Charitable giving often plays a role in the estate planning process.

The reasons to include charitable giving in the planning process may include one or more benefits. For example, you may want to take advantage of tax benefits or the possibility of creating a legacy. Sometimes the income and estate tax consequences are at the top of the list and sometimes they are not. Regardless of the motivation, individuals need to be aware of how different charitable giving strategies might impact their overall plan.

In this section, we will explore a few of the more common charitable giving strategies. These strategies include:

  • Outright gifts of cash or appreciated securities
  • Bequests in your will or trust
  • Naming charitable beneficiaries on retirement assets or possibly life insurance policies
  • Donor-advised fund
  • Charitable remainder trust
  • Pooled income fund
  • Charitable gift annuity
  • Charitable lead trust

We encourage you to discuss these strategies and others with your tax and legal advisors to evaluate whether they are a good fit for your tax situation and your charitable giving goals.

Giving cash or appreciated securities that have been held more than 12 months is simple and provides the charity with immediate use of your gift. You may also receive an income tax deduction. The deduction amount varies with each individual's situation, and may be reduced due to AGI (or adjusted gross income) limitations. Charitable deductions which are currently disallowed because of AGI limits may be carried forward for a five-year period. Certain high-income individuals may also find that their overall itemized deductions are subject to a reduction or "haircut" (sometimes known as a "Pease" limitation).

If you are subject to estate taxes, your charitable gift also reduces your potential taxable estate.

You can add a charitable bequest to your will or revocable living trust. This allows you to retain control of the assets during your lifetime, but benefit a charity upon your death. Bequests may be more appropriate than lifetime gifts if you are charitably inclined but have concerns regarding retirement income needs. If you are subject to estate taxes, the bequest reduces your taxable estate.

An often overlooked charitable giving strategy is that of naming a charity as the beneficiary or partial beneficiary of retirement assets such as an IRA, 401(k), or other retirement assets.

In large estates, retirement assets may be subject to both estate tax and income tax. (Remember, however, that for estates below $5,490,000 in 2017, the federal estate tax is not a factor.)

When you leave retirement assets to individuals, the individual beneficiaries must pay income tax on the funds they receive. On the other hand, if you name a charitable beneficiary, the charity does not pay income taxes. In addition, if you are subject to estate taxes, this gift reduces your potential taxable estate.

You may also name a charity as the beneficiary of a life insurance policy to reduce your taxable estate.

Donor-advised funds provide another simple charitable opportunity. These funds are available through community foundations and charitable funds established by mutual fund companies.

Donor-advised funds allow individuals to make irrevocable contributions of cash or securities. The individual (also called a donor) receives an immediate charitable income tax deduction for fair market value of each gift. (Multiple gifts may be made over the donor’s lifetime.) The donor may take several years to deplete the gift fund account. While the assets must eventually be used for charitable purposes, there is no mandatory distribution time for the fund. The assets are also removed from the taxable estate, reducing any potential estate tax liability. In addition to the tax benefits, the individual may name the account, giving them the option to enhance their visibility in the philanthropic community.

A charitable remainder trust, commonly referred to as a CRT, can benefit you and one or more of your favorite charities. This type of trust lets you convert an appreciated asset into lifetime income for you, or another beneficiary, without paying capital gain taxes when the asset is sold. A CRT can also provide you with a current tax deduction, and because you are removing assets from your estate, reduce your taxable estate. You will also make a future gift to the charity (or charities) of your choice.

Here's how a charitable remainder trust might work for you.

First, let's say you donate appreciated stock to your charitable remainder trust. In our example we'll use a $1 million gift, although a charitable remainder trust can be funded with any amount you choose.

The stock is then sold within the trust, free of capital gain tax. The proceeds are typically reinvested to create a diversified portfolio.

For this example, your trust is designed with a 6% annual payout. On a $1 million trust, the donor receives $60,000. Your stock may have been paying less than that in dividends, so you have the opportunity to increase your cash flow through this strategy.

A charitable remainder trust can be designed to provide either a fixed payout, or a variable payout based on the annual value of the trust assets.

In addition to the income stream, you would also be eligible for a current income tax deduction. The amount would not be for the full $1 million, because the charity typically has to wait for the duration of your lifetime (during which you would be withdrawing 6% a year from the trust). The value of the gift to the charity will be less than the $1 million. Your charitable deduction is the "present value" of the amount the charity is expected to receive after you die.

When you die, assets remaining in the trust are distributed to the charities you specify. You may reserve the right to change or add charitable beneficiaries during your lifetime. Your estate planning attorney can provide this flexibility when drafting your document.

You can donate cash and appreciated securities, (such as stocks or bonds) to a charitable remainder trust. With proper planning, you can also gift real estate.

Not all types of assets are appropriate for a charitable remainder trust. For example, special rules apply to gifts of tax-deferred assets, such as IRAs, retirement plan accounts, and annuities. Gifts of these types of assets while you are alive are not practical because gifting these assets triggers income tax to you.

However, it is possible to make a charitable remainder trust the beneficiary of an IRA or retirement plan after your death. Your partner or spouse could receive a payment from the charitable remainder trust for life, and the balance of the account would go to charity after the death of the partner or spouse. The present value of the income payments to an unmarried partner is included when computing the value of your taxable estate; if you are married, the gift of continuing income to your spouse is not a taxable gift because of the unlimited marital deduction. Other items, such as tangible personal property and mortgaged property, may not be ideal property to put in a CRT because they each have their own complicated issues when donated to a charitable remainder trust.

