Notes - The Power of Leveraging the Charitable Remainder Trust

November 21, 2024

Chapter 1: The Weapons of Mass Destruction in the War on Wealth

The Purpose of Chapter 1

This chapter introduces the concept of "accidental philanthropy," which the author defines as the unintended transfer of wealth to the government through taxation. The author aims to show how the current tax system can result in multiple taxes on the same dollar, leading to a significant loss of wealth that could otherwise be used for personal financial goals or charitable giving.

The Four Taxes

The chapter focuses on four major taxes that contribute to accidental philanthropy:

The Impact of Taxes on Retirement Plans

The chapter highlights how the tax system impacts retirement planning, specifically focusing on "qualified retirement plans" like IRAs and 401(k)s. While these plans offer tax-deferred growth, the eventual withdrawals during retirement are taxed as income. This system, according to the author, often leads to higher taxes in retirement, contradicting the intended benefits of these plans.

Example: Mr. Schmooley's Tax Burden

The author uses a hypothetical example of "Mr. Schmooley," who represents a successful business owner, to illustrate the cumulative impact of these four taxes. Different scenarios are presented, showcasing how Mr. Schmooley's wealth is affected by various tax liabilities depending on the value of his business, investments, and retirement accounts.

Chapter 2: Accidental Philanthropy—Adding Insult to Injury

Defining Accidental Philanthropy

This chapter aims to explore the concept of accidental philanthropy by first examining the definition of a true philanthropist. A philanthropist is described as someone who willingly donates money, property, or services to those in need or for the betterment of society as a whole. They are lauded for their generous contributions.

In contrast, accidental philanthropy occurs when individuals are forced to give up their wealth through taxation, even if they don't agree with how those funds are ultimately used. This involuntary redistribution of wealth is portrayed as an insult added to the injury of taxation.

Where Do Your Taxes Go?

This section of the chapter examines where tax dollars are allocated after they are collected by the government. The author uses the federal budget allocation as an example, noting that 42 cents of every tax dollar is allocated for military use, encompassing national defense, the Coast Guard, veterans’ benefits, and military-related interest payments on the national debt. In 2008, this amounted to over $874 billion out of a $2 trillion budget.

The chapter goes on to criticize government spending, particularly focusing on what the author refers to as "pork projects". These are described as projects that are often wasteful and unnecessary, added to the budget to benefit specific politicians or interest groups.

As an example, the author presents Table 2.1, which lists a few pork projects from the 2008 budget. The table highlights the amount of money spent on each project, the nature of the project, and the project's sponsor. These examples aim to illustrate how tax dollars are often spent on projects that taxpayers may not support or even be aware of, furthering the concept of accidental philanthropy.

Chapter 3: How to Fight Back Against the War on Wealth

Fighting Back

This chapter introduces a strategy to fight back against the “war on wealth” – a term the author uses to refer to taxes. The author emphasizes that the strategy is simple and effective.

Review of the War on Wealth

The chapter begins by reviewing the key points of the “war on wealth”:

Avoiding Accidental Philanthropy

The chapter argues that the best way to avoid the redistribution of wealth is to avoid taxation. It suggests that the best way to avoid “accidental philanthropy,” or paying taxes to fund programs one does not support, is to become an active philanthropist using the strategies detailed in the book. The chapter introduces “charitable leverage” as the solution and promises to explain the mechanics in detail.

Simplicity and Effectiveness

The author emphasizes that the strategy is both simple to understand and effective in protecting assets and potentially saving “America’s soul.”

Chapter 4: Unleashing the Power of Charitable Leverage

How Do You Define Charitable Leverage?

This chapter introduces the concept of charitable leverage as a method to fight against wealth redistribution through taxes. The author clarifies that "leverage" in this context is not the financial kind involving borrowing or risky investments, but rather refers to physical leverage - the ability to accomplish things that would require superhuman strength by using tools. Examples include using a screwdriver, wrench, or hammer.

Charitable leverage, therefore, uses a financial tool to exert maximum power with minimal effort for a desired financial outcome. In this strategy:

Both CRTs and CVLIs are long-standing financial tools, but combining them in a specific formula produces unique benefits, such as:

That’s It?

The strategy, as described by the author, is simple: Charitable Remainder Trust (CRT) + Cash Value Life Insurance (CVLI). However, the uniqueness lies in the novel way these two tools are used, requiring a "major paradigm shift".

The author's approach is explained in four steps:

  1. Explaining the features and benefits of all CRTs and CVLIs.
  2. Discussing the specific types of CRTs and CVLI policies used in the author's program.
  3. Illustrating the traditional way CRTs and CVLIs have been used (the existing paradigm).
  4. Introducing the new paradigm using the author's formula.

Chapter 5: The First Component to Charitable Leverage—The Charitable Remainder Trust

This chapter introduces the Charitable Remainder Trust (CRT) as a tool for wealth preservation and legacy creation. The author emphasizes that the CRT, sanctioned by the IRS in 1969, provides numerous tax benefits for individuals willing to support nonprofits.

