Like a lot of Americans, many of your clients probably plan to leave some of their wealth to charity. After all, it’s good to know that well-earned and carefully invested money is going to make the world a better place, and it doesn’t hurt that the gift might help to reduce estate taxes, too.
The problem is, your clients might not be making their planned gifts in the best way. While simply using a will to direct that a portion of an estate should go to charity might be a straightforward way to make a gift, that approach might not deliver most effectively on your clients’ gift-giving goals. Plus, it might overlook opportunities your clients haven’t considered – most notably, those that come from using estate proceeds to fund a donor-advised fund or charitable remainder trust.
A popular approach: Charitable giving through an estate
Americans generally are considered to be among the most generous people on the planet, giving hundreds of billions of dollars to charitable causes each year. In 2022, U.S. charitable gifts tallied $499.33 billion, up from $228.93 billion a decade ago.
Of that total, more than 9%, or $45.6 billion, came in the form of end-of-life gifts, also known as bequests or planned or testamentary gifts. And while that could seem to be a relatively small amount in the big picture, Giving USA notes that the number of estates including bequests has quadrupled over the past 40 years. And it likely will keep growing: This study suggests that up-and-coming generations will make even more gifts from estates, with 44% of people born between 1967 and 1996 saying they plan to leave a gift to charity in their wills.
Your clients might have a range of reasons for participating in such giving, but a 2019 Giving USA study cited three main motivations: the importance of the cause, a belief that the targeted charity makes a significant impact, and the ability to make a larger gift through the estate than while the donor is alive.
When we put these reasons alongside some top documented motivations for overall charitable giving (including the desire to establish a legacy of giving, family tradition, and tax impact), we see that this simple approach might leave a client’s goals unmet. For that reason, we suggest two alternative approaches.
Option One: The donor-advised fund (DAF)
DAFs have become the world’s fastest-growing charitable vehicle for a reason: They deliver on donors’ top motivations for giving.
For such a powerful tool, a DAF is pretty simple. A donor makes a gift to a sponsoring public charity that then creates a donor-advised fund account on the donor’s behalf. The donor gets an immediate tax deduction for the amount contributed and can also avoid capital gains taxes by contributing appreciated assets directly to the DAF. After the DAF is established, the donor can continue to contribute assets and receive tax benefits from those ongoing contributions.
Once the funds are invested, the investment proceeds are used to make grants to charitable organizations as frequently or infrequently as the donor feels is appropriate. While the donor no longer owns the assets contributed to the DAF, they can recommend how the assets are invested and recommend grants to public charitable organizations. This power remains with the donor for life and can be passed on to future generations.
Option Two: The charitable remainder trust (CRT)
A CRT serves as a great option for donors who want to garner the benefits of charitable giving while also creating an income stream.
A CRT is a tax-exempt trust in which assets are transferred to a qualified charity that invests the proceeds and pays a distribution to the donor or a designated income beneficiary for a set term. At the end of that designated time, which could be the donor’s lifetime or for a term of up to 20 years, the remaining assets – aka, the “remainder” – go to the charity.
Similar to how a DAF allows donors to change the charitable organizations that benefit from the fund, CRTs also allow donors to change the charitable remainder beneficiaries as often as they want, as long as the trust document permits them to do so. Like a DAF, a CRT can receive non-cash gifts and help to reduce the tax impact of appreciated assets.
While the initial donation of the assets can create tax deductions, distributions paid by the trust for the donor or their designated beneficiaries are taxable.
Funding a DAF or CRT through an estate
For a client who has long-term charitable objectives, the DAF and CRT offer sound options for testamentary giving.
Both can help your clients accomplish charitable giving goals, and both deliver certain estate tax benefits. Specifically, a DAF creates a 100% charitable deduction for the value of donated assets. A CRT, on the other hand, creates a present-value charitable deduction equal to the value expected ultimately to go to the charity designated to receive the remainder. Both a DAF and CRT can allow an estate to avoid certain IRD (income in respect of a decedent) taxes.
Regardless of the option chosen, a client would need to ensure that the legwork to establish a DAF or CRT is done ahead of time. Neither vehicle is difficult to create, and Ren can assist you and your client in the process. Once the DAF or CRT is established, the next step is simple: The client needs only to designate the fund or trust as a beneficiary in their will. An added benefit? The DAF or CRT also can be listed as a beneficiary of a retirement plan or life insurance policy.
Start with the estate plan
Much of this discussion has turned on one key assumption: That your client has a will. Unfortunately, a surprising number of Americans don’t. In fact, one recent survey found that only 32% of Americans have any type of estate planning document, and 40% of Americans say they’ll wait until they feel their life is nearing its end to create one.
So start there, using the conversation to learn more about your client’s long-term goals. As you talk about a longer horizon, ask your client about what is important to them. How much of their wealth do they want to see going to their heirs, and how might their likely estate tax liability affect their ability to reach that goal? What would be the best way to go about distributing that wealth? What causes or charity matter to them, and do they have plans to leave any wealth to them? How might those considerations work in tandem to deliver the most impact?
As a part of this conversation, urge your client to think about specific amounts or percentages of their wealth they would like to pass on to heirs or charities. Then consider how a DAF or CRT might help them reach those goals, remembering that, while each approach offers a number of benefits, they do have key differences.
With so many Americans giving to charity, and so many planning to do so through their estates, most clients expect financial advisors to discuss charitable giving with them. Going into the conversation with a clear understanding of beneficial options will simply make you more valuable to your clients, and better equipped to help them reach their long-term financial goals.
If you’d like to learn more about the way you can help your clients reach their philanthropic goals, talk to our experts at Ren.