Historically Low Interest Rates Can Increase the Charitable Deduction

As a result of low interest rates, you have experienced a decline in earnings from bonds and cash investments. However, you may not be aware that low interest rates are a good thing if you make certain types of charitable gifts. The benefit is a larger charitable deduction.

Each month the IRS publishes an interest rate to be used in determining the charitable deduction from certain types of gift arrangements. This interest rate is based on the average previous month’s return on certain federal obligations. In August 2012, the rate dipped to a historic low 1.0 percent. Since an individual can use the published rate for the month in which the gift is made or for either of the two immediately-preceding months, the 1.0 percent rate could have been elected at least through October. The rate remained quite low for the balance of the year.

The two types of gifts that are more appealing when the IRS rate is low are (1) the charitable lead annuity trust and (2) a transfer of title to a residence or farm, retaining the right to continue using it.

The charitable lead annuity trust makes fixed payments to a charity for a certain period. Then the trust terminates, and the principal can either be returned to you or paid to your heirs, typically children or grandchildren. Depending upon how the trust is structured, you receive an income-, gift-, or estate-tax charitable deduction―the size of which depends upon the duration of the trust, the size of the payments, and the IRS interest rate.

Suppose, for example, that you transferred $500,000 to a trust that would last 12 years and make annual payments to charity of $30,000. The charitable deduction would be $337,650. However, if the trust had been established in June of 2000, using that month’s IRS rate of 8.0 percent, the deduction would have been only $226,080.

A lead trust makes sense if you want to transfer wealth to future generations while minimizing the gift tax or if you want to make charitable gifts―perhaps to fulfill a campaign pledge―and eventually recover your money.

Gift of a Residence or Farm Subject to Life Usage.

If you intend to leave your residence to charity under your will, you might consider transferring the title now but retaining the right to occupy the property for the rest of your life. This transfer would result in significant income-tax savings without altering your lifestyle. The charitable deduction from such gifts has never been higher. For example, if a person age 75 arranged such a gift and her home was valued at $400,000, the charitable deduction today would be approximately $316,000, depending on the portion of the value attributed to the land; but if the gift had been based on the June 2000 IRS rate, the deduction would have been approximately $175,000.

If you would like to learn more about these timely instruments, and how, in general, to take advantage of this historically low IRS interest rate, please contact us.

Another Gift Plan Affected by the IRS Interest Rate

A charitable gift annuity (a plan where you transfer cash or other property and receive fixed payments for life) also generates a charitable deduction, but the lower the IRS interest rate, the lower the charitable deduction. Thus, this might not seem to be a good time to establish a gift annuity, except for another benefit that increases in value as the deduction decreases. That is the portion of the annuity payments that is tax-free. Because of the low IRS interest rate, the tax-free portion has never been larger. Indeed, in many cases as much as 60 percent or more of the payments would be tax-free.