The Ground Rules

Before going into specifics about the CRT, the author establishes some ground rules for the reader:

The Lever: The Charitable Remainder Trust

A CRT is described as a “lockbox” that holds assets like securities or real estate, transferred by a donor. Eventually, these assets are passed on to a qualified charity at a future date. The donor, or someone they designate, receives an income stream from the CRT for a defined period, like their lifetime.

The Shared Features of All CRTs

The two main types of CRTs are Charitable Remainder Annuity Trusts (CRATs) and Charitable Remainder Unitrusts (CRUTs). They differ primarily in how they pay income to the recipient: CRATs pay a fixed amount annually, while CRUTs pay a fixed percentage of the trust's value, fluctuating with market performance. However, both CRATs and CRUTs share six key features:

  1. Clear IRS Guidance and Support: Emphasizes the legitimacy of the CRT as a financial planning tool fully supported by IRS regulations.
  2. Shelter from Capital Gains Tax: CRTs allow the avoidance of capital gains tax when appreciated assets are sold within the trust. This prevents the loss of assets to taxes, enabling the full value of appreciated assets to be used for income generation and charitable giving. For example, if an asset appreciates by $50,000 and the capital gains tax is 20%, the CRT saves the donor $10,000 in taxes.
  3. Current Income Tax Deduction: The donor receives an immediate income tax deduction for the present value of their future gift to the charity. The deduction is typically 25-35% of the contribution.
  4. Increased Cash Flow with Favorable Tax Treatment: CRTs distribute income to the donor (or a designated beneficiary) throughout its term. The income can exceed the actual earnings of the trust. The distributed income is taxed under a favorable “four-tier” system, maximizing the after-tax income received.
  5. A Meaningful Charitable Legacy Instead of Meaningless Taxes: By utilizing a CRT, donors direct their assets toward their chosen charities rather than losing a portion to taxes. This fosters a sense of purpose and control over their giving.
  6. Asset Protection: CRTs provide a level of asset protection from creditors as the assets are held within the trust.

The CRT from Start to Finish

The process of how a CRT works from beginning to end:

  1. Transfer of Assets: The donor (you) transfers assets into the CRT, which becomes a "split interest trust" with both non-charitable (income recipients) and charitable beneficiaries. The CRT's duration can be tied to one life, two lives, or a set term (up to 20 years). Businesses must use a term of years trust.
  2. Tax Benefits: A current income tax deduction is generated for the present value of the future gift to charity. The assets can be sold within the CRT without incurring capital gains tax.
  3. Investment and Growth: The trust's assets are invested, and earnings accumulate tax-deferred.
  4. Distribution of Income: During the trust's term, the income beneficiary receives a fixed annuity payment (CRAT) or a percentage of the trust's annually revalued assets (CRUT). Income is taxed under favorable "four-tier" rules.
  5. Distribution of Charitable Remainder: Upon the trust's termination (either by death or end of term), the remaining balance (the charitable remainder) is distributed to the designated charities or to a legacy gift, such as a private foundation.

The author stresses that CRTs, while offering numerous benefits, have specific regulations to prevent abuse, and professional guidance is crucial for proper implementation.

Chapter 6: The Second Component to Charitable Leverage—The Cash Value Life Insurance Policy

Removing the Mystique: A Cash Value Policy Explained

The Four Steps to a Cash Value Policy

Benefits of a Cash Value Insurance Policy

Types of Cash Value Policies

Chapter 7: Blowing Up the Paradigms

This chapter of "The Power of Leveraging the Charitable Remainder Trust" focuses on challenging the traditional uses of charitable remainder trusts and life insurance to introduce the concept of charitable leverage.

Exploding Paradigm #1: The Charitable Remainder Trust Is a Planned Giving Tool That Results in a Gift to Charity

Author Daniel Nigito starts by emphasizing that both charitable remainder annuity trusts (CRATs) and charitable remainder unitrusts (CRUTs) offer similar benefits, such as tax authority, capital gains bypass, income generation, favorable accounting, income tax deduction, charitable legacy, and asset protection. He then explains that a term of years CRAT is more suitable for charitable leverage planning due to its simplicity and predictability. While lifetime CRUTs involve many variables for calculating tax deductions, a term of years CRAT provides consistent tax deductions regardless of age.

The traditional paradigm considers a charitable remainder trust as a tool for planned giving with an ultimate gift to charity. This usually involves using a lifetime CRUT, where the donor receives income for life, and the remaining balance goes to charity upon the donor's death.

The new paradigm proposed by Nigito involves using a 10-year term CRAT. This allows for a substantial charitable gift after 10 years, which is much sooner than in a lifetime trust. The income generated from the CRAT is then used to fund a cash value insurance policy, providing financial benefits to the donor and their family.

The Exploding Paradigm #2: A Life Insurance Policy Is Used to Provide a Permanent Death Benefit

This section challenges the common perception that cash value life insurance is primarily for providing a large death benefit. It reiterates that all cash value life insurance policies share features such as tax authority, tax-free death benefit, tax-sheltered cash accumulations, tax-sheltered cash flow, early access to cash, and flexibility in premium payments and death benefit adjustments.

