Illustration By Natalie Ascensios
In charity there is no excess, something Americans prove by being more generous with their wealth than the people of any nation on earth. According to The American Gift Fund, a tax-qualified public charity that takes donations and turns them into grants for some of the nation's 125,000 charities, Americans graciously unburden themselves of some $150 billion each year. The question, surprisingly enough, is not why so much, but why not so much more?
Everyone is a philanthropist; some people just don't know it. "It's not a question of whether or not a client is going to give, it's whether or not he's going to give it to the government or to the social good," says Elizabeth Holt, an advisor with offices in Los Vegas and Denver and a member of the National Association of Philanthropic Planners. The sad truth is that most people are unaware that the same government cursed for excessive taxes offers impressive incentives to avoid them, through charitable giving, or so-called social capital redirection.
This capital redirection is music to the ears of taxpayers who would like to do more with their abundance than bestow it upon Uncle Sam. For the vast majority of people, once they understand the undesirability of undiversified assets, accept the wisdom of controlling those assets via charitable trusts or partnerships, and discover that by doing so they can eliminate capital gains, enjoy an income tax deduction, and be blessed with a free pass on most estate taxes while receiving income for life, they want to know how - immediately.
After all, who wants to be former Miami Dolphins owner Joe Robbie, whose family had to sell the franchise in order to pay $55 million in estate taxes in 1994, when you can be Jackie Kennedy Onassis, whose beneficiaries paid only $6 million in taxes that same year on an estate of comparable size? The difference is that before her death, Jackie O. created a series of charitable lead trusts for her children and grandchildren - more on trust vehicles later - and Robbie didn't. The story is anecdotal gravy on the financial services chicken-dinner circuit, but apparently a lot of advisors, as well as attorneys and CPAs, haven't been, dare we say, listening.
"This is an issue where I don't think most advisors are up to speed," says Holt, adding that when advisors do encourage gifting, there are good odds that when they broach the subject with CPAs or attorneys, the first response is likely to be: "It's too complicated and probably not good for the client." Here's an example from Holt's client list: After a woman's father passed away in Las Vegas, the woman convinced her mother to go with her to one of the city's hotshot attorneys. Faced with an alarming amount of estate taxes, the mother and daughter asked the lawyer, "At what level of wealth do you bring up things like charitable tools, testamentary gifts, lead trusts, or whatever?" The lawyer's response was simple: "We don't."
In truth, there is no level of appropriateness. Contrary to popular perception, a client doesn't have to be Jackie Kennedy Onassis to leave a legacy and do some extraordinary good for his community or for a cherished cause - including his own. Thanks to computers, the gifting process is vastly easier than it was a decade ago. Now the public, who previously couldn't afford to gift with less than two or three million dollars, can launch a practical charitable remainder trust at the $100,000 level.
"Capitalism is a pretty humbling experience when it works right for you," says advisor Steven P. Kanaly of Houston-based Kanaly Trust Company. A knowledgeable advisor can help make sure it does work right, by suggesting charitable giving when the client doesn't and by explaining options and benefits applicable to that person's specific circumstance and goals.
"Our clients, whether they're cognizant of it or not, get to a point where they are working either for the U.S. Government 'charity' or their family," says Kanaly. "Their financial outcome depends upon which one they choose." The choice becomes simple when they realize that, in rough numbers, they can earn a dollar, pay 40% of it in income taxes, and then die and pay roughly 50% of the 60 cents left over in estate taxes. This leaves at best some 25 to 30 cents on the dollar for them to will to their children - and grantors rolling over and kicking themselves in their graves. Of course, this isn't necessary, since present limits on charitable deductions, if sought, are a bracing 50% of adjusted gross income for cash contributions, and 30% for contributions made in appreciated stock or other forms of property, which can be carried over for about five years.
The primary "arrows in the advisor's quiver," as Holts puts it, are charitable remainder trusts (CRTs), charitable lead trusts (which St. Louis lawyer and estate-planning speaker Lawrence Brody jokingly refers to as JOLTS, or Jackie Onassis Lead Trusts), and forms of family partnerships. The difference between an irrevocable charitable remainder trust and an irrevocable charitable lead trust is simply illustrated by Holt's tree and apple analogy: You can either own the tree or eat the fruit. With a charitable remainder trust, you get to eat the fruit for some period of time, and say goodbye to the tree. With a charitable lead trust, you give the fruit away for some period of time, but you get to keep the tree.
The remainder trust performs nicely for individuals with no children, or those wealthy enough to benefit charity and children alike. It works this way: The client puts his appreciated stock in trust, gives it to his favorite charity, sells the stock tax-free, and receives an income tax deduction for the value of the gift. In effect, the client will receive a lifetime income stream for himself and his spouse that can be anywhere from 5% to 10% of the gift value. When the client and spouse die, the residual value will go to the charity. "It's a neat way to diversify and help the client while alive," says Kanaly.
Use of the lead trust is especially advantageous at the death of the second spouse, he notes, when estate taxes are the greatest. This method allows creation of a trust that will not provide income to the family for 10 to 15 years, and instead funnels that income to a charity or a foundation set up by the family. At the end of the specified time period, payments to the charity will cease. What's left will pass tax-free to the children or grandchildren of the original grantor. In essence, the grantor is making a future gift to heirs and receiving a substantial discounting of the value of this gift for transfer, while doing something quite handsome for the charity or foundation.
