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UT Austin Gift Planner — Oct. 11, 2011

Giving News

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Oct. 11, 2011

With the changes to the tax laws that took effect in December 2010, some of your clients may be looking for ways to take advantage of the current $5 million federal gift and estate tax exemption while it lasts. For taxpayers with significant wealth, this is one of the best times in decades to pass money to future generations without incurring federal tax liability. Many of you are already working with clients on financial planning and solutions that pass wealth on to loved ones while taking advantage of the $5 million exemption. What you might not know is that a charitable lead trust could allow your clients to make a significant charitable gift and pass on considerably more than $5 million to future generations, all without exhausting the $5 million estate and gift tax exemption.

When a taxpayer puts assets into a charitable lead trust, the trust pays an income to charity for a specified number of years, chosen by the donor. At the end of the trust term, all remaining assets either pass back to the donor or to the donor’s heirs or other beneficiaries. For many people with charitable intent, this vehicle provides an excellent way to both provide for charity and pass wealth to future generations. Two factors generally influence the benefit of a charitable lead trust: the federal mid-term interest rate and the length of the trust term.

With regard to charitable lead trusts, when the federal midterm interest rate is lower, the charitable portion of the gift is larger, resulting in a larger income tax charitable deduction for grantor and defective grantor lead trusts or a larger gift tax charitable deduction for non-grantor, non-reversionary lead trusts and defective grantor lead trusts. In this case, with the interest rate in October down to 1.4 percent, there has never been a better time for wealthy taxpayers to consider a charitable lead annuity trust. Fluctuations in the federal midterm interest rate don’t significantly affect the charitable value calculation of charitable lead unitrusts.

Charitable lead annuity trust with annual, end-of-period payments

Payout rate and term of years needed for 100 percent charitable value

(“Zeroed out remainder”)

Payout rate Term of years
4.0% 31 years
4.5% 27 years
5.0% 24 years
5.5% 22 years
6.0% 20 years
6.5% 18 years
7.0% 17 years


1.4 percent federal midterm interest rate for trusts created and funded in October, November, and December 2011.

Let’s look at a few examples of how lead trusts can pass wealth to future generations and take advantage of the current gift and estate tax exemption while it lasts.

Example 1 – Charitable lead trusts to benefit children

Mr. Smith is a client with a long history of philanthropy and plans to eventually pass most of his wealth on to his children. To date he has not used any of his $5 million gift tax exemption. Mr. Smith decides to establish a $1 million charitable lead annuity trust with a payout rate of 6 percent and a trust term of 10 years.

The charity Mr. Smith chooses to benefit will receive approximately $60,000 each year for the term of the trust, or $600,000.  At the end of the trust, Mr. Smith’s children will receive the trust assets, which could be worth more or less than the original $1 million, depending on how the trust assets are invested.

When the trust is funded, the value of the charitable portion of Mr. Smith’s gift would be $556,270, and there is no gift tax on this amount.  The economic value of his children’s right to receive the trust assets is $443,730. In other words, Mr. Smith is passing roughly $1 million on to his children while using less than $500,000 of his gift and estate tax exemption.

Example 2 – Charitable lead trust to benefit grandchildren — charitable lead unitrust

Thanks to good financial planning, Mrs. Jones has a large estate and wishes to make a significant gift to charity and provide for her grandchildren. She also wishes to take advantage of the current federal estate and gift tax exemption while it is still in effect at $5 million. Mrs. Jones decided to put $2 million into a charitable lead unitrust, with a payout rate of 5 percent and a duration of 20 years. She names her grandchildren as the ultimate beneficiaries of the trust assets.

Throughout the 20-year term of the trust, the charity will likely receive more than $2.5 million. The economic value of this gift when the trust is funded is $1,272,540.  The economic value of the grandchildren’s rights to receive the trust assets is $727,460, even though they will ultimately receive as much as $2 million or more. In this case, Mrs. Jones can pass roughly $2 million to her grandchildren while only using $727,460 of her gift and estate tax exemption. In addition, there will be no additional gift, estate, or generation skipping tax owed when the grandchildren receive the assets, regardless of how highly the assets are valued at the end of the trust.

