The “In-Between” Solution

The “In-Between” Solution

Consider this strategy if you: 

  • Want to incorporate a charitable gift in your estate plan…but aren’t ready to part ways with those dollars just yet
  • Are looking for ways to maximize the money you will ultimately give to charity

In addition to doing good through organizations that provide critical services in our community, people who are charitably focused often consider the tax benefits associated with their gifts.  For gifts made during your lifetime, the tax benefit comes in the form of income tax deductions, which can be a powerful financial planning tool.   You also want to be realistic with giving to protect your current lifestyle. While you want to be charitable, there are many unknowns for the future. For this reason, some of the largest gifts to charity come through bequests made in a will or trust.  This allows you to retain control of your wealth during your lifetime and support your charitable interests in a larger manner at your passing.  However, the act of naming a charity in your estate plan does not create current income tax benefits, as no gifts are being made today.  

The “in-between” solution we address here, a Variable Annuity, is designed to provide current income tax benefits for dollars being left to charity later.  The VA also creates the opportunity to substantially increase the ultimate value of the assets bequeathed to the charitable organization(s)—gifting more dollars to the causes most important to you. 

Benefits of a Variable Annuity investment account: 

  • Defers investment gains from taxation
  • Allows you to maintain full ownership and control of the assets throughout your lifetime
  • Provides flexibility to adjust the beneficiary designation at any time
  • Substantially increase the ultimate value of the assets bequeathed to the charitable organization(s)

Example 

Mary
Net Worth: $10 million
Estate Plan: $8 million to her four children

$2 million (20%) to charity

While Mary fully intends to bestow $2 million to charity, she is not ready to part ways with that money right now. She may end up needing it in retirement, or she may decide a larger portion needs to go to her children.  During Mary’s lifetime, she continues to be responsible for the income and capital gains taxes associated with the growth of her entire estate since none of her wealth has been gifted to charity yet.  

The in-between solution provides a unique benefit: It can eliminate Mary’s current income and taxable gain recognition on the growth of the assets that are being left to charity.

By having those assets in an annuity “wrapper,” she no longer has to pay income or capital gains taxes associated with the growth of that money. 

How it Works

Mary liquidates $2 million of her investment portfolio and moves it in cash to a variable annuity.  Why a variable annuity?  By putting this money in a variable annuity, the assets receive tax-deferral on the growth, dividends, and all re-allocations of cash value in the future.  Mary will not pay income taxes or capital gains taxes on the $2 million while it is inside the annuity structure.  

The variable annuity contract fee will be around 60 basis points (0.60%) annually.   So, a 6% net return after investment management fees would result in a 5.40% return after annuity expenses.  

If left in a taxable account, that same 6% return would be subject to a 20% effective tax rate. Therefore, the net would only be 4.80% after taxes.

Account TypeTaxes/FeesNet Growth*Value of $2M in 20 Years
Variable Annuity0.60% contract fee5.40%$5.7 million
Taxable Account20% effective tax rate = 1.2%4.80%$5.1 million

*Assumes 6% annual return

The net tax savings provided by the annuity structure can mean more money to charity and less taxes.  That difference in net growth adds up to $600,000 over 20 years, creating an even larger gift for the organization(s) that matter to you.

As tax rates go up, this structure becomes even more compelling.   

Considerations

  • Variable annuities must be funded with cash. Liquidating current investments to fund the annuity could result in current gain recognition and therefore a tax.  
  • Liquidating funds from the variable annuity during life would trigger gain recognition at ordinary income rates; possibly converting long-term capital gain assets to ordinary income.

Summary

This in-between solution is not meant to take the place of current gifts to charity; those are not only important to your charitable organizations, but also provide the best income tax benefits.  This solution is an alternative to simply naming a charity in your estate planning documents, which could provide some current income tax benefits.  Please contact me if you would like to learn more.  

Scott Blackburn
Principal, Benson Blackburn LLC
[email protected]
239-348-1800

 

Disclosures: 

This article is for informational purposes only and is not intended to replace the advice of a qualified professional. Nothing contained herein should be considered as investment advice or a recommendation. 

All Examples are hypothetical and for illustrative purposes only. Actual results will vary. No part of this presentation is intended to make an offer of sale or purchase of any specific security or insurance product.

Variable annuities are long-term investments designed for retirement. The value of the investment options will fluctuate and, when redeemed, may be worth more or less than the original cost. Withdrawals and other distributions of taxable amounts, including death benefit payments, will be subject to ordinary income tax. If withdrawals and other distributions are taken prior to age 59 1/2 a 10% federal penalty may apply. A withdrawal charge may also apply. Withdrawals will reduce the value of the death benefit and any optional benefits. 

Investors should consider the investment objectives, risks, charges, and expenses of any variable life insurance product carefully before investing. This and other important information about the investment company is contained in each product’s prospectus. Please read it carefully before you invest. 

Securities offered through M Holdings Securities, Inc., a registered Broker/Dealer, member FINRA/SIPC. Benson Blackburn is independently owned and operated. 

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