Recently Retired? Create a Source of Additional Income That Can Increase—and Avoid Capital-Gain Tax

Ice melting on Lake MendotaPeople often find themselves in a classic “locked-in” position in their investment. They want to convert the value of the investment to a source of income but face heavy capital-gain tax. If you face this conundrum, consider a charitable remainder unitrust. A charitable remainder unitrust can provide significant tax advantages, increase income, and satisfy charitable goals.

Example: Ted and Mary N, both 67, recently retired. They have a number of stock investments that have appreciated but pay no dividends. Now that they are retired, they would like to increase their annual cash flow. The stock is worth five times the $50,000 they originally paid for it. When they retired, they talked about selling the stock and reinvesting the proceeds to produce income because it pays no dividends. However, they were discouraged to find that $30,000 of the $250,000 selling price would go to pay capital-gain tax.

Ted and Mary would like to make a significant charitable gift. In talking with their planned-giving representative, they discovered that they could avoid the capital-gain tax on the initial transfer of the stock to a charitable remainder unitrust. Because the unitrust is tax-exempt, it can sell the stock and owe no tax. This means the entire $250,000 value of the stock will stay at work for Ted and Mary, producing another source of cash flow. Further, their income will grow if the value of the trust increases. At 67 they plan to live a long time, so they decide on a 6% unitrust payment. The first year the trust will pay $15,000, but if the trust obtains an average total return of 8%, the distribution will be almost $20,000 in 15 years. They also get to deduct $75,390, saving them more than $21,100 in taxes.

One of the most attractive features of the charitable remainder unitrust is that the income is based on the value of the trust as it changes from year to year. If the value goes up, so does your income. As Ted and Mary discovered, choosing a relatively low unitrust percentage enables the trust to grow faster, thereby increasing the size of payments in later years. This is especially important to relatively young donors.

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