HOFFMAN,
WHITE & KAELBER FINANCIAL SERVICES, LLC
Investment managers &
Wealth Advisors
November 6, 2005
This is the November 2005 monthly Wealth Management newsletter from Hoffman, White & Kaelber Financial Services, LLC. If you do not wish to be included in our circulation, please reply indicating your desire to be removed and we will be happy to oblige. Alternatively, any of your friends or colleagues may receive this on a regular monthly basis by sending their name and email address to info@hwkfs.com. Feel free to forward this to any of your friends who may find it useful. Thanks for your interest and I hope you enjoy the letter.
Using Charitable Trusts to Build Family Wealth
There is
crispness in the air these days and, to me, this means one thing – the Holiday
Season is upon us!
The next
several months, for many people, is a special time; a time when people are a
little nicer, a little friendlier and a little kinder. It’s a time when we focus less on what we
don’t have and instead find ourselves grateful for what we have. It is a time for family and friends; and a
time for goodness and giving. This truly
is my favorite time of the year!
Giving
is, perhaps, the most basic expression of personal and family values. However, not enough people seem to comprehend
the vast benefits that charitable giving can bring to one’s self and
family. It can be one of the most
self-satisfying acts a person can perform and the practice can provide a family
much benefit in return for any effort expended.
It is the sharing that makes philanthropy a critical factor in the
development and preservation of family values – for both their “human” and
“intellectual” capital.
Philanthropy,
or in the original Greek translation philosanthropos,
means love of my fellow man. Modern
definition would describe a philanthropist as an individual who is a
significant supporter of charitable organizations. Yet, I’m sure many people associate the word
philanthropy as only relating to the wealthy.
Well that’s just not true! When
we focus on the word “significant”, a person can be defined as a philanthropist
whenever he or she is doing what is charitably possible according to his or her
individual situation.
Wealthy
families, however, have less choice in the matter because almost all practice
some form of philanthropy. For wealthy
families, philanthropy can be voluntary or involuntary and the choice is quite
simple. About half of a wealthy person’s
estate will go to their heirs. And, the
other half can either go to the government as taxes or it can go to
charity. When it goes to the government,
this type of philanthropy is involuntary.
By
contrast, doesn’t the voluntary kind seem more rewarding and valuable?
As readers of my newsletters well know, wealth management is
the ultimate goal of all that we do at Hoffman, White and Kaelber. Yes, we promote our services; yet, you will find that we
always seek to present thought provoking topics that are relevant to our wide
audience.
This
month’s newsletter will reflect how one facet of charitable estate planning can
offer affluent families more than mere estate planning. Then, as always,
we will finish with a review of the economic and investing climate for the
month past, the current market outlook and our investment performance.
Charitable Remainder Trusts
It was 1917
when the US Government first provided an income tax deduction for gifts to
religious, charitable, scientific or educational organizations. What was positive about this was that it
provided a financial incentive for people to contribute to charitable causes;
what made it less than positive was that it became a financial decision from a
tax standpoint when and if to give to charity.
Thereafter,
it wasn’t until the Tax Reform Act of 1969, that Congress gave a clear
definition to a tax advantaged arrangement known today as the charitable
remainder thrust (CRT).
A
charitable remainder trust is a legal arrangement that provides for specified
payments to one or more non-charitable entities (the “income beneficiary”),
with an irrevocable remainder interest in the trust property to be paid to a
charity or charities (the “charitable remainder beneficiary”). Ordinarily, one must contribute total ownership
in an asset to receive a charitable tax deduction. However, a handful of exceptions may apply
and a CRT is one of them. Assuming that
the CRT meets all the IRS requirements, contributions to it generally qualify
for a charitable deduction for income, estate and gift tax purposes.
There are
two basic types of CRTs – charitable remainder annuity trusts (CRATs) and
charitable remainder unitrusts (CRUTs).
The major difference between the two relates to how the income
beneficiaries are to be paid: A CRAT
would pay a fixed amount to income beneficiaries, at least annually, of a sum
certain that cannot be less than 5% nor more than 50% of the initial fair
market value of all property placed in the trust. Whereas, a CRUT provides for a varying payout, at least annually, based upon
a fixed percentage of not less than 5% or nor more than 50% of the net fair
market value of its assets as valued annually.
In the case
of both trusts:
- There can be to one or more
income beneficiaries.
- The term of the payout can be
made as either the life or lives of an individual or individuals living at
the time the trust is created, or for a term of up to 20 years.
- For new trusts, the remainder
interest must meet a minimum value requirement. The value of the remainder interest must
equal at least 10% of the: (a) initial fair market value of the property
placed in the trust, for CRATs; or, (b) net fair market value of the net
fair market value of each contribution as of the date the property is
contributed, for CRUTs. The IRS
Code provides guidance for calculating these numbers.
- After the term of the payout is
completed, the trust principal is irrevocably transferred to the
charitable organization.
What Are Some of the Benefits?
Philanthropic.
