Giving Strategies, Now and Later

If you have a significant estate and are thinking about how to give money to charity or individual beneficiaries, you might want to consider if it would be possible to make some of those gifts during your lifetime. Today, we are going to look at the tax benefits or implications of different large gift strategies.

A gift to charity from your estate will reduce your your taxable estate. However, with the estate tax threshold presently at $11.4 million per person, most people will never pay any estate taxes. This was not the case 15 years ago when the estate tax threshold was just $1.5 million. For married couples, the threshold is doubled to $22.8 million. So if your past estate plan was based on estate tax avoidance, it may be time to update your plans and revisit your charitable strategies.

Charitable donations remain eligible as an itemized deduction, although many tax payers will not have enough deductions to exceed the 2019 $12,200 standard deduction ($24,400 married). However, if you are contemplating a large charitable donation, you can deduct up to 60% of your Adjusted Gross Income (AGI) when making a cash donation to a public charity. (This was increased from 50% under the 2017 Tax Cuts and Jobs Act.) If making a donation of non-cash property, such as appreciated shares of stock, the limit is 30% of AGI. In both cases, you can carry forward any excess donation for five years.

Here are seven principles for giving to charities and to individuals, such as your children or grandchildren:

1. If you have stocks or funds with a large gain, you can give those shares to charity, get the full tax deduction and avoid capital gains tax. The charity will not pay any taxes on the shares they receive and sell.

2. If you leave an IRA to a charity, that is name a charity as a beneficiary of your IRA rather than a person, they will pay no tax on receiving your IRA.

3. For individual beneficiaries of your estate, they will have to pay income tax on inheriting your IRA. Presently, there is a Bill which has passed the House which will eliminate the Stretch IRA. However, beneficiaries will receive a step-up in cost basis on inherited taxable accounts. The most tax efficient split is to leave your Traditional IRA to charity and your taxable assets and Roth IRAs, to your heirs. Then neither will pay income taxes on the assets they receive.

Read More: 7 Strategies If the Stretch IRA is Eliminated

4. If you are over age 70 1/2, you can make up to $100,000 a year in gifts from your IRA as Qualified Charitable Distributions, which count towards your RMD. You do not have to itemize to use the QCD.

 Read More: Qualified Charitable Distributions From Your IRA

5. You can give $15,000 a year to any individual; this is called the annual gift tax exclusion. A couple could give $30,000 to an individual. This includes your adult children. Additionally, you can directly pay medical or educational expenses for any individual without this limit. 

Where many people are confused: exceeding the gift tax exclusion does not automatically require you to pay a gift tax. It simply requires filing a gift tax return, which will reduce your lifetime Gift/Estate tax limit, which again is $11.4 million per person (2019). For example, if you give someone $17,000 this year, the $2,000 over the $15,000 limit will be subtracted from your $11.4 million estate tax exemption when you die.

6. If you want to create college funds for your grandchildren or other relatives, you can fund up to five years upfront into a 529 Plan without exceeding the gift tax exemption. That is $75,000 per beneficiary, or up to $150,000 if coming from both Grandma and Grandpa. You can retain control of the funds, even change the beneficiary if desired, and the money grows tax-free for qualified higher education expenses. 

Read More: 8 Questions Grandparents Ask About 529 Plans

7. You can make a large donation to a Donor Advised Fund to receive an upfront tax deduction and then make small donations in the years ahead. For example, it would be more tax efficient to make a $100,000 donation into a DAF and make $10,000 a year in charitable distributions for 10 years from the DAF, than to make regular $10,000 donations each year for 10 years. 

Read More: Charitable Giving Under The New Tax Law

Even if you know all of this information, I think many potential donors are still looking for more flexibility in their giving plans. What if you need money later? How much should you keep for your own expenses and needs? Creating a comprehensive retirement analysis is an essential first step, and then we can help you consider other more advanced giving strategies.

There are many ways of structuring charitable trusts which can split assets and income between the creator of the trust, a charity, and/or beneficiaries. Generally, the donor is able to receive an upfront tax deduction for the present value of a gift, based on their expected lifetime or duration of the trust. The present value is calculated using your age and a specific discount rate, known as the Section 7520 rate, which is published monthly by the IRS. It is based on intermediate treasury bonds and is currently 2.2% for trusts created in September 2019. This rate is down from 3.4% from last August. 

With a very low interest rate being used for the discount rate today, it is quite unappealing to establish a Charitable Remainder Trust (CRT). The low rate means that the tax deduction is very small compared to trusts that were established when the rate was higher. That’s unfortunate, because a CRT is an ideal structure: the creator receives income from the trust for life (or a set period of years) and then the remainder is donated to the charity when you pass away (or at the end of the term). 

