Recently I met with a couple in their late 70’s who want to give a gift of appreciated stock worth $50,000 to a local Foundation in return for a lifetime income of 5% annually. They asked me what the most tax effective way this could be done.
The solution is to use a Charitable Annuity. When he contributes the appreciated stock to the Foundation, he will include only 25% of the capital gains in his income for that year. If he sold the stock and donated the cash, he would have to include 50% of his capital gain in his income.
The Foundation will then purchase an annuity from an insurance company, which will pay the couple $2,500 annually until the second one dies. It should be a joint last to die annuity with a 10-year guarantee. The market price today is about $28,000 for a couple of this age. This means that the Foundation will issue a $22,000 charitable tax receipt – the difference between the appreciated stock of $50,000 and the cost of the annuity. If they die before the 10 years, then the income will come to the Foundation.
The charitable tax receipt of $22,000 will create a refundable tax credit of about $9,600 based on 43.7% taxation. This can be used in the year of donation or up to five years in the future. Since annuity income is largely a return of capital and payment of a small amount of interest, there is very little of the $2,500 that will be included in his income.
During our first interview, I had asked them about their current financial situation and their short and long-term goals. I wanted to make sure that the Charitable Annuity fit in with their overall plans.
They have no children and they are concerned about reducing probate, capital gains and income taxes and seeing their donations at work. Both would like to preserve their capital in case things change but want to direct the taxes they pay to charities through planning on an annual and estate basis. They realize that they have to pay taxes but would rather the money was spent where they wish, and understand the use of charitable tax credits to do this. They have about $60,000 in pension income annually between them, plus he gets about $8,000 annually in dividends from his stock portfolio. Their combined RRIF’s total about $225,000 plus he has a large stock portfolio which has unrealized capital gains of about $90,000.
When the second partner dies, all the money in the RRIF is included in income in the year of death. Also, 50% of the unrealized capital gains will be included. Right now that would mean $225,000 from the RRIF’s and $45,000 from the capital gains on the stock portfolio would be included in income. The tax on this $270,000 is estimated to be up to $115,000, as the highest marginal tax in BC is 43.7%.
There is no way to stop the taxes from being due. However, if they add the charities of their choice as contingent beneficiaries to each RRIF, then the charitable tax credit will offset the income taxes completely. This strategy has the added benefit of avoiding probate on the value in the RRIF.
The stock portfolio will have to pass through the will and therefore will be included in the estate and subject to probate taxes. However, if the charities are again named as contingent beneficiaries, then the capital gains inclusion will be reduced by 50%.
However, if they continue the strategy of donating appreciated stock to local charities, it will have the effect of transforming the stock portfolio into income. This income will attract very little tax, the charitable tax credits will offset the taxes on their pension income and the stock portfolio will be reduced significantly so that probate taxes will be reduced.
If they choose to use the strategy outlined above they will have directed significant income to their favorite charities and probably will not pay taxes for the rest of their life, or on their estate.
Gill Campbell is a certified financial planner and an independent insurance broker. Please email with specific areas that you would like her to consider in developing future columns – firstname.lastname@example.org