The traditional paradigm emphasizes the death benefit of a life insurance policy, leading policyholders to prioritize maximum coverage for the lowest premium without focusing on cash value accumulation.

Nigito's new paradigm prioritizes the living benefits of a cash value insurance policy, particularly wealth accumulation. This involves selecting a policy with the lowest possible death benefit and maximizing cash value contributions. The death benefit serves as a secondary feature, providing for loved ones if the insured dies before realizing the accumulated cash value.

Exploding Paradigm #3: The Marriage between the Charitable Remainder Trust and Life Insurance

This section combines the new paradigms for both charitable remainder trusts and life insurance.

The traditional paradigm couples a lifetime CRUT with a life insurance policy focused on a large death benefit. The insurance policy's purpose is to replace the assets the donor placed in the CRUT, ensuring their heirs receive an inheritance.

Charitable leverage planning flips this model. The income from a 10-year term CRAT funds a cash value insurance policy designed for wealth accumulation. This allows for tax-sheltered growth of the cash value and potential tax-free income for the donor later on. The death benefit provides financial security for the heirs if the insured dies before accessing the accumulated cash value.

Chapter 8: Your Battle Plan for Fighting Back Against the War on Wealth

Introduction

This chapter focuses on outlining a four-step plan using charitable leverage as a strategy to combat what the author refers to as the “war on wealth,” specifically targeting the issue of accidental philanthropy. The chapter emphasizes that this strategy is simple and straightforward.

Step 1: The Conversion from Accidental Philanthropist to Active Philanthropist

This step focuses on setting up a Charitable Remainder Annuity Trust (CRAT) as the foundational element of the charitable leverage strategy. The author emphasizes the importance of funding the CRAT with cash or publicly traded securities for simplicity and ease of valuation.

Funding the CRAT

The author recommends funding the CRAT with assets that have a low cost basis. This means using assets that were purchased at a significantly lower price than their current value. This strategy maximizes the tax deduction benefits and mitigates potential capital gains tax liabilities.

Role of the Trustee

The chapter emphasizes the importance of the trustee in managing the CRAT. It highlights that individuals can act as trustees of their own CRATs, but cautions against “self-dealing” which involves using the trust to benefit family members. The author advises seeking professional guidance from attorneys or financial advisors specializing in CRTs to navigate the complexities and ensure compliance.

The Power of Tax Deduction

The chapter provides a table showcasing approximate tax deduction schedules for a 10-year term CRAT at various Applicable Federal Rates (AFRs). It illustrates the substantial tax savings individuals can achieve through this strategy. For example, with a 40% income tax bracket, a $310,000 tax deduction results in a tax savings of $124,000. This step signifies the initial action that sets the entire charitable leverage plan in motion.

Step 2: Active Philanthropy Opens the Door to Charitable Leverage

This step emphasizes the benefits of active philanthropy, contrasting it with accidental philanthropy. It underscores that actively directing charitable contributions through a CRAT allows individuals to have control over their charitable giving and avoid the unintended consequences of taxes being allocated to causes they may not support.

Benefits of the CRAT Structure:

The chapter highlights three key benefits of using a CRAT structure:

Step 3: Charitable Leverage Creates a Philanthropic Legacy Step 4: Charitable Leverage Creates a Financial Legacy for You and Your Family

These steps explore the dual benefits of charitable leverage: creating both a philanthropic legacy and a financial legacy for the donor and their family. The author emphasizes that both legacies can operate on “autopilot” once the initial steps are implemented, providing a lasting impact even in the event of disability or death.

Options for Directing the Charitable Remainder:

The chapter outlines two main options for directing the remaining assets in the CRAT upon its termination:

Building Financial Legacy

The chapter outlines the process of building a financial legacy through the use of a Cash Value Life Insurance Policy (CVLI). It describes seven key actions involved in utilizing a CVLI policy funded by the CRAT’s cash flow. These actions cover aspects such as choosing the right policy type, minimizing death benefit, maximizing cash value accumulation, and accessing funds during retirement.

Retirement Projections and Impact

The chapter offers retirement projections for a hypothetical male individual aged 45, demonstrating the potential financial benefits of funding a CVLI policy through a CRAT. It highlights the tax-free nature of both the cash accumulation and the income stream during retirement, emphasizing the advantages over traditional retirement plans.

Chapter 9: Why It Works

Efficiency and Effectiveness

This chapter explains why the charitable leverage strategy works. The key reasons are its efficiency and effectiveness in achieving the goal of avoiding accidental philanthropy. The author breaks this explanation down into two sections: Efficient and Effective.

Efficient

The author uses the dictionary definition of “efficient” to illustrate the efficiency of charitable leverage. The definition includes terms like:

The author connects the charitable leverage strategy with these definitions, stating that it is simple, systematic, and predictable. The simplicity and predictability of the strategy contribute to its efficiency.