Example 3 – Charitable lead trust to use entire $5 million gift and estate tax exemption

Mr. Thomas is a longtime client of significant means who comes to you because he wants to take advantage of the current $5 million federal gift and estate tax exemption.  Mr. Thomas is very philanthropic but also views this economic climate as an ideal time to go ahead and pass a major portion of his wealth down to his grandchildren. They are still fairly young, so Mr. Thomas thinks it might be best if they received his assets when they are a bit older; however, he very much wants to go ahead and put his plans in place while the gift and estate tax exemption is high. Until now, Mr. Thomas has always been very careful not to exceed the annual gift tax exclusion limit, and thus has retained his entire $5 million lifetime exemption and has not used any of his $5 million generation skipping transfer tax exemption.

To take advantage of the entire gift tax exemption, Mr. Thomas establishes a charitable lead unitrust using $13.5 million of assets.  The trust will have a payout rate to charity of 5 percent and will last for 20 years. At the end of the trust, the assets will pass to his grandchildren.

During that 20-year period, the charity will likely receive more than $18 million. The value of the charitable portion of Mr. Thomas’ gift when the trust is funded will be more than $8.5 million.  Most important, the economic value of his grandchildren’s right to receive the assets at the end of the trust is just over $4.9 million. In this case, Mr. Thomas has given roughly $18 million to charity and more or less than $13.5 million to his grandchildren without owing any federal gift, estate, or generation skipping transfer taxes.

Clients who wish to use a charitable lead trust to provide for both their heirs and for charity may also be interested in involving their children or grandchildren in making decisions about charitable giving. For these clients, a great option could be to establish a charitable lead trust and have the payouts go into a donor-advised fund with a local community foundation. This option does not change any of the numbers in the above examples. The only difference is that the payouts would go through the donor-advised fund before being directed to a charity or charities. The donor could set up the fund so that the children or grandchildren direct the distributions from the fund. In this way, not only would children or grandchildren benefit by being the ultimate recipient of the trust assets; they would also have the ability to learn about philanthropy by directing the charitable payouts from the fund each year.

As all of these above examples demonstrate, your clients now have a unique opportunity to both provide for their loved ones AND support the charities that matter to them, all while taking advantage of the current federal gift and estate tax exemption.

If you have any questions about charitable lead trusts and how they might benefit your clients, please contact the UT Austin Gift Planning team at 512-475-9632 or giftplan@www.utexas.edu.

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IRA rollover provision is in effect through 2011

Do you have charitably inclined clients who own traditional or Roth individual retirement accounts (IRAs)? If they’re 70½ or older, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 allows them to directly transfer as much as $100,000 per taxable year to qualified charitable organizations, through Dec. 31, 2011.

The amount transferred directly will not be included in the IRA owner’s gross income, and no itemized charitable deduction can be claimed for the amount transferred. The amount transferred may be used to satisfy the minimum distribution requirement for tax year 2011.

We understand that many individuals take their annual minimum required distribution in the fall before Thanksgiving, so now is the time to act; share this information with your clients so that they can take advantage of the charitable rollover law for 2011.

BOTTOM LINE: Many Americans have an IRA and must take their required minimum distribution or face great penalties.

Your clients may contribute funds this way if:

  • They are age 70½ or older at the time of the gift.
  • The gifts total any amount up to $100,000 in 2011.
  • They transfer funds directly from an IRA to charity.
  • They transfer the gifts outright to one or more qualified charities, but not to supporting organizations as defined under IRC 509(a)(3), or for charitable gift annuities, charitable trusts, or donor advised funds.

An IRA rollover has many benefits. The transfer generates neither taxable income nor a tax deduction, so your clients will receive the benefit even if they do not itemize their tax deductions. Most important, your clients can make an immediate impact on the charities they support, allowing them to witness the benefits of their generosity today.

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Estate planning for unmarried couples

For various reasons, more and more couples today are choosing to remain unmarried. Unfortunately, from a tax and financial planning perspective, unmarried couples do not enjoy many of the benefits and protections automatically granted to married couples. In fact, there are more than 1,000 federal benefits, rights, and privileges in which marital status is a factor. For unmarried couples, this means that comprehensive financial and estate planning is essential. In this article we will explore some of the financial and estate planning issues facing unmarried couples, and how certain charitable giving vehicles can be a part of the solution.

