Charitable Giving

Charitable giving can play an important role in many estate plans. Philanthropy cannot only give you great personal satisfaction, it can also give you a current income tax deduction, let you avoid capital gains tax, and reduce the amount of taxes your estate may owe when you die. There are many ways to give to charity. You can make gifts during your lifetime or at your death. You can make gifts outright or use a trust. You can name a charity as a beneficiary in your will, or designate a charity as a beneficiary of your retirement plan or life insurance policy. Or, if your gift is substantial, you can establish a private foundation, community foundation, or donor-advised fund.

Making outright gifts

An outright gift is one that benefits the charity immediately and exclusively. With an outright gift you get an immediate income and gift tax deduction.

Tip: Make sure the charity is a qualified charity according to the IRS. Get a written receipt or keep a bank record for any cash donations, and get a written receipt for any property other than money.

Will or trust bequests and beneficiary designations

These gifts are made by including a provision in your will or trust document, or by using a beneficiary designation form. The charity receives the gift at your death, at which time your estate can take the income and estate tax deductions.

Charitable trusts

Another way for you to make charitable gifts is to create a charitable trust. You can name the charity as the sole beneficiary, or you can name a non-charitable beneficiary as well, splitting the beneficial interest (this is referred to as making a partial charitable gift). The most common types of trusts used to make partial gifts to charity are the charitable lead trust and the charitable remainder trust.

Charitable lead trust

A charitable lead trust pays income to a charity for a certain period of years, and then the trust principal passes back to you, your family members, or other heirs. The trust is known as a charitable lead trust because the charity gets the first, or lead, interest. A charitable lead trust can be an excellent estate planning vehicle if you own assets that you expect will substantially appreciate in value. If created properly, a charitable lead trust allows you to keep an asset in

the family and still enjoy some tax benefits.

Example: John, who often donates to charity, creates and funds a $2 million charitable lead trust. The trust provides for fixed annual payments of $100,000 (or 5% of the initial $2 million value) to ABC Charity for 20 years. At the end of the 20-year period, the entire trust principal will go outright to John's children. Using IRS tables, the charity's lead interest is valued at $1,267,630, and the remainder interest is valued at $732,370. Assuming the trust assets appreciate in value, John's children will receive any amount in excess of the remainder interest ($732,370) unreduced by estate taxes.

Charitable remainder trust

A charitable remainder trust is the mirror image of the charitable lead trust. Trust income is payable to you, your family members, or other heirs for a period of years, then the principal goes to your favorite charity. A charitable remainder trust can be beneficial because it provides you with a stream of current income--a desirable feature if there won't be enough income from other sources.

Example: Jane, an 80-year-old widow, creates and funds a charitable remainder trust with real estate currently valued at $1 million, and with a cost basis of $250,000. The trust provides that fixed quarterly payments be paid to her for 20 years. At the end of that period, the entire trust principal will go outright to her husband's alma mater. Using IRS tables and assuming a 4.8% AFR, Jane receives $50,000 each year, avoids capital gains tax on $750,000, and receives an immediate income tax charitable deduction of $354,903, which can be carried forward for five years. Further, Jane has removed $1 million, plus any future appreciation, from her gross estate.

Private family foundation

A private family foundation is a separate legal entity that can endure for many generations after your death. You create the foundation, then transfer assets to the foundation, which in turn makes grants to public charities. You and your descendants have complete control over which charities receive grants. But, unless you can contribute enough capital to generate funds for grants, the costs and complexities of a private foundation may not be worth it.

Tip: One rule of thumb is that you should be able to donate enough assets to generate at least $25,000 a year for grants.

Community foundation

If you want your dollars to be spent on improving the quality of life in a particular community, consider giving to a community foundation. Similar to a private foundation, a community foundation accepts donations from many sources, and is overseen by individuals familiar with the community's particular needs, and professionals skilled at running a charitable organization.