The Charitable Leverage Chassis

The chapter introduces a visual representation of the charitable leverage strategy, which the author refers to as “the chassis”. The chassis includes six components:

  1. Charitable Remainder Trust (CRAT): A 10-year CRAT is recommended, with a payout rate of 8%, 9%, or 10%. The CRAT generates a tax deduction and predictable cash flow.
  2. Donor/Grantor: The individual or entity funding the CRAT.
  3. Cash Value Life Insurance (CVLI): This policy is funded by the CRAT’s cash flow.
  4. Charitable Beneficiary: This beneficiary receives the remaining balance of the CRAT at the end of the 10-year term.
  5. Income Beneficiary: This beneficiary receives the tax-free income from the CVLI policy.
  6. Insurance Beneficiary: This beneficiary receives the tax-free death benefit of the CVLI policy.

This chassis highlights the physical elements of the strategy (the CRAT and CVLI policy). However, the human elements are also crucial, as they determine how the strategy is applied.

The Players

The chapter refers to the individuals or entities involved as “the players”. The players are the individuals or entities that benefit from the physical elements of the strategy:

The author provides explanations of the various roles of these players.

Effective

The effectiveness of charitable leverage is based on its ability to be applied to a variety of situations by simply changing the “players”. The chapter outlines three major categories where charitable leverage can be applied:

  1. Personal Supplemental Retirement Plan or Deferred Income Plan
  2. A Grandparents Legacy Plan
  3. An Employer Sponsored Key Executive Benefit Plan

There is a fourth scenario, called the IRA Rescue Plan, which is discussed in Part III.

Chapter 10: How to Use Charitable Leverage to Build a Personal Supplemental Retirement Plan

The Targeted Classes

This chapter marks the beginning of Part III of the book, where the author applies the principles of charitable leverage to practical scenarios. It begins by highlighting the five groups of individuals who are prime targets for wealth redistribution through taxation, what he refers to as “the targeted classes.” These groups include:

Applicability of Charitable Leverage

The chapter emphasizes that charitable leverage strategies, as described in previous chapters, can effectively counter accidental philanthropy, particularly for individuals in these target groups. The author outlines three main areas where charitable leverage can be applied:

  1. Personal deferred income needs: This strategy helps individuals build a future income stream to supplement their retirement plans while minimizing tax liabilities.
  2. Multigenerational wealth creation: This strategy, referred to as the "Grandparents’ Legacy Plan," focuses on enabling grandparents to create and protect wealth for their children and grandchildren while minimizing tax burdens across generations.
  3. Meaningful benefit plans for key employees: This strategy helps business owners create tax-efficient benefit plans to attract and retain key employees, ultimately strengthening their businesses and minimizing their tax burden.

Assumptions and Disclaimers

The chapter then sets the stage for the subsequent "war stories," which are case studies illustrating the application of charitable leverage in specific situations. The author establishes the following assumptions to ensure consistency and clarity in these examples:

Tax Rates

Growth and Investment Returns

The author emphasizes that these assumptions are for illustrative purposes only and do not constitute guarantees of future returns. Additionally, he provides disclaimers stating that the material is for educational purposes only and that professional advice should be sought for specific financial planning needs.

Chapter 11: Charitably Leveraged Supplemental Retirement Plan for the Bold and Beautiful

The "Bold and Beautiful"

This chapter focuses on how charitable leverage can be used to build a supplemental retirement plan for individuals in their early thirties to mid-forties who have at least 20 years until retirement. The author calls these individuals "the bold and beautiful" and notes that this demographic typically includes young entrepreneurs, professionals, and physicians. These individuals have high earnings, making them targets for wealth redistribution through taxation, but they might not be as philanthropically inclined as other target groups.

Dr. Schmooley's War Story

To illustrate the power of charitable leverage in this context, the author presents the story of Dr. Schmooley, a successful surgeon who is 45 years old and has a strong desire to support his local hospital. The chapter walks through the steps of Dr. Schmooley's charitably leveraged supplemental retirement plan using specific numbers:

  1. Funding the CRAT: Dr. Schmooley transfers $1,000,000 to a 10-year Charitable Remainder Annuity Trust (CRAT) with a 9% annuity rate. This transfer generates a $310,000 income tax deduction for Dr. Schmooley.

  2. Funding the CVLI: The annual $90,000 income from the CRAT is used to fund a Cash Value Life Insurance (CVLI) policy on Dr. Schmooley's life. The death benefit of this policy is designed to be minimal, focusing instead on cash value accumulation.

  3. Retirement Income: At age 65, the CRAT term ends, and the remaining balance is distributed to Dr. Schmooley's hospital. Dr. Schmooley then begins taking tax-free income from his CVLI policy.

  4. Legacy at Death: Upon Dr. Schmooley's death, the death benefit from the CVLI is distributed tax-free to his family.

The author projects that by following this plan, Dr. Schmooley would:

Comparing to a Traditional Plan

The chapter then compares Dr. Schmooley's charitable leverage strategy to a traditional retirement plan where he would have invested the $1,000,000 in a tax-deferred account. This comparison highlights the advantages of the charitable leverage approach.

