Building a hospital wing for pediatric AIDS patients. Supporting research to preserve the polar bear’s habitat. Establishing an endowment at the student newspaper that gave you your start. For the philanthropic, giving back can be a beautiful thing.
Reducing your taxes is a beautiful thing too.
For high-income taxpayers seeking to shelter income, philanthropy can be the gift that keeps on giving. Instead of writing checks, though, savvy investors are signing over appreciated securities.
In the process, they’re reaping double tax breaks—one for the current value of the securities, and again by avoiding capital-gains tax on the appreciation.
In some cases, donors are also getting paid for their generosity, through a charitable gift annuity or charitable trust. These two staples of the "planned-giving" repertoire give benefactors a fixed income over their lifetime as well as the immediate benefits of both capital gains and charitable tax deductions.
(A caveat: The securities must be held by the donor for a minimum of one year to qualify. At the individual’s death, the charity or institution applies the gift according to the donor’s instructions.)
Other philanthropic strategies—foundations, trusts, and hugely popular donor-advised funds—offer the same tax benefits, but don’t generate income for the donor.
At the U.J.A. Federation of New York, 60 to 70 percent of the total dollars it receives as planned giving comes to the organization as appreciated securities from major donors, William Samers, vice president for planned giving and endowments, says.
"You’ll see more planned gifts in a market like this," he says. "Whether it’s the high-net-worth individual concerned about another Bear Stearns, I don’t know. After the internet bubble, people rushed to lock in gains. It’s the same now."
Surprisingly, many investors who engage in charitable giving—as much as 45 percent, according to some research—don’t realize that multiple tax breaks are available to them, Kimberley Wright-Violich, president of Schwab Charitable in San Francisco, says.
An October 2007 study by Fidelity Investments found an even greater percentage—more than two-thirds of the individuals surveyed—weren’t aware of the additional tax advantages of donating appreciated securities.
Another big slice—39 percent—didn’t realize that they could hold onto fast-growing stocks and reap a tax benefit by repurchasing shares after donating them. That locks in a higher cost basis and avoids capital-gains tax on the appreciation.
Another 17 percent of respondents to the Fidelity survey didn’t understand the tax benefits of donating appreciated securities at all, while 10 percent didn’t know you could use appreciated securities to fund philanthropy.
Nor do most potential donors consider the nuances involved with small, local charities that can affect their giving, Wright-Violich adds. Many of these groups don’t have their own brokerage accounts, for example.
Donor-advised funds offered by Schwab, Vanguard, and Fidelity, among others, solve many of these problems, Wright-Violich says. They offer flexibility, ease of entry and execution, and the knowledge that "you’re not committing to something for a lifetime."
At Schwab Charitable, which manages more than $2 billion in contributions, generous investors can choose a donor-advised fund as an alternative to private foundations, using as little as $5,000 in appreciated securities, Wright-Violich says.
In this way, she adds, a donor with annual income of $100,000 avoids capital-gains tax and receives a charitable deduction, reducing his or her taxable income to $95,000.
Schwab liquidates the donated securities and the proceeds belong to the donor-advised fund. The fund, in turn, invests them in one or more of a family of seven mutual funds, Wright-Violich explains.
The donor has the right to advise how the contribution is invested and how the proceeds are granted or donated at his or her death. The donor may also designate a family member or other individual to take over the donor advisory function.
Meanwhile, that $5,000 in the donor-advised fund continues to grow until the donor decides to grant it. The investment isn’t passive. All or part of the assets can be moved into another fund, or be split among several funds. The donor can continue to add to the fund to achieve a goal, receiving a charitable deduction with each addition.
"Say you want to endow a chair at your alma mater," Wright-Violich says. "When the fund reaches the level where you can endow that chair, you make the grant."
Part of the popularity of donor-advised funds stems from current economic conditions, she says. As investors rebalance their portfolios, they may want to sell stocks that have appreciated dramatically. If they have enough cash at hand, they can use that to buy safer securities and donate the stock, enjoying the double tax break in the process.
Charity is an American tradition, particularly for the wealthy elite. More than 60 percent of Americans give to charity, according to the Bank of America Study of High Net Worth Philanthropy by The Center for Philanthropy at Indiana University. The percentage is even higher among the wealthiest segment of the population: almost 98 percent.
About one-third of charitable giving by high-net-worth donors is done with appreciated securities, Ramsay H. Slugg, senior vice president and wealth-strategies adviser for U.S. Trust, Bank of America Private Wealth Management, says.
There are limits. Donors may deduct no more than 30 percent of their adjusted gross income for contributions of appreciated assets in any given year, though any excess can be carried forward for up to the five ensuing years.
Typically, charitable annuities and trusts attract donors with sizable stock holdings that pay scant dividends—in a sense, asset rich and cash poor. With a charitable annuity or trust, the institution sells the stock and manages the funds, which provide a lifetime income stream.
Take, for example a Michigan State University alumnus with a large, appreciated holding in utilities. His $10,000 investment is worth $500,000 today, but his dividend is negligible. With a charitable trust, that $500,000 can generate income during his lifetime and provide a very handsome gift for Michigan State.
"We’re responsible to the donor to make that payout and to grow that gift," Dan Chegwidden, M.S.U.’s director of planned giving, says, noting that a 5 to 7 percent payout rate is typical with trusts. "As the assets of the trust grow, so will his income."
By comparison, putting that $500,000 of stock in a gift annuity at a 6 percent rate (the rate is age-based) will yield $30,000 a year in fixed income. While the assets may grow to $1 million, the return to the individual is fixed.
"High net worth individuals tend to say, ‘I want to make a gift, I like the idea of my assets growing.’ But it’s all predicated on making the gift," he says, noting that this group tends to favor trusts over annuities.
"There are people who say they don’t need the income, and give the securities outright. The child of the 1930s may think twice."
There are several types of charitable gift annuities. Chegwidden cites an investor who sets up an annuity with 500 shares of stock purchased 35 years ago for $5,000 that’s now worth $50,000 and provides virtually no income.
With a gift annuity, the donor, now 68, receives $3,150 annually for the rest of her life; part of the income is tax-free until age 86. She takes a charitable deduction of $19,306 (based on the monthly mid-term Fed discount rate–in this case, 5.2 percent–and a quarterly payout) and avoids approximately $6,750 in capital gains tax.
With a deferred annuity, an option chosen by many donors who are not ready for retirement, the date when payments start is deferred at least one year into the future; most donors defer until retirement. The deferral increases the payout rate for the gift annuity and increases the charitable deduction. The longer the deferral period, the greater the deduction.
A deferred gift annuity of $250,000 using a stock with a cost basis of $100,000 made at age 55 will carry a deduction of $96,197 in the year the gift is made. When the donor retires at age 62, the annual annuity payment will be $20,750, and a portion of the income will be tax-free.
"People are a little nervous about irrevocably transferring assets and not getting something in return," Chegwidden says, citing Michigan’s tough economy. Many people there own stock that is underperforming, particularly shares in automakers.
"I know people who could give $200,000 outright, who don’t need the income," says Chegwidden. "But they think they do."
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