What is an Endowment
An endowment is most commonly established by a tax-exempt organization and is a permanent fund that uses its earnings to advance the charitable, religious, or educational mission of the organization for which it is established. The principal amount of the endowment fund always stays intact while all or a part of the earnings are utilized by the charity each year. The earnings are used to fund projects or programs designated by the endowment fund. A percentage of the earnings are generally left in the fund to increase the fund principal. As the principal increases, the earnings available for use each year increases.
Ways to Give
This is one of the most common and familiar forms of giving. Donors make an outright gift to the community foundation to establish a charitable fund personal to them. Donors have the priceless joy and satisfaction of turning their charitable dreams into reality as their philanthropic dollars go to work. Unless the donors choose to remain anonymous, their generosity is recognized both by the beneficiaries of the fund and the community as a whole.
An outright gift accomplishes three important tax objectives:
1. A charitable income tax deduction in the year of the gift.
2. The reduction of the donor’s gross estate for future estate tax purposes.
3. Avoidance of capital gains taxes (on the increase in value over the donor’s basis) for gifts of appreciated property.
Donors can create or add to the fund over time with gifts of cash, publicly traded or closely held securities, real estate, and other assets. (All gifts are subject to the various limitations as to deductibility applicable to different types of gifts made to public charities.)
Gifts by Will
A testamentary gift is often the simplest way for a donor to make a significant, lasting gift to the community. After the needs of a spouse, children, and other loved ones have been addressed, many individuals find it satisfying to know that a portion of their resources will go toward the common good. A charitable fund creates a permanent legacy—in the donor’s name or the name of a loved one—that will serve the community for generations to come.
A testamentary gift also can significantly reduce the federal estate tax and the state inheritance tax due at the donor’s death. A bequest to create a named fund with the community foundation qualifies for an unlimited charitable deduction.
A testamentary gift can create a dramatic tax savings for the estate and enable the donor to make a significant charitable gift at a relatively small cost to the heirs. If a donor’s exact charitable wishes are made obsolete by the passage of time, the community foundation has the obligation and power to redirect assets. Needs may change and specific organizations may no longer exist, but the donor’s basic intent will continue to be honored. A philanthropic fund with the community foundation can be created through a specific bequest of cash or property, a percentage bequest, a residual bequest, or a contingent bequest. See Appendix 1 for “Sample Bequest Language.”
There are two good and easy ways donors can use life insurance to fund their giving. If they have a paid-up (or cash value) life insurance policy that they no longer need for its intended purpose (e.g., children are grown, their spouse is pre-deceased, or tax laws have changed), they can give the policy to a fund at the community foundation. The policy will be cashed in, and they can use the proceeds to make grants to charities they recommend almost immediately. Or, they can make life insurance part of their estate planning by naming the foundation as a partial and/or contingent beneficiary of any insurance policy’s death benefit. If one or more of their primary beneficiaries predecease them, their share can go directly into a fund they establish at the community foundation.
When donors make an immediate gift of an insurance policy, they may claim an income tax deduction based on the policy’s basis points or policy value (deduction is limited to 50% of the client’s AGI) The community foundation may cash in the policy and have proceeds go directly into funds established by donors (other options can be explored that may be more advantageous for donors while still serving their charitable intentions). Or, they can convert the assets of the policy into a charitable remainder trust.
Qualified Retirement Plans and IRA Benefits
Qualified retirement plans and Individual Retirement Accounts (IRAs) are often the largest part of a client’s estate. While the account owners are living, minimum distribution rules require, under penalty, the taxable distribution of a certain portion of these accounts annually. When both husband and wife are deceased, a combination of estate taxes, income taxes, and generation-skipping taxes may reduce the account value up to 70%. Faced with these burdensome tax rules, many individuals prefer to make more of these assets available to family members or to charity, rather than see the majority of the assets consumed by taxes.