The traditional approach is broken down into three phases:

  1. Initial Investment: Dr. Schmooley deposits $1,000,000 into a tax-deferred retirement account.

  2. Accumulation Phase: The account grows at 6% for 20 years until Dr. Schmooley reaches retirement age.

  3. Income Phase: Dr. Schmooley withdraws income for 20 years, from age 65 to 85.

Using this approach, Dr. Schmooley would have generated $2,500,000 in retirement income. However, he would have paid $1,666,667 in taxes on that income, leaving $833,333 to his family. At his death, the remaining balance of the retirement account ($2,162,233) would be transferred to his family but subject to an additional $464,893 in income taxes.

Key Points of Comparison

The author compares the two approaches across several key factors:

Chapter 12: Charitably Leveraged Supplemental Retirement Plan for the Young and Restless

The Young and Restless

This chapter focuses on how the charitable leverage strategy can be applied to younger individuals with higher earnings, whom the author refers to as “the young and restless.” These individuals may have the financial capacity and desire to access their retirement income earlier than traditional retirement age. The author presents a hypothetical scenario involving a professional athlete, “The Pro,” to illustrate this concept.

The Pro Choice War Story

The Pro, a 25-year-old professional athlete, has a 10-year playing career ahead of him and anticipates earning a significant income of $1,000,000 per year during that time. He intends to fund a charitable leverage plan with $1,000,000 and aims to retire at age 55, accessing his retirement income from then onward. The author outlines The Pro’s plan:

  1. Funding the CRAT: The Pro will establish a 10-year Charitable Remainder Annuity Trust (CRAT) with a 9% annuity payout rate, funded with $1,000,000. This will generate an annual income of $90,000 for 10 years, totaling $900,000. The CRAT will also provide a tax deduction of approximately $310,000 (assuming a 4% Applicable Federal Rate).
  2. Funding the CVLI: The $90,000 annual income from the CRAT will fund a Cash Value Life Insurance (CVLI) policy. The author emphasizes that this CVLI policy is designed to maximize cash value accumulation while minimizing the death benefit. The death benefit will only come into play if The Pro dies before reaching age 55.
  3. Retirement Income: At age 35, the CRAT will terminate, and the remaining balance will be distributed to the designated charity. From age 35 to 55, The Pro will have no income from the plan. At age 55, The Pro will begin withdrawing tax-free income from the CVLI policy.

The cumulative impact of this strategy, based on the assumptions outlined in Chapter 10, results in The Pro receiving $4,443,208 in tax-free retirement income and his beneficiaries receiving a tax-free death benefit of $6,099,884 (assuming he dies at age 80). Additionally, the designated charity receives $1,835,112.

But, Is This the Best Approach?

The author acknowledges that in this particular scenario, the results of a traditional retirement plan may be comparable to the charitable leverage approach. The choice between the two hinges on The Pro's charitable intent.

Traditional Plan vs. Charitable Leverage Plan

The chapter compares The Pro’s charitable leverage plan to a traditional retirement plan, assuming a 6% annual growth rate for both:

  1. Investment Phase (Age 25-35): In the traditional plan, the $1,000,000 would grow tax-deferred for 10 years, reaching $1,790,848 by age 35. In the charitable leverage plan, the $1,000,000 is used to fund the CRAT, which generates income to fund the CVLI policy. By age 35, the CVLI will have accumulated a cash value of $1,126,708.
  2. Accumulation Phase (Age 35-55): In the traditional plan, the $1,790,848 continues to grow tax-deferred, reaching $5,604,411 by age 55. In the charitable leverage plan, the CVLI continues to grow, reaching a value of $3,316,506 by age 55.
  3. Income Phase (Age 55-80): In the traditional plan, The Pro would begin withdrawing income from his retirement account. In the charitable leverage plan, The Pro would begin withdrawing tax-free income from the CVLI policy.

Analyzing the Results

The author compares the total personal wealth (retirement income plus death benefit) generated by both approaches:

The results are very similar, but the author highlights the key differences:

The Choice to Confound Congress Through Compound Interest

The author argues that the charitable leverage strategy empowers individuals to take control of their wealth and direct their charitable giving, rather than relinquishing control to the government through taxes. He emphasizes that this approach allows individuals to make meaningful contributions to the causes they care about.

Chapter 13: Charitably Leveraged Supplemental Retirement Plan for the Old and Cranky

Challenges for the "Old and Cranky"

This chapter focuses on applying charitable leverage to retirement planning for individuals in their fifties, a group the author refers to as the "Old and Cranky". This group faces unique challenges because they have a shorter time horizon until retirement, making it more difficult to generate significant retirement income using the standard 10-year Charitable Remainder Trust (CRAT) strategy. The author acknowledges that any investment strategy with a limited time frame will face limitations in terms of potential growth.

Strategies for Success

To address these challenges, the author outlines several factors crucial to the success of a charitable leverage plan for this age group:

Case Study: Joe the Grocer

The chapter presents a case study involving a 58-year-old individual named Joe, who owns a produce business and wants to retire at age 65. The example illustrates how Joe can utilize a charitable leverage strategy despite the time constraints.

