The aging baby-boomer generation has brought its fair share of challenges to our country's economy and markets — everything from strained entitlement programs to difficulties providing health care. However, boomers have accumulated an unprecedented amount of wealth over their lifetimes and are now in the process of deciding what to do with it. Many have expressed desire to donate and transfer large sums of money.
A charitable giving plan is a great tool to help high-net-worth clients achieve their philanthropic goals while also solving some of their tax issues. Timing large charitable gifts around a significant tax event (e.g., selling a business or an asset with a low cost basis) can be of value to a client. A donor-advised fund is a particularly good vehicle to use in this scenario.
A major benefit of a donor-advised fund is the flexibility it provides. Donors can decide when they want to make contributions to the fund, and over what schedule they will make distributions out of the fund to their charities of choice. For example, let's say a married couple sells their small business in 2016. As a result of this sale, the couple has an adjusted gross income far higher than normal. They've always been charitably inclined, but like to spread their gifts out to multiple charities that vary from year to year.
In this scenario, with the help of their adviser and accountant, the couple could determine what amount they can comfortably contribute to a charitable fund without impacting their long-term spending and wealth transfer goals. This amount would move into a donor-advised fund and could be distributed systematically each year as the clients see fit. Additionally, the initial transfer to the fund qualifies for a tax deduction, thereby offsetting a portion of the tax bill incurred by selling the business. Any amount of deduction not used in the current year can be carried forward to future years.
Clients who own stock with a very low cost basis receive similar benefits. Their shares of stock could be transferred into a donor-advised fund and then sold. This transfer and subsequent sale would result in no capital gains tax for the client, and they also would benefit from a tax deduction based on the fair market value of the shares. The proceeds of the stock sale could then be invested as the client sees fit and potentially could grow over time.
Transferring assets to a donor-advised fund also can help clients manage estate tax issues. For clients with estates valued at more than the federal estate tax exemption (currently $5.45 million per individual), systematic planning is critical, especially considering the current federal estate tax rate of 40%. Moving assets out of their estate while they're alive eliminates all future appreciation of those assets, thereby avoiding eventual taxation. Keep in mind that some states have their own estate tax exemptions that differ from the federal exemption. Clients with estates under the federal exemption but over the state level would benefit from closer planning.
Discussions about charitable giving should be part of the overall financial planning process for high-net-worth clients. Once a level of trust is developed between the client and adviser, and the client is confident that their lifetime cash flow needs and family legacy goals are on track, philanthropic topics can be addressed. A recent Fidelity study showed that 93% of wealthy clients who work with a financial adviser make charitable gifts annually.
High-net-worth investors are making charitable gifts anyway, so why not help them maximize the benefits? Taking advantage of the significant tax advantages of a donor-advised fund, and the potential for asset transfers to appreciate over time in the fund, is one option that can really resonate with clients.
Greg Stevens is principal and senior wealth adviser at Cabot Wealth Management.