Donor-advised fund

Similar in some respects to a private foundation, a donor-advised fund offers an easier way for you to make a significant gift to charity over a long period of time. A donor-advised fund actually refers to an account that is held within a charitable organization. The charitable organization is a separate legal entity, but your account is not--it is merely a component of the charitable organization that holds the account. Once you transfer assets to the account, the charitable organization becomes the legal owner of the assets and has ultimate control over them. You can only advise--not direct--the charitable organization on how your contributions will be distributed to other charities.

Prepared by Forefield Inc. Copyright 2011

Annuities Get An Image Makeover

In January, 2010, the Obama administration’s Middle Class Task Force, headed by vice-president Joe Biden, released its preliminary ‘Fact Sheet’ which contained the following excerpt :

“The Administration is…Promoting the availability of annuities and other forms of guaranteed lifetime income, which transform savings into guaranteed future income, reducing the risks that retirees will outlive their savings or that their retirees’ living standards will be eroded by investment losses or inflation.”

With that one sentence, the annuity industry received an image makeover the likes of which could hardly have been dreamed of beforehand. So often derided in the media and among consumer advocates as being an instrument of evil, annuities (and particularly variable annuities) have long-suffered an image as expensive, complex and unnecessary products whose main purpose was to put money in the pockets of the unscrupulous agents who sold them.

So how is it that the newly elected Obama administration, seemingly the most progressive administration in decades, came to extol the virtues of the annuity contract and the potential income guarantees available in them? The key to understanding this paradigm shift is in the ripple effects of the so-called ‘Great Recession’ on the retirement savings of millions of American workers.

For many years now, employers large and small have been moving away from the large scale defined benefit pension plans of old and towards the defined contribution plans we have now become so accustomed to. Chances are that if you are under the age of 50 and work for anyone other than a government agency or possibly a large publicly-traded company that has been in existence for more than 50 years, you have never even considered the concept of a defined benefit pension as part of your retirement savings. The difference between a defined benefit plan and a defined contribution plan essentially boils down to who assumes the risk of the assets running out before the retiree has finished spending them (passed away). An employer who provides a defined benefit pension agrees to pay a set amount of income (usually based on some combination of years of service, life expectancy, average compensation or assets contributed to the plan) to the retiree for life. Thus, they are taking on the risk that the assets set aside for this purpose will last long enough to cover those payments. In most cases, the pension plan will need to invest the assets in the plan in order to at least keep up with inflation or grow over time. Obviously this can expose the plan and the employer to a substantial risk in the event of a major downturn in the markets in which the assets are invested.

The defined contribution plan on the other hand exposes only the retiree (or pre-retiree) to the risk of market downturns which is why the corporate world has moved to this model over the years. It also illustrates why so many workers now find themselves in a precarious position following the events of the past few years. As their plan accounts have fallen, workers are faced with the difficult responsibility of turning those plans into an income stream to replace their salaries in retirement which these days can last upwards of 30-40 years. Trying to determine what percentage of your pre-retirement income will be sufficient to get you through retirement is hard enough, but actually managing the investments and distributions in retirement can be daunting. Those who can afford to pay a financial planner to assist them in these tasks are at a significant advantage but even the most seasoned professional cannot completely shield workers who need growth over the long-term from the sometimes devastating effects of major market downturns in the short-term. So, if the question workers are faced with is: “how do I achieve long-term growth, while taking on minimum investment risk and eventually create an income stream that I cannot outlive in retirement?” one product with the potential for all of that is the variable annuity¹.

^[1] Annuities are long-term, tax-deferred retirement vehicles intended for retirement purposes. Guarantees for all types of annuities are based on the claims paying ability of the issuing insurance company. Annuities are not FDIC insured. Withdrawals prior to age 59 ½ are subject to 10% IRS penalty, and surrender charges may apply. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal, unless the contract is held inside a Roth IRA. Policies of any annuity type should be reviewed carefully before purchasing.

Variable annuities contain both investment and insurance components. They are sold by prospectus. The investment returns and principal value of the available sub-account portfolios will fluctuate so that the value of an investor’s unit, when redeemed, may be worth more or less than its original value.