First, it is important to consider who is included in the definition of an unmarried couple. With all the media attention currently paid to gay marriage, it would be easy to assume that same-sex couples make up the majority of unmarried couples. In truth, there are far more unmarried couples made up of partners of the opposite sex.  Regardless of sexual orientation, the same issues apply to ALL unmarried couples. In addition, unmarried couples can include nonromantic partnerships and family members such as elderly siblings who live together or even just close friends.

Among some of the very basic protections that unmarried partners do not have include:

  • No rights to partner’s estate.
  • No unlimited gifting between partners.
  • May not receive certain benefits of partner’s retirement plans*.
  • No survivor benefits with Social Security.
  • May not receive partner’s pension at death.

While good financial and estate planning cannot take the place of all the rights granted to married couples, professional advisors can help their clients create legal documents that approximate many of these rights.

Perhaps the single most important instrument for unmarried couples to protect their assets and their partners is a properly executed will.  Unmarried partners MUST have a will in order to ensure that their assets pass to their partner at death. Professional advisors should keep in mind that the wills of unmarried couples may be more likely to be challenged by other family members, but there are certain steps that can be taken to help minimize this risk.  Your clients can consider including statements to refute any suggestion of lack of capacity. They can also include a “no contest” clause to disinherit unsuccessful will contestants (although the deterrence achieved by these clauses is questionable).  One of the best ways to pass assets to an unmarried partner is to use testamentary substitutes that do not even require a will and are not subject to probate, such as beneficiary designations, trusts, life insurance, and jointly owned property. Estate planning attorneys may also want to suggest that each partner use a different attorney to draft their wills, so as to avoid any possible conflicts of interest.

A few of the other important documents professional advisors may suggest to their unmarried clients include things like:

  • Power of attorney.
  • Health care power of attorney.
  • Living will.
  • Pre and post-nups.
  • Separation agreements.
  • Domestic partnership agreements.
  • Contracts to make wills.

Although your clients may not be married, this does not mean that one or both of them will not have significant wealth. For these couples, it is important to remember that these couples will have to deal with estate tax at the death of the first partner, unlike married couples who have an unlimited estate tax exemption when the first spouse dies. Moreover, when an unmarried partner is named the beneficiary of a retirement plan, there is no rollover option for the surviving partner. That partner must begin taking withdrawals within a year AND pay taxes on those withdrawals.

Let’s look at two examples that show how the estate tax laws affect married and unmarried couples differently.

Example 1: Married couple

Matthew and Sarah are married and have $10 million in their joint estate, broken down as follows:

Joint Matthew Sarah
House $1 million
Stock $2 million $2 million
Retirement $2 million $2 million
Artwork $1 million


If Sarah should die first, her estate will be worth $5.5 million ($5 million of her own assets plus half of the jointly held home). Assuming she leaves her entire estate to Matthew, there will be no estate tax due because of the unlimited marital deduction.

At Matthew’s death, his total estate is now $10 million. Thanks to the marriage portability provision in the new estate tax law, Matthew’s estate owes no estate tax.

Example 2: Unmarried Couple

Now let’s consider Matthew and Thomas, who are not married but also have $10 million in their joint estate:

Joint Matthew Thomas
House $1 million
Stock $2 million $2 million
Retirement $2 million $2 million
Artwork $1 million

The house is held as joint tenants with right of survivorship.

If Thomas dies first, his estate will be worth $6 million ($5 million plus the full value of the house unless Matthew can prove he contributed to the purchase).  Under the current federal estate tax law, and assuming that Thomas did not incur any gift tax during his lifetime, the federal estate tax due will be $350,000 ($5 million exemption, then 35 percent of $1 million).

Assuming Thomas names Matthew as the beneficiary of his retirement plan, Matthew will incur income tax on the income from the retirement plan that he will have to take during his lifetime.

At Matthew’s death, his estate is now worth $10 million. After his own $5 million exemption, Matthew’s estate will owe $1.75 million in estate tax.

Whereas Matthew and Sarah owed no estate tax on their combined $10 million estate, Matthew and Thomas will have a combined estate tax liability of $2.1 million.

The unified federal estate and gift tax complicates things even further for unmarried couples. While married couples can pass assets back and forth to each other freely, there is NO unlimited gifting between unmarried partners. This means that each partner has $5 million to either give during their lifetime or to have exempted from their estate at death.

