Column for What’s Next website CHARITABLE REMAINDER TRUSTS By Mark Levine I’m now going to let you in on one of the secrets of the very wealthy—sometimes you can make more money by giving something away than by keeping it. Case in point: the charitable remainder trust. The charitable remainder trust is one of the secret wonders of capitalism. Don’t let its name scare you off. Far from being solely a device for wealthy philanthropists, it can be an incredible income generating tool for any Die Broker who owns an asset that has appreciated a great deal and isn’t generating sufficient income, or who could simply use a substantial tax break. Let me explain how they work. Say you own a piece of property, a stock portfolio, or a business that has dramatically increased its value since you purchased it. Perhaps you bought a rental property for a song that’s now worth a small fortune. Or maybe your cousin Jeff talked you into buying a block of Microsoft stock back before Bill Gates owned the universe. Or maybe the business you started from scratch 20 years ago is now a growing concern. For arguments sake and to make the magic of this technique more obvious, let’s say this asset is worth $1 million. (I know, you don’t have an asset worth close to that much. Don’t worry: the math works just about the same for any other amount; only the tax savings aren’t as dramatic.) Let’s say you believe you should live up to, not beneath your means, whether that involves spending on yourself or on your loved ones. Even though you’re still working, your earned income has dropped. You could use some more to keep up your lifestyle and to continue helping out your kids. You’ve got this asset worth $1 million, but it’s only generating a two percent income for you. If you sell it you’ll be required to pay capital gains tax based on how much it has appreciated. If it started being worth almost nothing and is now worth $1 million, you’ll end up keeping only about $650,000 after the federal, state, and local governments get their cuts. Take that $650,000 and invest it in something that pays a decent rate, say seven percent, and you’ll end up with an annual income of only $45,500 from your $1 million asset. (If you weren’t a Die Broker and wanted to pass this asset along to your kids, that $650,000 would be subject to around a 50 percent estate tax bite, leaving your heirs with $325,000—a nice sum only if you don’t remember the original asset was worth $1,000,000.) Okay, now let’s see what would happen if instead of selling the asset, you gave it away through a charitable remainder trust. You take your asset and give it to a trust. It sells the asset for $1 million. You instruct the trust to pay you a guaranteed income of seven percent a year by investing the money. If the trust’s investments don’t do that well one year you’ll still get your seven percent—if they must the trustee will just take the money out of the principal. That means the charity will end up with less, not you. You also instruct the trust to hand the money over to a charity (named or unnamed) when you die. Now, since you don’t have to pay capital gains taxes, you’re earning seven percent of $1 million, or $70,000, rather than seven percent of $650,000, or $45,500. In addition, since you’ve given the asset to a charity, you’re entitled to a tax deduction. The IRS, using actuarial tables and income projections, will estimate the benefit you’ll gain from the asset while you’re alive and subtract it from the asset’s value. The result is the “remainder.” Say the IRS determines that your lifelong benefit from the asset is equal to 50% of it’s value, that means the remainder is 50 percent, or a $500,000 contribution. That could result in a $175,000 tax savings. By giving the $1 million asset away rather than selling it you’ve not only increased your income from $45,500 to $70,000, but you’ve also gotten a $175,000 tax savings in the process. And you’ll be the man of the year at the charity’s annual dinner dance since you’ve given them $1 million (they won’t have to pay capital gains either). You’re happy. The charity is happy. For Uncle Sam it’s a wash: he has lost out on some capital gains and estate tax revenue, but that’s theoretically offset by all the good the charity will do with that $1 million. It’s your heirs who appear to have lost out. Sure, that $325,000 inheritance wasn’t a big share of $1 million, but it’s better than nothing, which is what they’ll get when you die if the asset is given to a charity.
Maybe you believe that inheritance isn’t the only way to help your children. Sure, you could use that extra income and those tax savings to travel the world. But you could also use them to help your son set up a business, or to help your grand daughter go to medical school. Alternatively, you could take that $175,000 tax savings and use the money to buy a second to die life insurance policy on you and your spouse so your kids could still end up with a $1 million inheritance, even though you’d given the asset away to a charity. Incredibly, everyone has done better by your giving an asset away, rather than selling it.