Comparison with Traditional Approach

The chapter provides a comparison table highlighting the differences in outcomes between Joe's charitable leverage approach and a traditional retirement plan. The comparison shows that while the traditional plan might yield a slightly higher inheritance for Joe's children, the charitable leverage plan offers significant advantages, including:

Chapter 14: How to Use Charitable Leverage to Fund the Grandparents’ Legacy

The Grandparent's Perspective

This chapter shifts the focus to grandparents and their desire to leave a meaningful legacy for their grandchildren while minimizing the impact of taxes. The author emphasizes the unique perspective of grandparents, reflecting on their own experiences as parents and the realization that time moves quickly. He highlights the natural desire to leave a lasting impact on future generations.

A Life Well Lived, a Legacy Well Planned

The author shares personal anecdotes from his career as a financial planner, emphasizing the common thread among successful individuals: a deep love for their grandchildren and a desire to leave a positive impact on their lives. He acknowledges the various aspects of a legacy, including memories, keepsakes, and financial resources. However, he suggests that a true legacy goes beyond these tangible elements, encompassing a lasting contribution to society and the well-being of future generations.

Four Steps to the Grandparents' Legacy

The chapter outlines a four-step process for grandparents to create a lasting legacy using charitable leverage.

Step 1: The Grandparents Start the Conversion from Accidental Philanthropy to Active Philanthropy

The first step involves establishing a 10-year Charitable Remainder Annuity Trust (CRAT). The grandparents contribute assets to the CRAT, receiving an immediate income tax deduction. This deduction provides tax savings that can be invested or used for other purposes. The author suggests funding the CRAT with a combination of cash and appreciated securities, as this approach offers both immediate liquidity and the potential to avoid capital gains taxes on the appreciated assets.

Step 2: The Grandparents Control All of the Cash Flow

The CRAT generates a steady stream of income for a predetermined period, in this case, 10 years. The grandparents, as the income beneficiaries of the CRAT, have complete control over how this income is used. The author emphasizes the flexibility of this arrangement, allowing grandparents to use the income for their own needs, supplement their retirement income, or direct it towards other goals.

Step 3: The Grandparents’ Defining Moment—A Charitable Legacy

At the end of the 10-year term, the remaining balance of the CRAT is distributed to the designated charitable beneficiary. This distribution represents the grandparents’ charitable legacy, a tangible expression of their values and their commitment to making a difference in the world. The author encourages grandparents to carefully consider their charitable goals and select beneficiaries that align with their passions and values.

Step 4: The Grandparents Create a Financial Legacy for the Next Two Generations

The income generated by the CRAT during the 10-year term is used to fund a Cash Value Life Insurance (CVLI) policy. This policy is designed to provide a tax-free death benefit to the grandparents’ children, ensuring financial security for the next generation. The author suggests a "second-to-die" CVLI policy, which insures both grandparents and typically offers a higher death benefit for a given premium payment. The grandparents' children, as the beneficiaries of the CVLI policy, can then use the tax-free death benefit to fund their own financial goals, including providing for their own children (the grandchildren).

The Power of Charitable Leverage in Action

The chapter provides a numerical example to illustrate the potential impact of the Grandparents' Legacy strategy. The example assumes a $1,000,000 contribution to the CRAT, a 5% annual return within the CRAT, and a 9% annuity payout rate. The authors assumes a 5% annual growth rate within the CVLI policy.

Based on these assumptions, the strategy is projected to generate the following benefits:

Chapter 15: A Grandparents’ Legacy War Story and Comparison

The Curto Family's Legacy

This chapter presents a case study, or “war story,” illustrating the Grandparent’s Legacy Plan in action using a real-life example of Peter and Gracie Curto, demonstrating how charitable leverage can be used to preserve wealth and create a lasting legacy.

Peter and Gracie Curto are a hard-working couple who own a successful dry-cleaning business and have accumulated an estate of $5,000,000, including $1,000,000 in liquid assets. They have a daughter, Angela, and two grandchildren, Steven and Sophia. Peter wants to leave a meaningful legacy for his family and a favorite charity, St. Jude Children’s Research Hospital, while avoiding estate taxes. The steps Peter takes to achieve his goals are detailed below:

  1. Action: Peter funds a 10-year Charitable Remainder Annuity Trust (CRAT) with $1,000,000 and names his daughter, Angela, as the income beneficiary. The CRAT uses an 8% annuity rate and designates the remainder to be distributed to the Curto Family Donor Advised Fund (DAF) at the local Community Foundation.

    • Impact: This generates a $351,000 income tax deduction for Peter. The annual annuity payment to Angela is $80,000, with an estimated after-tax payment of $64,000 (assuming a 20% tax rate on the annuity income).

  2. Action: Peter uses the $64,000 after-tax annuity payment to purchase a wealth-accumulation style cash value life insurance policy on Angela's life, with a $2,000,000 death benefit (plus the cash value account).

    • Impact: Peter maintains control over the policy's cash value as the owner, while Angela is the insured.

