Did you know each and every American already has a charitable giving program? Each year Americans give 5 Trillion to this charity without even thinking about it. It is the largest most powerful non-profit organization on the planet… the US Government. Did that get your attention? You see most people don’t realize that by utilizing charitable giving techniques you can decrease taxes long term, increase levels of tax free wealth, and along the way be a shining example of all the good money can do in this world.
Let’s take the case of a Charitable Gift Annuity. You may have seen these advertised in magazines. They are often overlooked because they are so simple. They don’t require tons of legal paperwork or administration. In addition you can minimize payment risk if you use a program that utilizes re-insurance (the charity uses an insurance company to guarantee your income). It starts when you sign a Charitable Gift Annuity and deposit a certain amount of dollars with the charity. This results in two outcomes. Because the program is run by a charity, you get a tax deduction for a portion of your gift and tax efficient lifetime income. There are a few downsides to this program though if not utilized as part of a long term strategy. However if we are clever, we can find solutions to enhance the planning process overall.
To see how simple this works let’s look at a sample clients Alex and Mary, ages 33 and 32 respectively. They had an uncharacteristic year selling real estate and want to use legal and ethical methods to reduce their tax bill. As part of their tax mitigation program they contribute $1,000,000 to a Charitable Gift Annuity (CGA). In this particular instance the CGA generates a tax deduction based on the current IRS rates of $310,000. The CGA also starts generating $36,000 of tax free income a year of which only $23,688 is taxable. In this way, it acts like a tax deductible Deferred Comp Plan. So how does the charity benefit. In this example, the charity is going to use re-insurance through an A rated Insurance Carrier. The cost of the re-insurance for the charity is $765,957 to insure this joint income stream for both Alex and Mary. This means that the charity then gets to keep the remaining $234,042 to use as they see fit. This is truly a way that both parties win. Alex and Mary still get the economic benefit of the income and the charity gets a sizable donation that they otherwise would not have gotten.
The major question you might be asking. What if you and your spouse die before recovering the income stream? What if, as in this case, you are young and don’t really need the income just yet? You could defer it, but you would just be increasing your tax bill.
There is a solution to this problem. We can introduce another strategy to this scenario known as a Wealth Replacement Policy. This is a form of life insurance that has multiple features that make it a great fit for this situation. First is it accumulates cash that we can access tax free later. We can get growth on this cash while still insulating from market risk. In addition, it provides a starting death benefit that is pretty close to our contribution amount, thus insuring that if unforeseen circumstances were to occur, we have access to the death benefit.
So in this scenario, we set the program up to use the entire $36,000 a year to fund the policy. Alex and Mary want to retire early, so we set this program up for income to start at age 51 meaning we make 17 years of premium payments. So how does this math look assuming that they live to age 85? Let’s total up the Gift Annuity income in retirement with the Life Policy income and remaining Death Benefit. In total proceeds are provided below.
The numbers don’t lie. In this situation, the client will have achieved over 5:1 leverage on those dollars, lifetime. Due to the nature of how the generated income and death benefits are taxed, only 22% of the total amount will even be subject to taxes.
So, at the end of this example what have we accomplished for Alex and Mary? First, we remedied a tax situation I liken to the snake eating an elephant. Instead of swallowing it whole and suffering the consequences, we broke it up and got a tax break for doing that. We constructed a tax free asset, that provides both tax efficient retirement income (in this case earlier than 59.5 years old), and highly efficient wealth transfer. We left a charity with a substantial donation to do good in the world, and while we are all still around to see it.
Many people are faced with tax and wealth management issues each year. In many instances, there are planning solutions that can mitigate these circumstances and turn a negative like a hefty tax bill, into a long term positive. At our firm, we really enjoy the challenge of creating a positive impact in these situations, both for clients and the charities they care about most. If faced with this situation we encourage you to proactively reach out as we are always happy to help.