You may know that if you itemize deductions, you recover some of the capital from a charitable gift. But you may not be aware of a plan whereby you not only realize immediate tax savings but may also recover substantially all of your capital after a certain number of years.
First, here is how you recover capital through itemizing: If you give us $10,000 outright and you are in the 35 percent tax bracket, you reduce your taxes by $3,500—which means, effectively, that you recover that portion of your capital, reducing the net cost of your gift to $6,500.
The plan that goes much further in recovering capital is known as a “charitable lead annuity trust.” Following is a description of how it works.
Example: John and Susan have been considering a major gift to us, but they would like to make their contribution over an eight-year period. They transfer $500,000 to a charitable lead annuity trust and stipulate that $30,000 per year be paid to us for a period of eight years—after which the trust is to terminate and all remaining trust assets are returned to them.
That amount could be more or less than the initial $500,000, depending on the trust return. If the assets are invested so that the return is 6 percent, they will recover the entire amount they contributed to the trust.
Moreover, John and Susan will receive an income-tax deduction of about $225,000—almost as much as the total deductions they would have realized from contributing $30,000 per year outright for eight years, and they can claim the deduction up front. They have high income this year, which means they can use the entire deduction. Since their tax rate is approximately 43 percent, they save $96,990 in income tax—and they can invest these savings.
They are taxed on the trust income—even though they do not receive it. But much of this income is likely to be dividends and capital gain that are taxed at a lower rate, so the total tax they pay over the duration of the trust is much less than their up-front tax savings.
| Summary of benefits | ||
| Amount of $500,000 principal recovered: | Approximately $500,000 | |
| Total charitable gift: | $240,000 | |
| Up-front tax savings: | $96,990 | |
| Estimated earnings on tax savings over seven years: | $30,000 | |
| Estimated tax on trust income | $60,000 |
John and Susan recover their principal and realize net tax savings of $66,990 ($96,990 + $30,000 – $60,000).
If you are in a high tax bracket, the charitable lead annuity trust could be the most effective way to make a major charitable gift. It is especially appealing in this low-interest environment because the allowable charitable deduction is exceedingly large. If you would like to retain control of investment of the assets, you can name yourself as trustee. You may also determine the duration of the trust and the payout rate.
To explore this option, please contact us and we can provide a personalized financial illustration for your situation.