Under this scenario you could potentially receive more income than you were receiving from ownership of the stock, a charitable income tax deduction, and reduce your taxable estate. You can also sell appreciated assets or diversify a concentrated position with no immediate capital gain tax. But if the charitable remainder trust was for your lifetime only, the remainder passes to charity at your death and would not benefit your partner, spouse, or children.

Let's see how you can retain all the advantages of the charitable remainder trust while still providing an inheritance for your partner, spouse, or children.

This can be accomplished by establishing a "wealth replacement" trust, that is, an irrevocable life insurance trust or ILIT.

In this hypothetical example, you're receiving taxable income of $60,000 annually from the charitable remainder trust. Let's say you keep only $40,000 in annual income from the trust to pay taxes on the income and to supplement your annual income. In this example, the donor uses the additional $20,000 in annual income provided by the trust to make gifts that are used to acquire life insurance in an irrevocable trust with a $1 million death benefit. Keep in mind, income from the charitable remainder trust is taxable to you. So your gifting is funded with after tax income from your charitable remainder trust.

Remember that life insurance premiums vary based on your age, and you must qualify through the underwriting process. The amount used here is simply a hypothetical example.

Upon your death, the proceeds paid into the ILIT will be both income and estate tax free and can be distributed to your spouse, partner, and/or children according to the terms of the trust.

By combining a charitable remainder trust with an ILIT, everyone may benefit. You get an income stream along with an upfront tax deduction. Your favorite charities receive a gift after you die. And your beneficiaries can receive tax-free insurance proceeds instead of taxable assets from your estate.

Hopefully, the information has helped you better understand charitable remainder trusts and the many potential advantages they offer to you, your beneficiaries, and your favorite charities.

Talk with your attorney and tax advisor to discuss if a charitable remainder trust is right for you.

Keep these alternatives in mind:

You can keep your appreciated securities until you die, to be included in your taxable estate. If you have a taxable estate, your beneficiaries will receive the balance of your estate after paying estate taxes.

You may decide to sell your appreciated securities now and pay the taxes. You have access to all of the principal, as well as income. You pay capital gain taxes now and possibly estate taxes later.

Or you could give your appreciated securities to charities now and take the full tax deduction. This option may provide you with a larger tax deduction, but you will no longer own the asset or receive any income.

The pooled income fund shares some characteristics with a charitable remainder trust and may be used by individuals who like the concept of retained income but may not want the complexity of a trust. It is a simple strategy available through some charities.

The pooled income fund provides the donor with an income stream during his or her lifetime. This income stream is taxable to the donor as ordinary income. The income is not fixed; instead, it will vary based on the fund's yield every year. Due to the variable income payout, this technique may not be appropriate for individuals who need or want a fixed income stream.

The charitable income tax deduction is based on the present value of the charity's remainder interest. The deduction is calculated when the irrevocable gift is made to the fund. The charity receives the account balance upon the donor's death.

Unlike the charitable remainder trust, the donor does not need to have a trust document drafted by their attorney. The pooled income fund offers administrative simplicity and the ability to generate some income. It provides an individual the opportunity to diversify a concentrated equity position without immediate tax consequences. It also creates a partial or pro-rated charitable income tax deduction and provides a charitable legacy. Potential estate taxes may also be reduced.

A charitable gift annuity is an unsecured contract between a charity and a donor. The donor gifts assets to the charity in exchange for an income stream for the donor's life. The payout is made by the charity; it is not guaranteed and does not involve an insurance company or commercial annuity. The charitable income tax deduction will be less than the full amount of the gift, as the donor retains the right to the income stream. The donor's deduction will be based on the charity's remainder interest. The deduction is calculated at the time the assets are donated to the charity. The charity keeps the remaining balance at the end of the term.

You can structure a charitable gift annuity to provide income not only for your life, but also for the life of a partner, spouse, or child. If the successor income beneficiary is not your spouse, this can have gift or estate tax implications, so be sure to work closely with your attorney and tax advisor to determine whether or not it is appropriate for your situation.

The final charitable opportunity we will review is a charitable lead trust. This strategy combines charitable giving and wealth transfer goals. This irrevocable trust may be funded during lifetime or upon death. During the trust term, which can be for the life of the donor or a set number of years, the trustee pays an income stream to one or more charities. At the end of the trust term, the principal is distributed to your unmarried partner, family members, or a family trust. Because the gift to the individual beneficiaries is delayed, tax law allows donors to discount the value of the family gift. This gift also reduces potential estate taxes. Let's take a look at an example of the charitable lead trust.

Let's assume you contribute $1,000,000 to a charitable lead trust during your lifetime. The trust makes an annual payment to charity for ten years. In our example, we'll use a 5% payout. This payout may be fixed or variable depending on the type of charitable lead trust. There are two types of charitable lead trusts. The charitable lead annuity trust (or CLAT) has a fixed payout; the charitable lead unitrust (or CLUT) has a percentage payout that will change each year with the portfolio value.

In this example, the $1,000,000 gift to your partner or family is discounted to $603,000 (assuming a CLUT and a §7520 rate of 2.0%). A gift tax return is filed, but no tax is due because of the exclusion. This gift will use $603,000 of your $5,490,000 gift tax exclusion. If the portfolio generates a total return of 5% or more over time, your partner or family could receive more than $1,000,000 after ten years. If the portfolio does not generate 5%, the amount remaining for your partner or family will be less than your original gift.

This type of trust differs from the other strategies because this trust is not exempt from income taxes. Either the trust or the donor will pay the annual income tax liability, depending on how it is drafted.

This type of trust may appeal to you if you wish to benefit a charity now and your individual beneficiaries later, and reduce potential estates taxes.