  3. Action: Over the 10-year CRAT term, the insurance policy's cash value grows to $1,458,000, and the death benefit increases to $3,458,000. The CRAT distributes its remaining balance of $1,792,000 to the Curto Family DAF.

    • Impact: At the end of the 10-year term, Peter's initial $1,000,000 investment has generated $1,458,000 in life insurance cash value and $1,792,000 for the Curto Family DAF, totaling $3,250,000.

  4. Action: Peter transfers ownership of the life insurance policy to Angela.

    • Impact: Angela now controls the policy's cash value and death benefit.

  5. Action: Angela begins taking tax-free income from the policy at age 55 for 10 years until she reaches age 65, using a systematic withdrawal strategy of $100,000 per year.

    • Impact: Angela receives a total of $1,000,000 in tax-free income during this period.

  6. Action: The Curto Family DAF, with an initial balance of $1,792,000, grows at a projected rate of 6% per year.

    • Impact: The fund grows to $3,584,000 over the 10-year period.

  7. Action: Angela and her children actively participate in grantmaking from the DAF.

    • Impact: The Curto family establishes a tradition of charitable giving and perpetuates their name through ongoing philanthropy.

  8. Action: Upon Gracie's death at age 85, the remaining insurance proceeds are paid to Steven and Sophia, now ages 58 and 56.

    • Impact: They share $1,742,000 tax-free and oversee the Curto Family Fund, now valued at $882,000.

Comparing Charitable Leverage with a Traditional Approach

To highlight the advantages of the charitable leverage approach, the chapter contrasts the Curto family's results with a traditional estate planning approach, where Peter and Gracie leave their $1,000,000 to their daughter outright, subject to estate taxes and income taxes on any earnings.

Traditional Approach:

  1. Action: Peter and Gracie leave $1,000,000 to Angela.

    • Impact: Angela pays $450,000 in estate taxes, leaving her with $550,000.

  2. Action: Angela invests the remaining $550,000 at a 6% annual rate of return.

    • Impact: The investment grows to $1,031,559 over 10 years.

  3. Action: Angela begins withdrawing $100,000 per year at age 55 for 10 years, paying a combined 40% tax rate on the income.

    • Impact: Angela receives $60,000 per year after taxes, totaling $600,000 over 10 years.

  4. Action: At Angela's death, the remaining funds are passed to her children, subject to estate taxes.

    • Impact: The estate pays $208,918 in estate taxes, leaving $202,629 for Steven and Sophia.

Comparison Table:

| Strategy | Estate Taxes | Income to Angela (after tax) | Inheritance for Grandchildren | Total to Charity | Combined Impact (Family and Charity) | | -------------------------- | ------------- | ---------------------------- | ----------------------------- | ----------------- | -------------------------------------- | | Charitable Leverage | $0 | $3,408,000 | $2,623,000 | $2,179,000 | $7,598,374 | | Traditional Approach | $658,918 | $600,000 | $202,629 | $0 | $3,029,477 |

As you can see in the table, the charitable leverage approach provides significantly greater benefits to both the Curto family and their chosen charity.

The Importance of Charitable Intent

The chapter emphasizes the importance of charitable intent in the successful implementation of the Grandparent’s Legacy Plan. The plan is not simply a tax avoidance strategy; it's about aligning financial goals with philanthropic desires. By choosing to direct assets to charity, the Curto family can amplify their impact and leave a meaningful legacy for future generations.

Chapter 16: How Businesses Can Use Charitable Leverage to Attract and Retain Key Employees

The Burden of Taxation on Businesses

This chapter explores how businesses can utilize charitable leverage to offer attractive benefits to key employees while navigating the challenges posed by taxation. The author begins by acknowledging the significant tax burden faced by businesses, particularly in the United States, where corporations are subject to multiple layers of taxation, including federal, state, and local taxes. This heavy taxation, the author argues, can hinder business growth and profitability, ultimately impacting job creation and economic prosperity.

The Need for Key Executive Benefits

The chapter emphasizes the importance of providing benefits to key employees as a means of attracting and retaining top talent. However, the traditional methods of providing these benefits, such as deferred compensation plans and executive bonus plans, often come with tax implications that can be burdensome for both the employer and the employee.

Charitable Leverage as a Solution

The author suggests that charitable leverage offers a potential solution to this dilemma, enabling businesses to provide valuable benefits to key executives while mitigating the impact of taxation and simultaneously supporting charitable causes. The author stresses the importance of genuine charitable intent in utilizing this strategy, cautioning against solely focusing on tax benefits.

Defining the Terminology

The chapter then clarifies the terminology used in describing this type of benefit plan, settling on the term "Charitably Leveraged Employer Sponsored Key Executive Deferred Income Plan." For brevity, this term is subsequently referred to as "The Plan.".

