Here’s a little tax magic to augment your retirement income. This works for people with a highly appreciated asset that they would like to convert to a lifetime income and also down the road benefit a favorite charity: The split interest trust.
We most often see this technique used with appreciated real estate, but it would work with any highly appreciated asset.
Let’s say twenty five years ago you purchased a vacation condo in Aspen that you no longer use. Today you are much happier retiring in the south of France. Your kids don’t want it. They have their own. Meanwhile, a little extra retirement income would be nice. Taxes, insurance, maintenance, condo fees and other expenses gnaw into your pocketbook. Over the last quarter century the condo has gone way up in value, so the capital gains tax would take a hefty bite out of any sale proceeds. Finally, you have always wanted to endow a chair in economics at your alma mater.
A split interest trust might be just the thing to unlock the value of your condo, avoid capital gains tax, plug the expense drain, generate a substantial charitable tax deduction, provide you with a generous tax sheltered lifetime income, and finally endow that chair at the University.
In this split interest trust you make a completed charitable gift to the trust. It’s irrevocable. But, you retain a lifetime interest of income for yourself and your spouse while the charity receives a future benefit of the remaining capital at your death. The trust splits interest between current beneficiaries (you and your spouse) and future beneficiaries (the University).
When the trust subsequently sells the condo, because it’s a charitable trust the sale avoids a capital gains tax. The trust re-invests the proceeds and then makes annual or more frequent income distributions to you. You have a variety of ways you might design the income stream to meet your needs.
Having made a charitable gift, you will reap an income tax deduction based on the calculated value of the future benefit to the University. That future benefit is calculated from an IRS table based on your ages and the amount of your retained lifetime income stream. The older you are and the smaller your retained income the higher your income tax deduction.
If you don’t use all the income tax deduction in the year you make the gift, you can carry the unused balance forward for many future years. So, most or all of the income you receive may be tax sheltered by the carried forward income tax deduction.
In the right situation it’s a WIN-WIN-WIN.
Use your imagination to edit the fact pattern in our example. It doesn’t have to be real estate. It could be your Picasso, antique car, stamp collection or any other highly appreciated asset.
It is CRITICAL that you design the trust and donate the property BEFORE you enter into any agreement to sell the condo. You cannot transfer a sales contract to the trust. And, of course, the ultimate charity must be an IRS qualified charity.
Your financial planner will assist you with design ideas to tailor your gift to meet your exact needs. And most major charities have a planned gifting officer to consult with you. But, it goes without saying that you need a highly qualified attorney to draft the document. As always, don’t try this at home.
Hopefully you will live a long time enjoying sunshine and fine wines in Southern France, the balance of the trust will grow even after your income distributions, and ultimately the University will endow a chair in economics in your name.