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APPRECIATED REAL ESTATE AND SECURITIES
If you have owned assets such as real estate, stocks, mutual funds and other
similar assets for a long period of time, you may have accumulated a significant
appreciation. If you were to sell them, the gain (absent pension accounts,
401(k)'s, IRA's, 403(b) and similar accounts) receive a benefit in taxation
at the capital gains rate. While this changes due to political whims, they
have historically been at lower rates than ordinary income. Nonetheless,
if one is taxed at the federal level of 20 (plus state tax as applicable),
that still can seriously erode the earning power of the remaining principal.
Here are some of the issues you must consider. Assume you are in your retirement years and own $300,000 of securities that you bought 20 years ago with a current basis of $40,000 (that is NOT the same as what you bought it for. Be careful here- if you don't understand what the 1099's you got each year actually meant to your basis, then you just made your tax bill all the larger. Seek expert advice.) A sale of those assets would incur a federal tax bite at (add state tax as applicable) of $52,000 (rounded) in a 20% LTCG bracket. That leaves $248,000 which could be reinvested at, say, 6% for a yearly return of $14,880 (rounded). If you had been able to reinvest the ENTIRE $300,000, the return would be $18,000- an increase of $3,120. To some, $3,120 may not be much, but to many it may mean the difference of a comfortable versus a troublesome retirement. Further, the $3,120 over 20 years amounts to $62,400. Quoted another way, assuming a 3% rate of inflation, the income stream is equivalent to an extra $46,795 of principal assets at the time of retirement. When put in that context, one can do appropriate retirement planning.
The essence of that review is to simply gift the assets to charity and let them sell the fund. Since they incur no tax, they receive the entire $300,000 which they can invest for YOU. You can receive an income stream for your life and for the lives of others as well. Further, you can get a tax deduction to use on your current tax return.
Let's put some of that in full focus by exploring another example from the American Cancer Society (1997 tax brackets). Here they used a 75 year old man with $100,000 of stocks with a "cost" (they actually mean current basis) of $35,000 which are yielding only 2%. He is in a combined federal and state bracket of 36%. Selling the securities and incurring a "loss" due to taxes of $23,400 would leave $76,600 to invest. Assuming a 7% yield, that would provide $5,362 of income- certainly better than the 2% currently earned. However, a gift of the $100,000 to the charity would allow a 7% return through a charitable remainder annuity trust of $7,000 a year- $1,638 MORE. But he would also receive an income tax deduction of $41,000 (based on age, income received, number of lives covered, etc.). This would yield a $14,760 tax deduction.
SPECIAL NOTE: I did not include IRA's, 401(k) plans, annuities, etc., in the above gifting during life since these assets actually incur major taxes even though gifted. The sale the assets in a tax deferred status will result in an ordinary income tax on ALL of the assets. For example, if the $300,000 had come from a 401(k) plan, you would have incurred an immediate receipt of $300,000 of ordinary income to be included with other income for that year. However, the gift of an IRA or similar plan at death is a viable consideration- even more so than other assets that were considered for a gift. The following will help to explain some of the issues, but they focus primarily on the understanding of basis. This MUST be understood for proper retirement and estate planning.
Assume you wanted to gift some assets at death to a charity but still leave most funds to beneficiaries. You have the option of gifting a $50,000 IRA or a $45,000 mutual fund. At first glance, you might opt for the $45,000 mutual fund since you desire your beneficiaries receive the greater value. NO, THEY WON'T!! The entire $50,000 of IRA's and similar plans (with no basis) remain taxable as ordinary income since there is no step up in basis at the date of death. Therefore, if taxed at 28% (and up to 39.6% federal tax plus state tax as applciable), the net amount left would be $36,000- far less than if you had left them the $45,000 of mutual funds which do get a FULL STEP UP IN BASIS AT THE DATE OF DEATH and which would incur NO tax upon a subsequent sale at $45,000. In fact, the IRA would need to be valued at $62,500 in order to equate to a $50,000 net after tax at 28%. So do your homework before gifting and make sure you understand basis.
In summary, you need to understand the tax implications of various assets and both current basis and any adjustments at the date of death. As always, seek competent counsel- perhaps separate from the charity. Don't expect them to have the capability of doing financial planning. Someone must be competent with the HP12C.