Two Models for The Plan

The chapter outlines two traditional models for key executive benefit plans that can be enhanced through charitable leverage:

  1. Nonqualified Deferred Compensation Plan: This model involves a promise by the employer to pay a deferred income benefit to the executive at a future date, typically upon retirement. The executive does not receive current taxable compensation, as the benefit is not yet realized. However, this model presents risks for the executive, as they become an unsecured creditor of the company and may not receive the promised benefit if the company faces financial difficulties.
  2. Executive Bonus Plan: Also known as a Section 162 plan, this model allows the employer to purchase life insurance on the life of a selected employee, with the premiums paid by the employer. The premium payments are included in the employee's taxable wages, and the employee is the owner of the policy, retaining control over beneficiary designations and cash value access. The employer can deduct the bonus amount, typically equivalent to the premium payment, as compensation expense.

The Players in The Plan

The chapter then breaks down the roles of the various “players” involved in a Charitably Leveraged Employer Sponsored Key Executive Deferred Income Plan, using Figure 16.1 to illustrate the flow of funds and benefits. The key players and their roles are summarized as follows:

Funding The Plan

The chapter explains the funding mechanics of The Plan for both the deferred compensation model and the executive bonus model:

Designing an Executive Bonus Plan with Charitable Leverage

The chapter then focuses on the executive bonus plan model, arguing for its simplicity and advantages. The steps involved in designing such a plan are outlined as follows:

  1. Establish a CRAT: The employer establishes a 10-year CRAT, with the annuity payments designated to fund the key executive's CVLI policy.
  2. Fund the CVLI: The CRAT income is used to fund a CVLI policy, with the key executive as the owner and beneficiary.
  3. Key Executive Benefits: The key executive receives tax-sheltered growth and tax-free income from the CVLI policy.
  4. Employer Benefits: The employer benefits from the income tax deduction associated with the CRAT contribution and the ability to deduct the bonus payments as compensation expense.
  5. Flexibility: The employer has the flexibility to fund multiple key executives from a single CRAT or redirect CRAT income to different policies if a key executive leaves the company.

The Schmooley War Story

The chapter presents a war story featuring Mr. Schmooley and his son, Eddie, to illustrate the application of an executive bonus plan with charitable leverage. The story highlights the following key points:

Cost Recovery and Flexibility

The chapter concludes by emphasizing the potential for businesses to recover their initial CRAT contributions through key man insurance policies, further enhancing the financial benefits of The Plan. The author also highlights the flexibility of the strategy, allowing businesses to fund The Plan at various contribution levels and potentially structure multiple CRATs to benefit different key executives.

Chapter 17: Can Charitable Leverage Save Your IRA?

The Challenge of IRA Transfers

This chapter addresses the challenges of transferring wealth accumulated in Individual Retirement Accounts (IRAs) to heirs while minimizing the impact of taxes. The author acknowledges that this chapter is specifically for individuals who have substantial IRA balances that they do not anticipate fully needing during their retirement and who wish to pass on the remaining funds to their children.

The chapter highlights several key challenges associated with IRA transfers:

The IRA Rescue Strategy

The chapter introduces a strategy called the Charitably Leveraged IRA Rescue Strategy to mitigate these challenges. This strategy uses a modified version of the charitable leverage approach described in previous chapters, combining a Charitable Remainder Annuity Trust (CRAT) with a specific type of Cash Value Life Insurance (CVLI) policy.

Dr. and Mrs. Sherman's Situation

The chapter illustrates this strategy through a case study involving Dr. and Mrs. Sherman, a couple with a $9 million estate, including a $2 million IRA. Both are 60 years old and in good health. Their goal is to transfer their wealth to their three children while minimizing taxes.

Step-by-Step Breakdown of the Strategy

  1. Establish a 10-Year CRAT: The Shermans establish a 10-year CRAT with a 5% annuity distribution rate. This rate maximizes the initial income tax deduction. The CRAT beneficiary is designated as the Sherman Family Donor Advised Fund, which will receive the remaining balance after 10 years.

  2. Fund the CRAT with the IRA: The $2 million IRA is transferred to the CRAT, generating a substantial income tax deduction.

  3. Use CRAT Cash Flow to Purchase Life Insurance: The annual 5% distribution from the CRAT, which amounts to $100,000, is used to purchase a “2nd to Die” CVLI policy on Dr. and Mrs. Sherman. This type of policy provides the highest death benefit for the premium paid.

  4. Maximize Death Benefit, Not Cash Value: Unlike previous charitable leverage strategies, this approach focuses on maximizing the death benefit of the CVLI policy rather than cash value accumulation. This death benefit is intended to replace the value of the IRA that was transferred to the CRAT.

  5. Designate an Irrevocable Life Insurance Trust (ILIT): The beneficiary of the CVLI policy is an ILIT, which will receive the tax-free death benefit and distribute it to the children and grandchildren.

Benefits of the Strategy

The chapter outlines several benefits of this strategy:

Alternatives and Comparisons

The chapter explores alternative approaches to managing the Shermans' IRA, including:

The author analyzes the financial implications of each approach, comparing the tax liabilities, inheritance amounts, and charitable contributions. The chapter concludes by highlighting the potential of charitable leverage to save IRAs from accidental philanthropy and emphasizing the importance of professional advice in implementing such strategies.