ELITE ADVISOR BEST PRACTICES
How to Make Charity Begin at Home
A LEGA-C Plan™ is a powerful combination of a life estate and a CGA. This real-world case study explains how it works.
By Randy Fox
- A life estate is an agreement between a donor and a charity, allowing the donor to gift a personal residence to the charity while continuing to live in the property until death.
- A charitable gift annuity (CGA) is an agreement between a donor and a charity in which the donor transfers property to a charity in exchange for a lifetime income.
- A LEGA-C Plan™ is a powerful combination of a life estate and a CGA. This real-world case study explains how it works.
One of the many reasons that it is so important for advisors to understand philanthropic planning is because it can often be applied to problems that might otherwise seem insurmountable. As baby boomers age and retire in a low-interest-rate economy, it can be challenging to find income, while reducing risk, preserving capital and attempting to maintain the lifestyle to which they’re accustomed. There’s only so much advisors can do, isn’t there?
This article will discuss one more option to consider—the Life Estate Gift Annuity Combination Plan (LEGA-C Plan™). Although it is not appropriate for every circumstance, a LEGA-C Plan™ can be miraculous when properly thought through and applied, because with this strategy, we use two different gift vehicles to generate a remarkable result. First, I will review each gift technique individually. Then, I will present a case study to demonstrate how the combination of the two gifts interplays.
A life estate is an agreement between a donor and a charity that allows a donor to gift his or her personal residence to a charity in exchange for the right to continue to live in the property until death. For the remainder of his or her life, the donor receives a current charitable income tax deduction for the present value of the future gift. While the calculation is complex, it can be handled by a number of available computer programs that take into account items such as the salvage value of the property, depreciation, the age of the donor and the current federal discount rate, i.e., the §7520 rate that is utilized in many charitable computations. For the donor, nothing much changes: He or she can continue to pay most of the usual expenses of homeownership, including utilities, real estate taxes, insurance and maintenance. Note that I did not indicate mortgage payments, as this strategy is generally not appropriate for properties with debt.
The donated property does not have to be the donor’s principle residence, and in some circumstances the donor does not have to remain in the residence until death. And, while many clients tell advisors that they “want their kids to have the home,” this is often not the case. In fact, as families become more geographically dispersed, the children will very likely have to, or want to, sell the parents’ home. What the children want (and what the clients generally mean) is that the children want the “value” of the home. This can be accomplished with careful planning.
A charitable gift annuity (CGA) is an agreement between a donor and a charity in which the donor transfers property to a charity in exchange for a lifetime income stream. Gift annuity laws vary from state to state, but they generally follow the guidelines established by the American Council on Gift Annuities. Donors receive a current income tax deduction for their gift, and their income is guaranteed by the full faith and credit of the charity. Depending on the type of asset that is contributed, the donor’s cash is composed of ordinary income, return of capital (tax-free) and capital gain. This can make the after-tax equivalent income to the donor very favorable.
The charity may or may not use the donated capital immediately, depending on its relative size, its capital reserves, state law and other factors. Nonetheless, charities generally assume that they will ultimately receive 50 percent of the donation when the donor passes away.
These two gifts seem somewhat similar, and thus combining them into a single gift seems counterintuitive. So, to help illustrate the differences between them, here is an example from real life, although names have changed and amounts have been scaled back slightly.
Evelyn Brooks is an 85-year-old widow. She and her late husband bought their home in coastal California many years ago for $75,000, and it is now worth $5 million. While Evelyn’s home has risen in value, however, so have her expenses. Unfortunately, her personal income hasn’t kept pace with the cost of owning her home, and she finds herself unable to pay her longtime caregiver fairly or easily meet her property tax obligations. Since Evelyn doesn’t own much in investable assets, not many advisors are interested in working with her. But, she’s been on the auxiliary board of the local hospital where her late husband was a physician for his entire career. She would like to make a gift to the hospital, but she doesn’t think she can really afford to. Here’s what a LEGA-C Plan™ did for Evelyn.
We transferred her home to the hospital in a life estate agreement. This produced a charitable income tax deduction of $4,340,665, which Mrs. Brooks could use to offset up to 30 percent of her adjusted gross income (AGI) for the current year and five subsequent years. Our analysis tells us that with Evelyn’s currently modest income, she will never utilize this tax deduction. And, of course, we haven’t increased her income at all.
So, we then gift her tax deduction to the hospital in exchange for a CGA. Note that the tax deduction is considered to be Evelyn’s “property” and is a capital asset. This new gift will produce a deduction of $2,420,062, which can be used to offset up to 30 percent of her AGI this year. Unused amounts can be carried forward and utilized for five additional years. The annuity amount she receives is $28,214 per month—or $338,568 per year! Much of Evelyn’s income is tax-free return of capital, and much more is sheltered by her income tax deduction. She is able to pay her taxes, her caregiver and much more.
There are many complexities in this type of plan, of course, and there are also a number of “moving parts.” The charity must be substantial enough to afford to make payments without receiving a usable asset. And the charity must be able to accept gifts of real estate and be able to issue CGAs. However, the powerful outcome for the donor and for the charity makes knowing about the LEGA-C Plan™ and other charitable planning techniques critical for the advisor who expects to differentiate himself or herself from the pack.
And, in this case, it appears that charity actually begins “with” home, as well as “at” home.