One way to greatly reduce estate and income taxes is to use these assets to satisfy charitable desires at the account owner’s death. In some cases, this approach is combined with the use of lifetime distributions from the account to fund the purchase of life insurance. The life insurance then replaces the assets that would otherwise pass to children and other family members were it not for the burdensome tax environment for qualified plans and IRAs. From a tax standpoint, persons who have already decided to make charitable gifts often find that it is prudent to withdraw funds from a qualified plan or IRA, rather than to deplete other assets which are not taxed as heavily at death.
In some situations, your client can receive a distribution from the qualified plan or IRA (which is subject to income tax) and make a charitable contribution in the same year without negative income tax consequences. This strategy allows your client to make the charitable gift while living and to preserve other assets that will be taxed least at death.
Charitable Remainder Trusts
Giving through a charitable remainder trust allows your client (or someone they select) to receive income for life, knowing that whatever remains will benefit their community. They do this by placing cash, property, or other assets into a trust that distributes to the “income beneficiary” an annual income for life or for the duration of the trust. Your client receives an immediate tax deduction for the present value of the gift in the year the gift is made. After death or the end of a specified trust term (up to 20 years), the remainder of the trust transfers to a fund your client has named at the foundation or to a specific charitable organization. Grants from the fund will be made in accordance with your client’s interests.
Four options for Charitable Remainder Trusts are available:
1. Annuity trust pays a fixed dollar amount.
2. Standard unitrust pays an amount equal to a fixed percentage of the net fair market of the trust and is recalculated annually.
3. Net income unitrust pays the lesser of the fixed percentage specified by the trust agreement or actual trust income; some net income unitrusts allow your client to make up deficiencies in past years.
4. Flip unitrust is a net income unitrust that converts to a standard unitrust upon a triggering event, such as the sale of an asset used to fund the trust.
A charitable remainder trust is particularly useful for people who own securities or real estate that have increased in value but earn little income, since the assets—once placed in the trusts—can be sold and reinvested free of capital gains tax.
Charitable Lead Trusts
A charitable lead trust enables your client to make significant charitable gifts now while transferring substantial assets to beneficiaries later. It works like this: A trust is set up from which the community foundation receives annual payments for one’s life or for a specified number of years. These funds may be distributed to charities your client specifies or be added to a donor-advised fund. When the trust terminates, the trust principal is returned to your client or distributed to their children or others they may designate. The trust assets pass to the recipients at reduced tax cost, sometimes even tax-free.
A charitable lead trust shelters investment earnings from tax, and it offers gift, estate, and generation-skipping tax benefits. For example, trust assets are removed from your client’s estate for estate tax purposes.
Donors can establish a charitable lead trust during their lifetime or through their will. They can choose to have either a fixed percentage of the trust assets or a set dollar amount distributed to the fund they establish through the community foundation.
The fund can continue to grow and support their community even after the trust terminates. A charitable lead trust may appeal to those who want to reduce their estate tax or who want to delay their heirs’ receipt of an inheritance.
A charitable gift annuity is a simple contract between the donor and the community foundation. In exchange for the donor’s contribution, the community foundation promises to make fixed, guaranteed payments for life to one or two annuitants (usually, but not necessarily, the donor). The amount paid is based on the age of the annuitant at the time of the gift, in accordance with the foundation’s gift annuity rate schedule.
This gift provides a unique opportunity for donors to enjoy lifetime income and tax benefits, while also being able to choose a nonprofit organization to benefit from the remainder interest. When the gift annuity ends, the money remaining, up to the original gift amount, will be used to create a permanent charitable fund at the community foundation to benefit a charitable purpose important to the donor.
Deferred Gift Annuities
A donor may elect a deferred gift annuity by which the donor receives larger annuity payments, beginning later in life. The donor receives a larger income tax deduction than for a current gift annuity. A deferred gift annuity works well for people in a high tax bracket who expect their income to decrease in the future when they retire.