A more effective structure for a low interest rate environment is a Charitable Lead Trust (CLT). In this type of trust, a charity receives income for a period of years (say 10 years) and then any remaining principal is distributed to your beneficiaries, free from gift or estate taxes. This might hold some appeal for tax payers who would be subject to the estate tax and who do not need or want income from some portion of their assets. But it doesn’t offer much appeal to donors who want income or flexibility from their trusts. 

If you are thinking about charitable giving or where your money might eventually go, let’s talk about which strategies might make the most sense for you. 

What Happens If You Die Without a Will?

Last April, a long-time client passed away unexpectedly at his home. I ask all clients if they have an estate plan. If they do not, I recommend they get one and provide a referral if they do not have an attorney. Unfortunately, not everyone follows my advice, and this client passed away without a will or estate plan in place.

It has been over a year now, and his estate is still not settled. I was able to transfer his IRA to his spouse within days of receiving the death certificate. But, his individual account and his home and business assets remain tied up in Probate Court. His account, which I was managing, is frozen, and I cannot place any trades in the account or pay any bills (yet) for the estate.

Assets which have designated beneficiaries, such as life insurance policies, retirement accounts, or annuities, will go to the beneficiaries without the involvement of the Probate Court. Additionally, joint accounts with rights of survivorship, may go to the survivor, such as a spouse, almost immediately.

For all other types of assets, their disposition is determined by your Will. When you do not have a Will, it is said that your estate is “Intestate”. In these cases, your individual assets will be distributed based on state law. For real property, for example, one-half of your home would go to your surviving spouse, and one-half would go to surviving parents or siblings. But you wanted your spouse to receive all of your house or real estate investments? Too bad, you don’t have a will with those instructions.

Chart of Distribution of Assets in Texas Without a Will.

For parents of minor children, not having a will means that a court will determine who gets custody of your children. And since minors cannot own, inherit, or manage investments, any funds designated for their care would have to be placed in trust under the management of a court-appointed trustee (not of your choosing). Expenses for your children would need to be approved by the court.

Everyone does need to have a will and a few other estate planning documents. Typically, you will also want:

  • Durable Power of Attorney: authorizes a person to make financial decisions and enact transactions such as paying bills on your behalf, in case you are incapacitated or unable to make those decisions.
  • Health Care Power of Attorney: designates someone to make health care decisions if you are too ill or injured to speak for yourself.
  • Physicians Directive: instructions on what care or life support you would like to receive or not.

Here in Texas, we are a Community Property State, but even for married people you still need a will. If you die “intestate”, your assets could be tied up for a year or more, assets might not automatically go to your surviving spouse, and you increase your expenses and the potential for fights and lawsuits between family members. I have seen a LOT of families fall apart over disagreements about a parent’s estate, and yet parents never think it would happen with their kids. But it does, with sad consequences that no parent would want.

Do you need a trust? The majority of people do not. It used to be that a trust was needed to avoid the estate tax. But for 2018, a married couple has basically $22 million that can be passed on without any estate taxes at all.

I have an experienced attorney here in Dallas who will create a complete Will and set of Estate Documents for you. Like me, he believes this is essential protection which every family needs. He will meet with you face to face and determine your needs before making a recommendation. For families needing standard documents, the cost is a flat $750, which is less than some online services.

After my experience of having a client pass away without a Will, I wished I had been more adamant about insisting he had gotten this done. I realize it is a morbid topic that most people don’t want to think about. But the responsible way to take care of your loved ones is to make sure your Estate Plan is in place.

If you have a Will, you may need an update or a new one, if:

  • you have moved to a different state,
  • you have gotten married, divorced, or had children,
  • any of your beneficiaries have passed away,
  • your documents are more than five years old.

This is so easy to put off for another day because you are “too busy”. Please don’t wait. There is never an ideal time. Let me help you get this done, and I promise you will feel better once you have this settled.

The Rate of Return of Life Insurance

Life insurance is a necessity for many families to protect them from the unexpected potential loss of income that could occur with a loss of life. For young families, term insurance is an excellent vehicle to address this risk.

As we get older, we hopefully have generated some wealth and we will have fewer future expenses. At some point, your kids will be out of college, you may have paid off your house, and accumulated a nice size retirement account. Each year, your need for life insurance is reduced, and eventually, you may be able to self-insure the risk of an unexpected death.

Still, I know that many pre-retirees like the idea of having a permanent life insurance policy to leave money for their spouse, heirs, or charity. Unlike a Term policy, “permanent” life insurance may provide a specified death benefit for as long as you keep the policy in force. Obviously, a permanent policy is much more expensive than term insurance. But is it a good rate of return?

It depends on how long you live! The longer you live, the more premiums you pay, and the longer your heirs have to wait to receive a fixed payout. Therefore the return is lower. Here’s an example.

