Patrick Henry once said, “I have but one lamp by which my feet are lighted, and that is the lamp of experience.”
After years of working in the area of wealth transfer, business succession, estate planning and related areas, my view of my client’s view of philosophy changed. Why? Experience! You’ll like what you are about to read: How to actually make money while giving it away.
An important task for tax advisors (particularly those doing estate planning) is to make sure they have a clear understanding of each client’s goals. So, one of the questions yours truly or my staff would ask each client was, and still is, “Do you have charitable intent?”
Most clients answered, “No” and that was that. For those that said, “Yes,” we had a large arsenal of tax-advantaged charitable strategies that would enrich not only charity, but substantially enrich our clients too. Every client always made an economic — after-tax — profit.
One day about 10 years ago we decided to dig a bit deeper when a client said, “No” to our charity question. The following are the two most important questions we asked, the answers and what we learned to our surprise.
Question #1: A simple one word question: “Why?” (did you say “No”). About two out of every three clients responded with something like, “I don’t want to reduce the amount of my children’s and grandchildren’s inheritance.” After learning this, it made good sense to follow with the next question.
Question #2: Actually two questions designed to get a “Yes.” First, “Would you consider making a substantial gift to charity, if it would not reduce your heirs’ inheritance?” And if that didn’t do the trick, then second, “Would you make a large charitable gift if you could actually make an after-tax profit?”
Now, almost all clients say “yes” or “show me how” or something similar. The simple fact is that the tax law has two tax-free environments: charity and life insurance. Marry them and you are on the road to tax heaven. Let’s stay away from the technical stuff (like charitable remainder trusts and charitable lead trusts and their many ways to help you and charity) and look at two basic examples.
Example #1. Suppose Joe and Mary (married and both age 65) buy a 15- year pay, $4 million second-to-die life insurance policy. The annual premium is $20,618 per $1 million payable for 15 years or a total of $1.237 million ($20,618x15x4). Joe and Mary set it up so their Favorite Charity (FC) is irrevocably the beneficiary of the policy.
Let’s take a look at the tax consequences of this charitable gesture by Joe and Mary. They are in a 40% income tax bracket (counting State and Federal combined) and a 55% estate tax bracket, using 2011 rates. First, let’s look at the estate tax picture: in a 55% estate tax bracket, the real story is that the IRS paid 55% of that $1.237 million. Since it’s gone, the IRS can’t tax it. So, the real out-of-pocket cost to Joe and Mary (after estate tax consideration) is only $557,000 (45% of $1.237 million).
Second, let’s look at the income tax consequences of the transaction. In a 40% income tax bracket, Joe and Mary save $8,247 ($20,618x40%) each year as a charitable deduction.
Next, Joe and Mary buy $1.6 million of 15-year-pay, second-to-die life insurance in an irrevocable life insurance trust (to keep the proceeds out of their estate). What’s the annual premium cost for 15 years? You guessed it — their annual $8,247 income tax savings.
Finally, let’s put it all together. Favorite Charity will wind up with $4 million. Joe and Mary’s family will make a little more than a cool $1 million ($1.6 million insurance proceeds less the after tax cost, $557,000, of the premiums paid for the gift to charity).
Example #2. The above is only the tip of the iceberg. There are dozens of similar strategies to enrich your family while you enrich charity.
This example, the one with the best leverage, is “premium financing” where $500,000 can be turned into $6.5 million for Joe and Mary and then shared with their favorite charity. Joe and Mary can divide the $6.5 million, $5 million to their family and $1.5 million to charity (or in any other ratio they desire). Now, $500,000 turned into $5.5 million — that’s tax and economic leverage!
Most of the time Favorite Charity is your own Family Foundation, that bears your name. By now you get the idea: if you (or your spouse or both) are lucky enough to be insurable, you can leverage small amounts of capital (a $500,000 investment or less, paid out in small amounts over many years) to mushroom into large tax-free amounts ($5 million or more). Divide your taxfree profits between your family and charity any way you desire.
Irving Blackman is a partner in Blackman Kallick Bartelstein, 10 S. Riverside Pl., Suite 900, Chicago, Ill. 60606; tel. 312/207-1040, or via email at [email protected]