For unmarried couples who enjoy making gifts to each other, or where there is a strong discrepancy between the partners’ respective incomes and wealth levels, one or both partners could potentially incur significant gift tax liability during their lifetimes. Things like purchasing a car for a partner or putting a partner on the deed to a house that the other partner has paid for are considered gifts, and could subject unmarried partners to gift tax or at least count toward total gift/estate tax exemption. Even payment of living expenses for a partner could be a taxable gift.

Fortunately, along with other estate and financial planning tools, charitable gift planning can provide unmarried couples with estate and gift tax benefits. Giving vehicles such as charitable gift annuities, charitable remainder trusts, and charitable lead trusts all provide philanthropic donors with ways to benefit both their partners and the charities they love.

Let’s review two examples of how a charitable gift annuity can be used to benefit an unmarried partner.

Example 1

Sam contributes to a charitable gift annuity (CGA) and names his partner, Anne, as the beneficiary. Note that Sam will only owe gift tax on the present value of Anne’s income stream if it is more than $13,000 (the amount of annual gift tax exclusion), not on the full amount contributed for the CGA.** Because gift tax is only calculated on the present value of the gift, the donor has less potential gift lax liability with a CGA than with an outright gift to a partner.

Sam establishes the CGA with $100,000 for the benefit of Anne, who is 72 years old. The present value of the gift for gift tax purposes is approximately $70,000. After the annual exclusion of $13,000, only $57,000 could generate gift tax. Sam receives a charitable deduction of nearly $36,000, and Anne receives a total benefit during her life expectancy of more than $84,000.

Note that the difference between what Anne expects to receive ($84,000) and the value of Sam’s gift to Anne ($57,000) that could generate gift tax is $27,000. Also note that if Anne outlives her life expectancy (in this case 14.5 years), any income after that does not count toward Sam’s gift tax exclusion.

Example 2

Sam is again establishing a CGA to benefit Anne, but this time Sam does not want the value of his gift to Anne to exceed his annual $13,000 gift tax exclusion.

Sam decides to donate $18,000 to a CGA to benefit Anne, who is 72 years old. The present value of the gift is $12,714, below the $13,000 annual exclusion.  Sam receives a charitable deduction of almost $6,500 and has NO potential gift tax liability.  Anne receives a total benefit over her life expectancy of more than $15,000. In this way, Sam could create multiple annuities year after year to benefit Anne and never incur gift tax liability.

With unmarried couples, sometimes one partner wants to make sure that the other person is well provided for but may not necessarily want the partner to inherit all of his or her assets. In the case of an unmarried partnership where one of the partners has children, the partner with children may want to set up a trust that provides income for the life of the surviving partner but ensures that the assets pass to the partner’s children. Where neither member of the couple has children, a philanthropic partner could consider using a charitable remainder trust to provide income to the surviving partner for life, with the assets passing to charity upon the death of the survivor.

Let’s again consider Sam and Anne. This time Sam has a $1 million IRA account, and a total taxable estate of more than $5 million. If he leaves his IRA directly to Anne, she will have to start taking withdrawals immediately and will owe taxes on that income. If, however, Sam names the trustee of a 5 percent charitable remainder unitrust as the beneficiary of his $1 million IRA, he will save $194,148 in estate taxes (35 percent of $554,710, the amount of the charitable value). Anne will receive income for life from the trust ($50,000 in the first year), subject to income tax. At Anne’s death, the charity receives the funds from the trust.

Most important to remember is that estate and financial planning for unmarried couples poses a unique set of challenges. Professional advisors can help their unmarried clients create comprehensive estate and financial plans in order to protect and provide for one another. In addition, professional advisors need to consider the ramifications of potential gift tax liability when assisting their unmarried clients with major financial decisions. Finally, keep in mind that certain charitable gift planning vehicles may be useful in assisting your clients with providing for their loved ones and the charities they support while also minimizing tax liability.

*ERISA requires that spouses be at least a 50 percent beneficiary of retirement benefits unless the spouse expressly consents otherwise. There is no similar protection for unmarried partners.

**A deferred charitable gift annuity does not qualify for the annual exclusion because it is considered a future interest gift.

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