Is Philanthropy the Missing Link in Your Estate Plan?

Families who aspire to generational wealth are currently facing a “use it or lose it” opportunity to make lifetime gifts this year or next. That’s because the lifetime exclusion amount—which currently stands at $13.61 million per person, with an expected inflation-adjustment in 2025—is set to be reduced by half effective January 1, 2026. As a result, many families are scrambling to plan ahead and protect their assets before the clock runs out.

It’s not an easy task. Sizing a gift requires careful calibration and sophisticated forecasting. Give away too much and you could impair your retirement lifestyle. Plus, you can’t control the capital markets. Should you be conservative and assume the worst in terms of market downturns, persistent inflation, or other headwinds? What if markets behave in a more “typical” fashion, resulting in lingering estate tax exposure at the end of your life?

Families who are charitably inclined may be able to close this gap by including testamentary charitable strategies into their estate plan.

A Charitable Couple

Consider George and Rita, a 65-year-old couple with adult children. They have amassed a liquid portfolio of $30 million, including $5 million in tax-deferred retirement accounts, and a home valued at $4 million. They spend roughly $390,000 each year. When it comes to their legacy, their main objective is to pass on their wealth to their children. But they also have a desire to give to charity and want to explore how they can incorporate both goals into their estate plan.

Using advanced modeling techniques, the couple’s financial advisor forecasts that over a 30-year period, the growth of their liquid portfolio and the value of their home will lead to an estimated federal estate tax obligation of almost $25 million—assuming no additional planning is done (Display).

To reduce their tax exposure, George decides to use his current lifetime applicable exclusion to make a gift of $13.61 million to a grantor spousal lifetime access trust (SLAT) for the benefit of Rita and their children. By removing this principal amount and any later appreciation from their estate—while still paying the associated income taxes due to the SLAT’s grantor trust status¹—George and Rita manage to significantly reduce their projected estate tax liability to less than $3 million (Display). What’s more, the model projects that George and Rita will still be able to sustain their annual expenses, adjusted for inflation, from their non-SLAT assets (at a 90% confidence level).

While George and Rita are thrilled at the chance to maximize wealth for their family, they haven’t entirely eliminated their estate tax exposure. They’re satisfied with the amount of trust assets that are expected to be passed down to their children. But they’re curious if they can lower their tax liability even more by implementing strategies that align with their charitable goals.

Worth the Effort?

George and Rita met many years ago at a local university and have supported their alma mater ever since with generous donations. Their team of professional advisors informs them of two possible ways to include the university in their estate plan. The first is a testamentary charitable lead annuity trust (CLAT). Under this structure, they would transfer a portion of their liquid estate into a CLAT at death, free of estate tax. The trust would then make annuity payments to the university over a set number of years, with any remainder passing to their children at the end of the trust’s term.

The CLAT appeals to the couple in that it enhances their overall wealth (thanks to reduced estate taxes) while potentially benefiting both family and charity. But it comes with trade-offs: it shifts wealth from their children to charity, compared to an outright inheritance. And any remainder that does pass to their children tends to be after a 10, 15, or 20-year term—meaning their children may not benefit from the strategy until they are well into retirement. 

That’s not all. The charitable annuity payments from the CLAT are designed to transfer not only principal, but also interest based on the federal Section 7520 rate, which sits at 5.2% in August 2024. The trust must generate investment returns that exceed this “hurdle rate” to successfully transfer wealth to family. As shown below, the current interest rate environment has a significant impact (Display). If a $1 million 20-year CLAT is established today, it is projected to transfer only $100,000 to non-charitable beneficiaries after 20 years. However, a lower rate of 3.2% could potentially transfer over a half million, while a higher rate may result in zero wealth transfer after a lengthy lock-up period in the trust.

A Charitable Bequest

George and Rita are hesitant to move forward given the uncertainty surrounding prevailing interest rates. Instead, their advisors encourage them to consider writing a charitable bequest into their estate plan, leaving what could become a sizable grant. And since assets left to the university would not be subject to estate tax, this would further reduce any potential liabilities at death.

The couple carefully review their assets to determine the best pool of funds for such a bequest. They notice that in their wealth forecast, their retirement assets are expected to remain over $5 million by the end of their lifetime. Allocating this portfolio to charity would further reduce their projected estate tax liability to less than $1 million. Otherwise, these retirement assets would have a limited lifespan in a tax-deferred state after their passing. That’s because George and Rita’s children, as beneficiaries, would be required to take annual distributions from the inherited IRA assets and completely distribute them by the end of the tenth year following the owner’s death. The resulting income tax liabilities for the children could be substantial. 

A charitable bequest of their IRA assets isn’t the only option to mitigate future income taxes on their IRAs. George and Rita could also consider converting their tax-deferred assets to Roth IRAs while they’re still alive, which would accelerate payment of tax liabilities and ultimately transfer after-tax IRA money to their children. The inherited Roth assets could continue to grow tax-exempt for ten years (with no required distributions) and would then pass to the children free of income tax. Some might find this quite appealing, given the current requirements on inherited IRAs. Plus, the strategy delivers the added benefit of spending down a taxable estate today with an eye toward providing a greater after-tax benefit to children down the road. Ultimately, George and Rita conclude that their children will receive sufficient wealth from the SLAT and consider their IRAs most suitable for a potential charitable bequest.

The Path Forward

After careful consideration, George and Rita elect to write a charitable bequest of IRA assets into their estate plan to supplement the near-term gift to the SLAT. They understand that if markets underperform in the long run, their charitable legacy may be limited. But they like the idea of potentially leaving a generous gift to an organization that has played a meaningful role in their lives. Families facing similar choices should work closely with their tax, legal, and financial advisory team to customize a plan that fulfills their own legacy goals.