A Silver Lining in a Bear
Market
By Susan Ashman
Has the market’s two-year slide caused
you to postpone giving stocks to your favorite charities? Perhaps these
equities are worth less than you paid, and you want to wait for them to recover
their value so that you can get a larger tax deduction. Or maybe you’re just
not ready to part with some of your favorites that you believe are only
temporary victims of the bear market and will rebound in the next up cycle.
These declines in your portfolio, however, might actually present an
opportunity for you to help a worthy cause and reduce estate taxes without your
family permanently giving up control of the assets.
A charitable lead trust (CLT) is designed
to provide a stream of income for a stated period of years to one or more
designated charities. You determine the size of the payments (either a fixed
percentage or dollar amount) and how long they will last (20 years maximum)
when you set up the CLT. Non-charitable beneficiaries, such as your heirs, will
receive the remaining trust assets when the CLT terminates.
Now here’s where lower stock prices and
interest rates can help. Stocks you transfer to your CLT will be considered a
taxable gift at the current market value of the remainder interest that will
pass to your beneficiaries. This value is determined by the size of the
payments to the charity, the trust’s term, and an IRS benchmark rate of return.
A lower stock price and a lower benchmark rate will result in a lower taxable
gift. In addition, you will receive a federal gift tax charitable deduction
that is based on the present value of the income stream that will be paid to
the charity. A lower IRS benchmark rate used to discount the income stream to
present value will result in a higher deduction.
This benchmark rate is tied to the U.S.
Treasury’s interest rates and, as of October 2002, was 4.16%[i].
This is the lowest it has been in more than 13 years. When you set up your CLT,
you lock in the IRS’s valuations for gift tax purposes. Hence, any growth or
accumulated income inside of your trust at the termination date will pass both
estate and gift tax free to your beneficiaries. Therefore, there is now a
greater chance than there has been in years that your CLT might appreciate at a
rate exceeding the government’s benchmark rate.
Many investors own beaten-down stocks
that still produce dividends or are liquid enough to make the required
distributions to a charity. These can be the best assets to transfer to a CLT
because they will have two or three business cycles (approximately 2 to five
years per cycle) to appreciate.
For example, let’s say that you own a
high-quality stock that was trading at $85 per share two years ago and is now
trading for $35. Furthermore, you believe that there will be an upturn in the
economy over the next 10 years and this stock will greatly benefit from the
upturn. If you give it to a beneficiary now, the gift tax value will be $35.
But if you transfer it to a CLT with a 10-year term, you might realize a
further discount in the gift tax value when the IRS discount rate is
applied.
If you were to specify a 5% distribution
each year to the charity, and your stock grew (income and appreciation) by 8%,
the 3% difference plus the trust’s principal would bypass your taxable estate.
You have no control over a market
decline. But why not use it to your benefit, especially if you don’t need the
income and your heirs can wait up to 20 years for their inheritance? A CLT can
allow you to pass assets to your beneficiaries at a reduced gift and estate tax
cost before you die, immediately help your favorite charities, and see your
legacy plan materialize while you are alive.
Susan Ashman, CFP( is a Vice President
and Private Client Advisor in the North Palm Beach office of Wilmington Trust
FSB, Florida.
This article is intended for
information purposes only and not as an offer or solicitation for the sale of
any financial product or service or a recommendation or determination by
Wilmington Trust that any investment strategy is suitable for a specific
investor. Investors should seek financial advice regarding the suitability of
any investment strategy based on the investor’s objectives, financial situation
and particular needs. This article is
not intended or designed to provide legal, investment or other professional
advice since such advice always requires consideration of individual
circumstances. If legal, investment or
other professional advice is needed, the services of an attorney or other
professional advisor should be sought.
© 2002 Wilmington Trust Corporation. Affiliates in California, Delaware, Florida,
Georgia, Maryland, Nevada, New Jersey, New York and Pennsylvania. Members FDIC. Other offices in Tennessee, Dublin, London, Milan, Cayman Islands
and Channel Islands.