bracket, this income represents an effective equivalent annuity rate of 9.92% when compared to a fully taxable return.

Now, consider that same 70 year old transferring $100,000 of Genetech stock with a $50,000 cost basis in exchange for a charitable gift annuity will enjoy the same fixed 6.5% income for life and the same $35,938 tax deduction (limited to 30% of the transferor's AGI).  And, like the charitable remainder trust, the transferor escapes the initial tax hit on the capital gain. In the case of the charitable gift annuity, gain realized on the purchase of the annuity contract can be reported ratably over the annuitant's life expectancy... again, good tax deferral planning.

The taxation of the annuity payments would look like this:

  $2,470.00 taxable at ordinary rates
+$2,014.53 taxable at capital gains rates
+$2,015.47 tax free return
Total                $6,500.00

Again, assuming a 35% ordinary and 15% capital gain rate, the effective equivalent annuity rate is 9.39%.

Final Thoughts

When it comes to planning for the short and long term income needs of your clients consider the charitable alternative. Properly integrated into the financial and estate plan, a planned gift can provide an opportunity to establish a lasting legacy while making your clients' days full and enriched. On more than one occasion when we have thanked an individual for their gift the unsolicited return compliment has been "thank you for helping us." Charitable planning techniques can combine the "live good" with the "feel good." Try it, your clients will thank you for the income and the advice.

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Hedging clients'income investments.

Let's hope that the author's use of the Lehman Aggregate Bond Index(LABI) to model the income component of a 50-50 balanced investment portfolio doesn't inspire anyone to actually use only that index for clients. With the LABI's exposure to intermediate and long- term bonds, increases in intermediate or long -term interest rates could be disastrous for portfolio performance. Under current conditions any sizeable income portfolio should include significant exposure to inflation-sensitive debt securities, even if that means sacrificing current income. After all, aren't most clients interested in total return?

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