Helping Donors Answer Their Most Perplexing Questions

Anyone who has ever toyed with the idea of making a planned or testamentary gift to charity knows that before any significant giving decision could be made, he/she had answer two very important questions: 1) How much will my spouse and I need to live on for the rest of our lives? And 2) How much should we give to our children and grandchildren?

By comparison, the first question is far easier to answer than the second. Most people with significant giving capacity have spent decades working on the first question with financial professionals. A carefully constructed and regularly reviewed financial plan serves as the answer to question one – What will we need for the rest of our lives?

Question two is far more complex because it’s not just a matter of how much we can give but when and how much we should give to our children. Parents have to figure out what is the right thing to do—what would be beneficial to their children and what might be detrimental. That is complicated further by spouses, children’s liability exposure, potential divorce settlements, the ability to handle money, and some parents’ obsession with always making everything equal. Consequently, many potential donors quickly work through the first question, only to freeze with indecision on the second.

The most effective (but uncommon) response is to help donors create a plan to answer that all-important question two.

Most non-profit executives have been confronted with this situation before. They have donors with more money than they could ever spend on themselves. However, those same donors cannot make a decision about a testamentary gift to charity because they are still unresolved about what they should do for their children. Common responses from non-profit executives include: a) pressing harder for an immediate commitment, b) making a note to visit again next year, or c) quickly moving on to the next donor. On the other hand, the most effective (but uncommon) response is to help donors create a plan to answer that all-important question two.

A few years ago I sketched out a little diagram. There is probably no tool that solves every communication problem, but this the closest thing I have found to something that works every time. I introduce a diagram with the comment:

“The positive or negative impact your financial assets will have on your children is largely the result of how much, at what time, and by what means you pass on your wealth to them. Would you be interested in seeing how that works?”

Very seldom do they say anything other than “yes.” Often the response is an emphatic, “You bet I would!”

“Great,” I reply. “I have three basic questions I need to ask, then we can discuss your answers.”

Question #1: Do you already know what percentage of your assets you would like to give to your children?

Most people don’t know precisely the current value of their estates; many have no idea. I also understand that many assets are not easily divided equally—the family home, control of family business, etc. So, for the purpose of this exercise, we’re just going to talk about a percentage of total net worth. Getting clarity on that simple question helps with all the other asset transfer decisions.

Some people already have a general idea about what they want to do. For others, that’s where they are stuck; how much to give? Don’t worry if they don’t know the percentage now. By the end of the conversation, they many have a better sense of what they want to do.

Question #2: So, what percentage of your children’s total inheritance would you like to give outright at death, to give as an ongoing income stream, or to give as lump sum payments over a period of time?

There are three common ways parents often transfer assets to their children. The first is outright testamentary gifts to children at the time of a parent’s death. Some parents choose to immediately distribute the entire inheritance to their children at death. That is, of course, the simplest strategy but many times not the safest. If I left my son $200,000, and in the future he files for bankruptcy, for divorce, or is sued for any number of reasons, that inheritance is subject to judgments against him. Typically, parents who approach wealth transfer with a strategic plan transfer ten to twenty percent of the estate to their children as outright gifts at the time of their death.

Distributing wealth to children as a stream of income doesn’t guarantee frugality or financial responsibility, but it does help with one of their greatest fears…

A second type of testamentary wealth transfer is using a lump sum to create a stream of annual income. We’ve all heard about sudden wealth syndrome and how quickly inherited money disappears. Distributing wealth to children as a stream of income doesn’t guarantee frugality or financial responsibility, but it does help with one of their greatest fears—that the wealth they have worked their entire life to accumulate will be quickly depleted. The percentage of children’s total inheritance devoted to an income stream is usually around forty percent for a period of twenty years at five percent annual payout.

The third way people pass on wealth to children and grandchildren is to transfer lump sum payments in stages over a period of time. This usually happens in five-year increments with the lump sum payment increasing each time, the last two payments often going to grandchildren.

After a brief explanation of these three forms of wealth transfer and how the timing of those three kinds of gifts will impact their children, we begin plugging in some percentages. Obviously, these amounts would change based on any number of circumstances but putting down some preliminary numbers is the first step. With these percentages penciled in, we’re on the way to creating a wealth transfer plan.

Now it’s time to address the tax and giving issue.

“There is a portion of your accumulated assets that are by law designated to be used to benefit society,” I say. “We’ll call that ‘social capital.’” That brings us to the final question about the means by which these transfers are made.

Question #3: Would you prefer the social capital that you cannot transfer to your family to go to the Internal Revenue Service, or would you rather give it directly to a charity that you choose?

Rarely will you ever hear people say that they would rather give it to the IRS—but not because they are unpatriotic. They opt to give to charities because they believe the money will be used more efficiently to do good.

This little illustration works best if you keep it simple. You don’t have to dive headlong into the details of the Federal Tax Code. So to put it simply, I explain, “You can create these wealth transfer instruments with the use of trust and annuities, each incurring a substantial tax liability. Or you can choose to divert all or most of the money going to the IRS to charities through the use of charitable trusts and annuities. Would you like to see how that works?”

Again, the answer is almost always “Yes”.

If a person is going to give an income stream to the children, the perfect tool to turn a tax liability into a charitable contribution is a Testamentary Charitable Remainder Trust or TCRT. The TCRT is set up with a testamentary gift, and a charity is named as the eventual beneficiary. A fixed percentage from the TCRT will be made to the children (their income stream). At the end of the term of the trust (maximum of 20 years), the remainder goes to the beneficiary (the charity).

The lump sum payment can also be set up to benefit heirs while directing social capital to charities rather than to the IRS. A great instrument for this current financial environment is a series of Testamentary Charitable Lead Annuities or TCLATs. The Charitable Lead Annuity Trust (TCLAT) works just the opposite of the Charitable Remainder Trust (TCRT). With the Charitable Remainder Trust, the heirs receive interest payments and the charity receives what is left (the remainder) after 20 years. With the Charitable Lead Trust, the designated charity receives the interest payment, and the heirs receive the lump sum (the remainder) after the term of the trust expires. Four-tiered Charitable Lead Trusts can be set up to terminate in five, ten, fifteen, and twenty years, sending the lump sum payment to heirs.

There is a temptation to begin drawing circles and arrows to explain the details of TCRTs and TCLATs, but remember that the goal of this conversation is not to design an estate plan but to start a process. I conclude our meeting by asking if they would like our estate planning professionals to draw up a more detailed plan to help the answer the question: How much should we give to our children?

Eddie Thompson, Ed.D

copyright 2011, Eddie Thompson
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