2004-10-21 / Business & Finance

If You’re Charitable, You Can Receive A Lot In Return

A previous column was about charitable giving and how to do it in the most advantageous—to the recipient and the donor—manner. It described Charitable Remainder Trusts (CRT) and Charitable Lead Trusts (CLT) as being useful tools for giving one’s assets to a charity and receiving some tax benefits and a lifetime’s income. This column is about pooled income funds, another tool that provides similar benefits to donors and charities.

A Pooled Income Fund—PIF—is a combination of CRT and mutual funds.

You can donate appreciated property and receive income over your (and someone else’s) lifetime. Also, you get an income tax deduction for making the gift, and the asset is out of your estate so neither an estate tax (with rates between 37% & 50%), nor a state inheritance tax (up to 15%) will be paid on it. Here’s how it works.

Let’s say that you own a stock that has appreciated greatly over many years. We’ll further assume that it pays low dividends. You would like to sell the stock and invest it in a diversified portfolio of stocks, bonds, and cash that can pay you a decent income. I recently worked with some people who were in this situation.

Meet John and Mary. They had a stock in their portfolio worth $200,000 that they bought a long time ago for $20,000. Since they were near retirement, they wanted to convert the growth position to one that produced income. If they sold the stock, they would have a capital gain of $180,000. On this gain they would pay $36,000 to Uncle—and $9000 to your governor for a total tax of $45,000, leaving them with $155,000 to invest. As you might imagine, they viewed this as “not very appetizing.” Fortunately, there were other alternatives.

One is to be charitable. By giving, you can receive a lot. Several mutual fund companies have created Pooled Income Funds (PIF). These are IRS approved tax-qualified public charities. John and Mary contributed the $200,000 of appreciated stock. As long as either of them is alive, they will receive a monthly payment from the PIF. Although payments are down with the market, the long-term average is about 10%. So, they can expect to receive around $1,666 per month, which is a lot more than the dividend income that they were not receiving from the stock.

In addition to receiving income for life, they got an income tax deduction of $73,000 for their $200,000 contribution. This is because upon their death, whatever is left in the PIF will go to the charity(s) that they selected. They did not receive a $200,000 income tax deduction because the gift will not be made now, but at their death. Because they are in the 28% tax bracket, getting an income tax deduction of $73,000 will result in tax savings of $20,440 (this can be compared to the cash-back deals that the automobile companies are making these days). There are annual limits on the amount of an income tax deduction one can take for the contribution of appreciated assets to a charity, so they may have to carry forward the deduction for a few years.

Well, this sounds like a pretty good deal. Instead of paying capital gain taxes of $45,000, they received a tax rebate of $20,440. Instead of receiving a paltry dividend, they will receive approximately $1,600 monthly for the rest of their lives. If they had an estate tax due at their deaths, which they do not, their estate would be reduced by $200,000. Additionally, by contributing the ap-preciated stocks to the PIF, the charities that they have named will receive substantial contributions. This leaves only one loser in this transaction: the children who will not inherit the appreciated stock.

John and Mary were deeply troubled at the thought of taking anything away from their children. Not to worry. We turned a lemon into lemonade. They purchased a second-to-die life insurance policy in the amount of 300,000. This type of policy pays off at the second death so the premium is less than that of an individual policy. The annual premium for the policy, which is $6,500, is paid from the $20,000 annual payment from the PIF.

The moral of the story is, because they implemented the above strategy at their deaths, their children will re-ceive $300,000 tax-free (instead of $200,000). The charities that they have named will receive approximately $200,000 (instead of nothing), and they will have more money during their lifetimes to buy things for their children and grandchildren.

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