For a 60 year old male in good health, you might pay $8,000 a year for a $500,000 policy. Even if you live for another 25 years, that means your heirs would receive $500,000 and you only paid $200,000 in premiums. That must be a good return, right? Let’s take a look:

$500,000 future payout, cost is $8,000 a year.
Rate of Return

10 Years 32.1%
15 Years 16.5%
20 Years 9.9%
25 Years 6.5%
30 Years 4.4%

I would say the return is excellent if you live for 20 years or less. If you live for 30 years or more, you may have more total wealth if instead of purchasing insurance, you had simply kept your $8,000 a year invested. Historically, it has not been very difficult to beat 4.4% over 30 years. So as a long-term investment, I don’t like life insurance. Which brings us back to the primary purpose of life insurance in my mind: to protect against the danger of pre-mature death.

To be fair, the rate of return on insurance is generous because so many policies lapse. When that happens, insurers will have received years of premiums and never have to pay out a death benefit. Other policy holders will borrow from their policies, causing them to deplete and never payout. I believe the majority of people who start a permanent policy will never receive a death benefit because of their own choices.

I should add that getting the best price on a life insurance policy is no easy task. Underwriting for a permanent policy will be rigorous, looking at your health, weight, blood tests, family and occupational history and more. Now, if your premium was higher than $8,000 a year for this hypothetical policy, the rates of return above would obviously be much lower.

My recommendation for most people: get term to cover you until your kids are out of college. For many people, that will be the only life insurance policy they will ever need. There are some good uses for permanent insurance, such as for business succession or estate planning. But it’s not the vehicle financial planners prefer for long-term wealth accumulation.

Do You Know Your Spouse’s Beneficiary Designations?

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Beneficiary designations are important. The people you list on your IRAs, retirement plans, and life insurance policies will receive those monies regardless of the instructions in your will. What happens when you don’t indicate a beneficiary or if the beneficiary has predeceased you? In that case, the estate is named as the beneficiary of the account.

It is usually much better if you have a person indicated as the beneficiary rather than the estate, for the following reasons:

  1. If a person is the beneficiary, they can receive the assets very quickly by completing a distribution form and providing a copy of the death certificate. When the estate is the beneficiary, you may tie up the assets in probate court for months, or even years.
  2. A person can roll an inherited IRA into a Stretch IRA and keep the account tax-deferred. The beneficiary is required to continue taking Required Minimum Distributions, but even doing so, the IRA can last for many years. When a spouse is the beneficiary of an IRA, he or she can roll the assets into their own IRA and treat it as their own. By spreading distributions over many years, taxes may be lower than if you took a large distribution all in one year and are pushed into a higher tax bracket.
  3. When the estate is the beneficiary, they do not have the option for a Stretch IRA. They can either distribute the IRA immediately or over 5 years. Either way, the estate will be paying taxes sooner than if the beneficiary was a person.
  4. The tax rate on estates can be much higher than for individuals. An estate or trust will pay the maximum rate of 39.6% on income over $12,400 whereas a married couple would hit this tax rate only on taxable income that exceeds $466,950 (2016 rates).

For many individuals, a substantial portion of their estate may be in IRAs, retirement plans, life insurance and annuities, where the beneficiary designation is vitally important. In the last two months, the IRS has issued two Private Letter Rulings (PLR) specifically on beneficiary designations and the rights of surviving spouses. A PLR is official guidance from the IRS on how they interpret and enforce tax law, based on specific cases which are brought to the IRS.

In PLR 201618011, a spouse did not indicate any beneficiaries on her IRA. When she passed away, the absence of a beneficiary designation meant that the estate would be the beneficiary of the IRA. The husband was the sole beneficiary and executor of the estate under her will. The IRS ruled that in this scenario, the surviving spouse has the right to rollover the inherited IRA and treat it as his own, even though the decedent failed to designate a beneficiary. This exception is granted only for surviving spouses and does not apply to other beneficiaries, such as children.

On June 3, the IRS issued PLR 201623001, which is of particular interest to Texas residents as it deals with community property issues for married couples. (Texas is one of nine states with Community Property laws.) A man listed his son as the sole beneficiary of his three IRAs. He passed away and his wife claimed that she should be entitled to one-half of the IRA assets because they were community property of the marriage. The IRS ruled that Federal Law takes precedence over state law and rejected her claim.

Both of these rulings show how important it is to know your spouse’s beneficiary designations on all of their accounts. Even if you have a will that is up to date and perfectly legal, it won’t help you if you don’t indicate a beneficiary, or indicate the wrong person. Review your beneficiary designations every couple of years and especially if you have gotten married, divorced, or had births or deaths in your family.

Beneficiary designations are not exciting or complicated. However, a big part of financial planning is getting organized and taking care of these small details. If your beneficiary designations are wrong, it could have a major impact on your heirs and cost thousands in additional, unnecessary taxes.