by Robert F. Sharpe, Jr.
There has been much speculation about how and when Baby Boomers will embrace philanthropy and whether by their sheer number they can fill the gap that will be left by the extraordinarily generous Greatest Generation. All Boomers have now reached their middle years with the youngest already 40 and the oldest turning 60 this year.
Many Boomers are making more money than ever before, but they are also facing financial pressures that may delay their full participation in philanthropy. Since many of this generation waited longer to marry, start families, and establish careers, their disposable income will be limited until a later point in life. Others, however, have led more traditional lives and are enjoying more wealth than their parents did at the same point in life. These Boomers may form the core of a new generation of major donors.
Regardless, it is certain that the size of the Boomer generation will change the landscape of planned giving in the future. With 10,000 Boomers turning 50 every day, now is the time for gift planners to plan how to bring Boomers into the fold.
Reflections on retirement
It has been over 30 years since the original ERISA retirement plan laws were passed and almost a quarter of a century since IRAs were expanded to include most workers. The Boomers will be the first generation to spend their entire working years under these types of retirement plans, and they may well be the first generation to use them widely for charitable purposes.
The oldest of the Boomer generation, born in 1946, are just now reaching the age of 591⁄2, a critical age under various retirement plans. This is the minimum age at which funds may be withdrawn without a 10% penalty, paid in addition to the income tax that would normally be due.
For these and other reasons, the charitable sector is again aggressively lobbying for the passage of the CARE Act or other legislation that would simplify and encourage gifts from individual retirement accounts (IRAs). The most recently introduced bills and the provisions in the Bush budget provide for outright gifts from IRAs only for those over 701⁄2. Consider, however, that charitable gifts from these assets can also make sense today for those over the age of 591⁄2, even while we await passage of the CARE Act.
In most cases, outright charitable gifts may be arranged from these plans today in a fashion that would, in effect, result in much the same tax treatment as under the proposed law. The various proposals basically make qualified charitable transfers non-taxable events, which in effect would guarantee a “wash” for tax purposes. A so-called “wash” occurs when there is a tax deduction that fully offsets an otherwise applicable tax liability. For example, suppose someone withdraws $10,000 from her IRA and gives that money to charity. Under current law, she has $10,000 of taxable income but is also entitled to a $10,000 charitable income tax deduction, resulting in no tax liability—hence a “wash.”
To give effectively from IRA funds under current law, donors must be over 591⁄2 (the leading edge of Boomers) to avoid the 10% penalty, and gifts must be structured in such a way that they create a deduction that fully offsets tax liability. This means that gifts must be within the 50% of adjusted gross income (AGI) limitation and that the partial reduction of itemized deductions for some high-income taxpayers must be considered.
Some practical examples
For example, imagine a recently retired couple, both over the age of 591⁄2, with $100,000 in adjusted gross income. They would like to make an outright gift of $25,000 and have an IRA worth over $1 million. Under today’s law, they can withdraw $25,000 from their IRA and use those funds to make the gift, which is fully deductible up to 50% of their AGI. Note that the IRA withdrawal serves to increase their AGI to $125,000, and the donation amount falls well within the 50% of AGI limit.
Where higher income donors are concerned, planners may also have to consider the limit on itemized deductions. Persons with taxable incomes above a certain amount ($142,700 for joint filers in 2004) will find that their itemized deductions are reduced by 3% of the amount that their income exceeds the threshold level. For instance, if a donor’s income were $100,000 over the threshold, his or her itemized deductions would be reduced by 3% of that amount, or $3,000. Practically speaking, this limitation rarely affects charitable gifts. The $25,000 gift described above would be unaffected in any event as the couple’s $125,000 AGI is below the threshold at which the 3% reduction would begin to apply.
Even donors with incomes far in excess of the threshold can usually still benefit from charitable gifts from retirement account assets. Take the case of a donor with $1 million in income over the threshold. He would find that itemized deductions for taxes, mortgage interest, and other expenses would be reduced by 3% of that amount, or $30,000, whether or not he made charitable gifts. If a taxpayer in this situation decided to make a gift from IRA assets, the gift would still result in a virtual wash for tax purposes. In this situation, a $100,000 IRA withdrawal followed by a charitable gift in the same amount would increase adjusted gross income by $100,000, which would entail a reduction of the taxpayer’s itemized deductions by $3,000. The result is a 97% wash for tax purposes, with just $3,000 of the withdrawal amount subject to tax. In a 35% tax bracket, some $1,050 in tax would be due on the $100,000 withdrawal, but 97% of the withdrawal would be tax free due to the charitable deduction. Keep in mind also that many wealthy donors will have other itemized deductions, such as taxes and mortgage interest, that are, for all practical purposes, “fixed” and would arguably absorb the statutory reduction amount whether or not a charitable gift were made.
Address concerns with careful planning
If the donor is concerned about the size of the gift, or bumping into the 50% AGI limitation, a little gift planning may be the answer. This concern might be addressed by breaking the gift into installments. For example, assume a retired couple with a $100,000 AGI would like to make a $200,000 gift from an IRA with a balance of over $2 million. If they withdrew $200,000 to make the gift, they would not be able to fully deduct it. Their new AGI would be increased to $300,000, but their deduction would be limited to $150,000. However, if they split the withdrawal and subsequent gift into two equal installments over two tax years, the gift would be fully deductible. This could be as simple as making one gift in December of 2005 and the other gift in January of 2006. In a capital campaign setting, the withdrawals and subsequent gifts might be spread over a three to five year period. This could provide a relatively painless way for larger numbers of Boomers who are older than 591⁄2 to arrange five- and six-figure campaign gifts.
Under current law, the deduction for a gift to a split interest plan such as a gift annuity or charitable remainder trust will not serve to fully offset the tax due on a withdrawal from an IRA. For Boomers wishing to arrange a gift to provide an income for life or a term of years, other strategies may be used. We should keep in mind that even if new legislation allows a tax-free rollover to split interest gifts, all of the income from a gift annuity or charitable remainder trust will be treated as ordinary income that will be taxed at rates as high as 35%. Boomers might be better served to use their IRA funds to make outright gifts or leave funds in their IRAs and let them continue to compound tax free until their first mandatory withdrawal at 701⁄2.
In the meantime, if a Boomer wishes to fund a split interest gift, it may be better to use other assets that allow them to take a current income tax deduction and enjoy the benefits of partial exclusion of payments from income tax and/or the benefits of using the tier structure of income reporting to take advantage of capital gains and dividend treatment of income at rates as low as 15%. When donors fund a life income gift with cash, stock, or other appropriate assets, they may choose to use that charitable deduction to shelter withdrawals from their retirement plans.
The bottom line
The best prospects for the gifts mentioned above under today’s law are persons over 591⁄2 with significant retirement plan balances who would like to make larger charitable gifts. But don’t forget to promote beneficiary designations as a bequest substitute that will keep these assets from ever being subject to an income or estate tax.
We all hope the CARE Act will become law, but we have now been hoping for five years or more. With trillions of dollars at stake, it may not be necessary in all cases to wait for pending or proposed legislation to make gifts of retirement plan assets more attractive. Instead, look to the affluent portion of your constituency over 591⁄2. Significant tax planning opportunities already exist under current law, and charities that fail to begin promoting appropriate gifts of these assets may be missing an important “pocket” from which older Boomers can make meaningful gifts today.