Americans are generous and charitably minded. How charitably minded? According to the latest annual report Giving USA 2024: The Annual Report on Philanthropy for the Year 2023, last year we broke the record once again in terms of total dollars given of $557.16 billion!
Although the record for total dollars given was broken, the increase did not keep pace with inflation. However, given heightened inflation and the necessary tightening of belts going on elsewhere in life, one might have expected one of the first cuts to be to charitable giving, and that has not been the case.
If you are philanthropically minded and considering a substantial gift to charity, you might want to consider a charitable trust. There are many scenarios in which the charity and the giver can maximize the benefits of the gift. One situation to consider – a concentrated holding in a stock position.
Winners sometimes turn into concentrated holdings.
Consider this fictious example:
Alan has the good fortune of a potential tax problem. Back in the 1990s, he bought shares in a number in tech companies. One of these turned out to be a real winner—an investment of $50,000 has blossomed into $2.5 million! Although that sounds wonderful, the stock does not pay much in the way of dividends, which is a problem as Alan enters retirement and needs more income. If he sells some shares to raise cash, he will have to pay substantial federal and state capital gains taxes on the sale, so he has been reluctant to do that—he expects the value of the shares to keep going higher. At this point, Alan realizes that this is quite a big risk because his total stock portfolio is $5 million—the shares of this one company represent 50% of his investable assets.
Financial planners apply the term “concentrated holding” to any position that represents more than 10% of a portfolio. Such positions can be risky because a decline in the value of a concentrated holding can really damage overall portfolio returns.
What are some strategies for diversification of a concentrated holding?
Alan might consider –
- selling all or part of the holding, and accepting the tax consequences
- hedging the position by buying a protective put option, selling a covered call option, or utilizing a collar, combining both of those elements. Options trading is not suitable for all investors, however, and presents risks of its own.
- Or – For those who have philanthropic aspirations, the charitable remainder trust offers a tax-efficient alternative.
What is a charitable remainder trust, and how could it help with this issue?
A charitable remainder trust (CRT) is a permanent financial arrangement. The grantor transfers assets to the trust, which pays an annual income to lifetime beneficiaries, typically the grantor and/or spouse. The trust may continue for a specific term of years (up to 20), or it may last for the joint lives of the income beneficiaries. When the trust terminates, the assets pass to a designated charity.
The income interest in the charitable trust may be expressed as an annuity, a fixed dollar amount paid every year, or as a unitrust interest, which is a fixed percentage of the value of the trust, again paid every year. An annuity will not change over time, while the unitrust interest rises and falls with the value of the trust assets. During periods of economic growth or when inflation is high, the unitrust interest will often be preferred. The annuity interest, on the other hand, provides steady income even during economic downturns.
What would the difference be between using the Charitable Remainder Trust and selling and giving the cash to the charity?
For concentrated portfolios of assets with a low tax basis, benefits from using a CRT include the avoidance of paying capital gains tax on the appreciation and the deferral of income taxes.
Let’s say Alan wants to divest the concentrated holding to reduce his risk portfolio, but is charitably minded so thinks he’ll likely be donating the remainder of his assets in twenty years. He sells the tech stock to place it in a diversified fund, realizing the capital gain which reduces that part of the portfolio from $2.5 million to ~$1.90 million. He retains full control, and it returns ~5% ($95 thousand) per year for the next 20 years and he only spends the income each year of this fund. So even though he’s withdrawn $1.90 million over 20 years, he still has a major gift of $1.90 million to give at the end of the 20-year period.
On the other hand, let’s say Alan uses a Charitable Remainder Annuity Trust (CRAT). He relinquishes all rights to the holding and the trust sells the concentrated holding instead of him to place it in a diversified fund, with no reduction for taxes. He is the income beneficiary for the next twenty years, and receives 5% each year, and the trust has an average return of 5% per year. As opposed to the example above, Alan would receive $125,000 in income each year (a total of $2.5 million), and the charity would receive $2.5 million at the end of the 20-year period.
There would also be an income tax deduction. Generally, the income tax deductible value of a charitable remainder interest ranges from 20% to 50% of the value of the assets that are placed in trust. The exact amount is determined by actuarial tables, the nature and duration of the income interest, and prevailing interest rates when the trust is funded.
What’s the main trade off when considering a Charitable Remainder Trust?
In Alan’s case, this difference of about $600,000 dollars is worth the substantial planning, but Alan does give up all rights to that asset so could no longer bank on it as a safety net. He’d have to rely on the remaining $2.5 million in his investment account for that. Thus, this works particularly well when the grantor is comfortable enough in the rest of the portfolio and expenditures to consider such a substantial gift as having been fully made.
The make-up of different families’ wealth portfolios will not match up to each other, so the scenario of benefitting from the greatly appreciated concentrated holding will not apply to everyone. That’s where a holistic review and Garden State Trust Officers come into the picture. Meeting with people to help fulfill philanthropic goals is one of the best parts of being a trust officer, and they can go over options to ensure that substantial planned giving benefits are maximized for both the giver and recipient.
Please reach out to us for more information.