Understanding how to use a CRT in the financial planning process can
allow people to create something that lives on long after they are gone. Many people would like to make a charitable
gift for various reasons but are not in a financial position to do so or simply
do not know how. For a person who has
charitable intent, the CRT provides the opportunity to express this desire.
Tax advantages.
Since a CRT is a tax-exempt vehicle, it can sell highly appreciated
property without being taxed on the capital gain or ordinary income. Also, just like any other charitable
contribution, the CRT gives the donor a current income tax deduction in the
amount of the present value of the remainder interest and any of that deduction
that is not used in the current year can be carried forward to future
years. As an estate planning tool,
assets placed in a CRT are not included in the estate of the donor, nor subject
to gift taxes. Since the assets would be
outside of the estate, this could cause the overall estate to be smaller, which
could create compounded tax savings.
Investment advantages.
From the perspective of managing one’s investments, an individual may
own highly appreciated assets in the form of real estate or a closely held
business. Often an investor may be
reluctant to sell some of their investments in order to diversify or to
generate more income because they do not want to recognize a capital gain. If you knew that the value of your assets
would drop 20% or more the moment you sold, wouldn’t you think twice about
selling? Historically, it has been shown
that a lack of diversification increases the risk of a portfolio more than the
character of the actual investments.
Using a CRT allows one to reposition the portfolio without loss due to
taxes.
Of course,
if taxes and portfolio diversification were the only objectives, a person could
employ other strategies that would not involve surrendering ownership of the
assets to a charity. However, the CRT
makes good sense for the individual who wants to make a charitable gift and has
appreciated assets.
Wealth Replacement Example
More often
than not, life insurance is purchased to provide financial relief to dependents
in the event that a family’s breadwinner(s) prematurely dies. This is the most significant use of that
product. Yet, in the following example,
we’ll review an effective planning tool in which the income and/or tax savings
from establishing a charitable remainder trust can be used buy life insurance
to replace the asset given away. Also,
life insurance, when held in an irrevocable insurance trust, allows the death
benefit to pass to heirs free of estate taxes.
Example:
Mr. and Mrs. Smith, both age 55 and in excellent health, were recently offered
$2 million for their closely held company and an additional $1 million, each
year, for a 2 year consulting agreement.
Their cost basis in the stock is almost zero and even at a reduced rate
of 15%, for federal taxes, and 5.75%, for
Their
creative thinking financial advisor suggested that they look at a charitable
remainder trust to alleviate the tax burden and support their philanthropic
wishes. They decide to establish a $2
million charitable remainder unitrust and, using their after-tax income, buy a
$2 million second-to-die life insurance policy naming their heirs as
beneficiaries.
The
suggested action steps look like this:
1. The Smiths create a CRT and transfer
their company stock to the trust. At the
same time, they arrange for an independent trustee and money manager.
2. When the company is sold, the trust
receives $2 million in cash for the company stock.
3. The money manager conservatively
invests the cash in a portfolio designed to preserve capital and generate
returns to pay the Smiths 7.5% annually.
4. The Smiths contribute approximately
$22,000 each year to a wealth replacement trust in order to fund a $2 million
second to die life insurance policy.
5. After Mr. & Mrs. Smith are
deceased, the remainder interest will be transferred directly to the charities
or to a private family foundation designed to assist with the community’s
charitable needs. And, at the same time,
the heirs will receive $2 million on life insurance proceeds tax free.
And, the
expected tax and cash flow benefits look like this:
Concluding
Thoughts
One of the
first axioms of financial planning states, "It's not how much you make
that counts; it's how much you keep." In charitable gift planning that
phrase could be modified to, "It's not how much you give that counts; it's
how much it costs you to give!" This is not to suggest that charitable
giving is motivated primarily by tax considerations; however, it does suggest
that to be good philanthropic stewards, donors should take full advantage of
the tax laws to optimize their gifts.
Hoffman, White & Kaelber Financial Services Investment
Performance Update
How much
have we been impacted by oil prices?
And, are we immune from these effects?
I’ve read and heard arguments that the
One word of
caution in the GDP estimate, however, was that expanding business inventories
also contributed to the increase. While
inventory increases can signal strength in an economy, it can also signal
weakness as well. It can signal weakness
when increases in inventories are due to slowing turnover and business hasn’t
gotten the message yet.
Also this
month, the Consumer Price Index (CPI) – including energy and food prices – for
September registered up 1.22%. This is
its largest monthly increase in over ten years and the measure and is now up
4.47% on a year to date basis. CPI is
the most widely cited inflation indicator and is the basis for calculating cost
of living adjustments for most
For the month ended October 31, 2005, our
one-month performance is down 0.17%, our year-to-date return is up 4.03%, and
our average annualized return since inception is up 8.36%. By comparison, the S&P500 and Russell
2000 were down 1.77% and down 3.17%, respectively, for the month and both are
in negative territory for the year. As
well, our portfolio volatility continued to edge down to +/- 5.54% while
volatility continued to increase in the equity markets. For
more performance information, please see our web site for details.
Is a comfortable retirement or preservation of wealth important to
you?
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