With a variable annuity, funds are invested in underlying sub-accounts with the value of the annuity fluctuating in connection to the performance of those sub-accounts over time. Most variable annuities have optional riders² for purchase which will provide minimum income and death benefit guarantees among others. Once it is time to turn the funds into an income stream, you can annuitize the annuity, at which point you give up the ability to access the funds and the insurance company agrees to pay you a specific amount regularly (monthly, quarterly, annually) for the rest of your life, or for some other pre-determined amount of time. Through income guarantees and annuitization, clients can effectively transfer the risk of the income base going down from themselves to the insurance company. Alternatively, there are now many companies who offer withdrawal benefit riders that will guarantee that a certain percentage (such as 5 or 6%) of the value of the annuity can be taken out each year for life, while still having access to the balance of funds if needed.

² Riders are guaranteed options that are available to an annuity or life insurance contract holder. While some riders are included in a base contract, others may carry additional fees, charges, limitations and restrictions.  Please consider them carefully.

Over the years, annuities and their supporters have often been vilified and painted as the bottom-feeders of the industry. These characterizations are not totally unfounded and we have seen plenty of clients come to us after having been sold an annuity that they did not understand or may not have needed. As with most financial products, there is nothing inherently bad about the product itself, but with the way it has been sold. Too often annuities have been the wrong product at the wrong time for the wrong client, but sold nevertheless by unscrupulous brokers trying to make some fast money. However, for the right client with the right needs, they serve their purpose dutifully.

The main issues detractors tend to have with variable annuities are cost and lack of liquidity. The cost of an annuity and associated riders can run upwards of 3-4% annually which is considerably higher than the 1-2% total annual cost of investing in a typical managed ETF portfolio for example. This is something to be considered carefully for sure, but may not be as onerous as it seems at first glance.

First, many clients find the premium a worthwhile price to pay for the accompanying guarantees and transfer of risk. Second, if the confidence those guarantees inspire allow the client to stay invested for the long term where he or she might otherwise make knee-jerk or emotional decisions during volatile markets, the additional costs may well be substantially less than the damage caused by those decisions. Finally, for clients with a long-term accumulation horizon, the benefit guarantees encourage them to invest more aggressively in the underlying sub-accounts than they would be comfortable with in a regular investment account. Thus, over the long-term, the potentially higher returns which may be achieved by investing more aggressively have a good chance of balancing out the additional fees associated with the variable annuity and accompanying riders.

Many variable annuities come with surrender charges (a penalty assessed if funds are withdrawn before the end of an annuity’s multi-year surrender period), making the product fairly illiquid. Also, once a contract is annuitized (turned into an income stream), the client no longer has access to the underlying funds. For these reasons, it is always recommended that clients who are considering a variable annuity have both a long-term (10 years or more) time horizon and other more liquid assets that can be accessed if necessary. As usual, diversification is the key, and as such, a variable annuity should always be considered as just one part of a client’s overall retirement savings portfolio and never the sole vehicle.

As of the writing of this article, the S&P 500 is up almost100% from the March 2009 lows. As head cheerleader when the market was at its lows 2 years ago, and in our attempt to be the voice of reason now that it has doubled since, we would be remiss if we did not caution that, as we all know, the market cannot go up indefinitely. For some, it may make sense to take a small amount of those gains, and lock them in, using a vehicle such as a variable annuity while still allowing for potential upside going forward. This is a strategy we have seen used effectively and feel has merit for the right clients.

There has been a significant shot in the arm for the annuity industry recently, beginning with the market meltdown of late 2008 and the resulting recession, and culminating with the Obama administration’s promotion of annuities and other forms of guaranteed lifetime income products to help workers prepare for retirement. For our part, we neither viewed annuities as instruments of evil before the recession nor as the savior of worker’s retirements now that the president has endorsed them. Rather, variable annuities, like most other financial instruments, are but one tool which, when used properly and in concert with other financial tools, can help to build the foundation of a long and fulfilling retirement.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.  Diversification does not ensure against market risk.