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Donations and the Wealth Replacement Trust

With a bit of planning you could link generous tax incentives to charitable donations by establishing a trust that donates a significant gift to the charity of your choice without slighting your heirs. The amount of your donation is replenished by a "irrevocable life insurance trust (or "wealth replacement trust") thatís funded by a steady stream of income that you receive by forming a "charitable remainder trust." By giving to your favorite charity and enjoying the financial advantages of that venture, your children can also receive their full inheritance. With a sound financial plan you could have the best of both worlds.

By forming a "charitable remainder trust" with appreciated assets you are excused from paying the capital gains taxes that you would normally pay when selling certain assets. You would also enjoy many other financially sound advantages including:

You can save the money you would have otherwise paid in capital gains taxes, and protect your heirs from massive estate taxes as you establish a charitable legacy. Almost any type of asset, from real estate to bonds, can be placed in a "charitable remainder trust."

However, setting up the trust is not easy and may not be the best option for everyone. It can involve making many choices that are best answered by a financial planner. This also involves some legal processes that you will need your lawyer for.

Charitable Remainder Trust

A "charitable remainder trust" has two beneficiaries. The first is the income beneficiaries who receive a percentage of income from the trust during the course of their lives. The second beneficiary, or the designated charity, receives the trust assets after the income beneficiary dies. Most people establish themselves as the trustís income beneficiary. Income beneficiaries are exempt capital gains taxes making them ideal for investors whose assets have a low cost basis but a high appreciated value. Keep in mind that the trust is irrevocable, so once you have committed an asset to the trust, there is no turning back.

The trust is flexible in that it allows you to control how your assets will be invested. In some cases the person setting up the trust can act as the trustee and maintain full investment control of the trustís assets. You can change the charity beneficiary during the course of the trust. Itís designed for investors who want to convert their highly appreciated assets into a lifetime income stream without generating estate and capital gains taxes.

For example you could contribute a $1,000,000 property to a charitable trust. When the trust sells the property the capital gains tax of $266,000 is saved inside the charitable trust. The income beneficiary of the trust, in turn, receives more income from the trust because the $266,000 was not lost in capital gains taxes.

Letís say the one-million-dollar asset represents your business. You are about to retire, and your children have already established careers of their own, so you donít have anyone that you would want to hand the business down to. Instead of selling your business to a competitor, you give your business to a "charitable remainder trustí that you establish. This is considered a "charitable donation." The trust then turns around and sells your business to the competitor. Since the trust sold the business, the $266,000 capital gains taxes does not apply, and you can now enjoy the benefits of a $1,000,000 "charitable remainder trust" including income and tax deductions. You can designate yourself as the "charitable remainder trustís" trustee, which will give you the flexibility to make tax free investment decisions.

After the "charitable remainder trust" sells the business used in this example, you can begin to direct various investments that the trust makes with its tax-free cash. This could be in the form of mutual funds, CDs and so on. There is no tax because the "charitable remainder trust" is a qualified charity.

The "charitable remainder trust" would then pay you (as the "income beneficiary") for life. The norm is 5% to 8% of the of the "charitable remainder trust" asset. So, if the payout is 7%, you would receive $70,000 annually. As the value of the trust increases through investment growth your annual income would increase as well.

Also, "charitable remainder trusts" are not subject to annual gift limits. Trustees can deduct the present value of the remainder interest to the trust. Deductions cannot exceed 50 percent of your gross adjusted income, but any deductions not used in the year of contribution can be carried forward for the next five years. The amount of the deduction is a complicated calculation that uses the estimated life expectancy of the beneficiary that statistically should live the longest, the percentage (or dollar amount) of the trustís payout, and the current federal discount rate. The higher the percentage payout is, the lower the deduction.

And finally, "charitable remainder trusts" gives you control over "social capital." Most people have the opportunity to give to our society, through taxes, or through charity. A trust gives you the flexibility to take back those funds that the government would have claimed, and redirect them to a charity that you are involved with, or just know about and want to help. Itís personal satisfaction to know that youíve had the opportunity to give to a charity that means something to you, rather than just paying taxes.

"Charitable remainder trusts" are the answer for many estate planners, but they are not necessarily for everyone:

And, setting up the trust can get complicated. There is a lot of frustrating paperwork, and your would be best served to hire a certified financial planner. But, if done properly in conjunction with a "wealth replacement trust" both your favorite charity and your heirs could benefit in this highly rewarding venture.

Wealth Replacement Trust

As you plan your estate you may find that your favorite charity could help you leave your children and other beneficiaries more. Using a "wealth replacement trustí you can replace the amount of the "charitable remainder trust" asset that is donated to your charity and leave the money to your children and other heirs. The value is in the form of an insurance policy death benefit thatís held inside an irrevocable trust. One of the most attractive features is that the death benefit can be structured so itís paid without being subject to income or estate taxes. The insurance trust becomes a "wealth replacement trust" allowing your beneficiaries to receive the benefits lost due to the charitable trust donation.

You need your attorney to form a "wealth replacement trust," which is also known as an "irrevocable life insurance trust." The trust would be the owner, premium payer and beneficiary of a life insurance policy replacing your childrenís lost inheritance. The savings and income that your "charitable remainder trust" generates can pay the premium for this life insurance policy. So in essence, the life insurance policy "replaces" the amount that the charitable trust donated to your charity and your heirs still enjoy their inheritance.

Itís a win-win plan for a lot of people planning their estates. Once the premium is issued the payment amount typically remains level for life.

How are the Trusts Dispersed?

The assets from your "charitable remainder trust" are donated to the charity that you designate upon your death. You and your children would naturally be concerned about such a sizable sum being given away to charity, but since you formed the "wealth replacement trust" your children will receive the life insurance proceeds Ėtax free. Your children would not have to pay any Federal Estate Tax on the value of the "charitable remainder trust." So, both your charity and your heirs receive their fair entitlements.

Is this right for me?

Only you and your financial planner best can best answer that question. The "charitable remainder trust" has been in use since 1969. As you can see, there are quite a few advantages, but it may not be a viable option for some people for either financial or medical reasons. Another thing to consider is that a "charitable remainder trust" is permanent. One you form it you canít reclaim you asset. Whatever you decide, the combination of the "charitable remainder trust" and "wealth replacement trust" has served many investors and charities well over the years.