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Charitable Remainder Trusts/Charitable Gift Annuities vs PAT's

By Roccy M. DeFrancesco, JD, CWPP™, CAPP™ - Email Editor

Date: Sept 5, 2006

 

Dear Subscriber:

For a while, I'm going to start all my articles off with a similar statement by reminding readers about “Global” Asset Protection.

Global Asset Protection revolves around the statement that “anyone or entity that can take your money is a creditor.” That means the IRS, the stock market, long term care costs, etc...

For this newsletter, I am discussing how to protect your money from capital gains taxes with a discussion about Private Annuity Trusts (PATs) and Charitable Planning. PATs are all the rage these days because they are not widely known. Now that advisors are becoming aware of them, they seem to be the answer that is most given when talking about mitigating capital gains taxes on the sale of a highly appreciated asset. PATs are a nice option, but for you to receive the best advice possible, your advisors must be familiar with all the options available to mitigate capital gains taxes.

With much of the American public investing in highly appreciated real estate or stocks, “capital gains taxes” are certainly on our minds.

In my past newsletters, I've discussed how PATs works to “defer” capital gains taxes on the sale of a highly appreciated asset. On their face, PATs are fairly simple:

1) Client (grantor) sets up a PAT.

2) Client transfers asset to a PAT in exchange for a lifetime annuity payment (immediate or deferred). The client pays NO capital gains tax at this point.

3) The Trust then sells the highly appreciated property with NO current gain.

4) The PAT pays the client per the Trust document. The client then pays a blended tax rate on each payment received (along with a tax free basis return).

5) One of the most powerful things about a PAT is the ability of the client to immediately transfer an asset out of the estate for estate tax planning.

Sounds great right? Defer capital gains taxes for years (payment must begin by age 70½), receive a lifetime income stream, and move an asset out of the client's estate.

Don't get me wrong, it is a neat topic, but it's not a cure all. Maybe you would be better off with a Charitable Plan instead?

Charitable Planning

What are the benefits of charitable planning? Read the following and ask yourself if the Plan sounds like it is a charity base. What if you could have a Plan that could:

1. Increasing discretionary (“spendable”) income.

2. Reducing or eliminating income taxes, capital gains taxes, and estate taxes.

3. Securing a tax free inheritance for chosen heirs.

4. Leaving a lasting family and social legacy.

Again, does the above sound like a Charitable Plan or a Really Neat Plan a client with wealth would be interest in?

Why use a CRT (Charitable Remainder Trust) or CGA (Charitable Gift Annuity) instead of a PAT when attempting to mitigate taxes on a highly appreciated asset? Because the client can sometimes receive a better benefit from a charitable solution.

What aspects of a charitable solution are better than what a PAT can offer?

1) You receive an immediate income tax deduction (with a PAT there is NO income tax deduction upon transfer).

2) You receive a payment stream for life from the charity, and the capital gains component of each payment is discounted. (With a PAT you will pay ALL of the capital gains over the payment period).

3) A charitable gift annuity can be set up with NO costs. A PAT will cost anywhere from $7,500-$15,000 depending on the complexities.

What are some aspects of a PAT that are better than a charitable solution?

1) The entire asset (minus capital gains taxes if any) will pass to your heirs. With a charitable solution, you typically would purchase a life policy owned by an ILIT to “replace” the wealth of the asset gifted to the charity. Also, if you are not in good health, you will not be able to buy wealth replacement life insurance.

2) You receive ALL the money plus growth on the money in the form of a lifetime annuity stream (assuming you live long enough). With a CGA/CRT, some money stays with the charity, and therefore, does not all come back to you via the annuity stream.

Which one is better for you?

Generally speaking, if you are still earning a decent amount of income each year, the charitable solution is going to make more sense. Why? Because you will receive a nice sized income tax deduction when making the gift, and the capital gains taxes are reduced when payments are made.

If you have no income or are in poor health, a PAT is typically going to be a better solution since you can not take advantage of the income tax deduction. Also the asset is immediately moved out of your estate for the benefit of your heir.

Summary

This is a short newsletter where I am giving you a little insight into the topic of PATs and why you should not use them as a cure all. They do work for the “right” client, but more than 50% of the time you will NOT use a PAT, and instead will use a charitable solution or even an Intentionally Defective Grantor Trust (which I will cover in an upcoming newsletter).

Roccy M. DeFrancesco, JD, CWPP™, CAPP™

If you have an interest in these topics, it would be wise to purchase the Educational Module on Private Annuity Trusts and/or the Charity Planning Module .

These modules were created to educate life insurance agents, estate planners, CPA/accountants, EAs, real estate agents, mortgage brokers and attorneys about the solutions to help clients mitigate or avoid capital gains with highly appreciated assets.

The 27-page Private Annuity Trust professional module will review several different strategies, how PATs work, what steps must be followed, and what the benefits and pitfalls are of each one.

The 28-page Charity Planning professional module will cover the major charitable planning solutions: Charitable Gift Annuities, Charitable Remainder Trusts, Charitable Lead Trusts and Family Foundations.

The modules have been written so the lay person can read it with ease.

Before implementing any solution:
• get educated on these topics
• know what your advisor knows
• learn the topics so you can ask your advisor the proper questions.

 

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