Family partnerships are usually the most complex option to implement, and function well for clients with substantial assets, generally around $5 million and up. This vehicle calls upon a charity, foundation, university, church, or some organization or individual to partner with a client family in various investments the family will make. The client contributes a low-basis, high-value asset, giving the charity 98%, keeping 1%, and giving 1% to his family. Somewhere down the line, with or without a prior understanding, explains Brody, the family redeems the charity at 10? or 15? on the dollar. The charity enjoys the cash flow from their partnership interest; in turn, the family gets a hefty charitable deduction up-front. In the end, the family owns 100%, having paid 10% or 15% for 98%.
None of the three vehicles above is necessarily better than the other. "You sit and explain and find the right one for each individual client," says Kanaly. "It's sort of like going to the doctor, or to an architect to get a blueprint." The key, he maintains, is to work with people before they sell and diversify, so that proper steps can be taken to eliminate negative income tax implications. A common client pitfall is saving too much, too long, in a 401(k) or IRA rollover account while living off capital outside that account. The biggest asset in a client couple's estate may be their biggest liability, if husband and wife die prior to pulling their money out of savings, forcing heirs to pay the 40% income tax and 55% estate tax. The advisor can avoid this situation, says Kanaly, by creating a default option near the end of a client's life expectancy, wherein the 401(k) or IRA rollover would not pass to the children at mom and dad's death, but instead go directly to the family foundation or charitable trust, eliminating any tax implications.
"We've got people who think they've got $600,000 in a pension plan and we tell them that their family will get $170,000 out of it," says Holt. "We ask them, 'Can't you think of a better place to give $430,000 than to the government?' They always think of something."
In some cases some charities are more favorable than others. Nancy Frank of Frank Advisory Services in New York City cites the example of a 69-year-old client who, with no dependents, retired after a long career at IBM. Stock options comprised a huge portion of her portfolio. She wanted to generate more income and do something charitable. The result was the establishment of a gift annuity at Memorial Sloan-Kettering Cancer Center - a measure that was both financially and emotional satisfying to this breast cancer survivor.
If Frank's client had taken $100,000 of her IBM stock and sold it, she would have been paying capital gains on practically all of it because the cost basis was so low. The income dividend was 1.5%. The gift annuity enabled her to receive more income, have a more diverse portfolio, and give to a charity she really believed in.
If it's so easy for the client to win the charitable giving game, why is the government even playing? For one thing, Washington is stupendously inefficient at sending money where it belongs. It costs the government $1.45 to collect the dollar it took from your client to then give back to charities. If you give directly to your favorite cause, the dollar doesn't detour through bureaucracy, and the government saves 45 cents.
Margaret Thatcher once said that no one would remember the Good Samaritan if he'd only had good intentions; he was remembered because he had money as well. Some citizens gift for tax-saving reasons alone, some wish to support charities anonymously, others to have buildings named after them or foundations established in their name. "Foundations sound nice," says Mark Pash, of Pash & Benson International in Encino, California, "but unless you want to have some sort of legacy and have substantial capital, you can accomplish the same thing, from a tax standpoint, with a straight-out gift or charitable trust."
Then there are those who have psychological or emotional reasons for giving. Frank had a client who at one time gave away more in charity than she earned, and since she did her own taxes, decided for herself what was reasonable to deduct. "I did suggest it might not pass muster with the IRS," says Frank, "and that she might reconsider refiling according to, oh, I don't know, tax laws?".
To serve the average investor/saver, the number of trust vehicles, such as those offered by Vanguard and Fidelity, and non-profit community foundations such as New York Community Trust, is ever increasing. So are programs such as Leave A Legacy. The American Gift Fund (www.giftfund.org) in Wilmington, Delaware, as noted earlier, turns donations from Americans into grants to charities across the country. The fund can be used as a remainder beneficiary with charitable remainder trusts and as an income beneficiary on a charitable lead trust. The fund promotes itself thusly: "If you wish to give, but you're too busy living your life to become a charitable giving expert, you should consult with your advisor about how you can use The American Gift Fund - a sensible alternative for philanthropy." There are no start-up costs, and maintenance costs are a fixed 1% of assets, assessed against the fund account. Required distributions are 5% of average assets over five years.
Of special interest is American Gift Fund's pitch to advisors who place client assets with them. "Generosity has never been so profitable," the fund's print ad reads, meaning profitable for the advisor, who will earn fees and commissions of 1% up front and an ongoing stream of 75 basis points per year. The offer is met with raised eyebrows by advisors who say they don't counsel clients with an eye toward their own bottom line; one planner went as far as to call the ad "repugnant." Others are less critical. "The American Gift program combined with their pooled income fund is very, very good," said another.
For advisors interested in charitable giving there is the National Association of Philanthropic Planners (www.- napp.net), headquartered in Laguna Hills, California. Launched as an independent non-profit in 1998, the group presently has 240 members nationwide, and is adding about five new members each month. The only requirement for membership is that the majority of an advisor's business be in the philanthropic planning arena.
According to Steve Kanaly, there's an inverse correlation between wealth and security: the more wealth you accumulate, the less secure you feel. He is referring to Tom Brokaw's "Greatest Generation" clients, humbled by the vast and unexpected riches they find themselves saddled with and in need of a strong guiding hand. Then there are the newly rich boomers, many of whom are part of high-earning dual-career couples. Add to all this extended life expectancies, and the advisor's task becomes considerably more complicated, though with a potential for huge rewards. Furthermore, the rewards can be more than monetary. "It is a heartwarming, enriching thing to be a part of, to watch these people get the opportunity to direct social capital and see what kind of good it does," says Elizabeth Holt.
The concept of redirecting social capital, with its attendant benefits, has power to convert the skeptical skinflint who wonders whether an even greater way to save on taxes exists. Does it? "Sure," says Steve Kanaly. "Go offshore and drop your citizenship."