Finding ways to compliantly create favorable tax deduction is an important part of wealth and estate planning.
People astute enough to acquire meaningful wealth in a Solo 401k often think about how to charitably share their good fortune. A powerful way to accomplish this is by combining estate planning for heirs with charitable giving. Interestingly, this combination is often a much needed estate tax planning tool. Pre-tax IRA or 401k plans pay tax when passed to heirs. This makes this type of tax planning important and wise.
One of our previous blogs shared knowledge about Charitable Remainder Trusts. Two ways to receive retirement income include a Charitable Remainder Unitrust (CRUT) and Charitable Remainder Annuity Trust (CRAT). You are the grantor of the trust. However, there are other types of trusts that work with a Solo 401k or self-directed IRA. Here is useful information about several other charitable trusts that may provide a favorable tax deduction.
Other Favorable Tax Deduction Charitable Giving
In addition to the CRAT and CRUT, there are other tax favorable ways to donate to charities and non-profit organizations. These include:
- Charitable Lead Trust
- Retained Life Estate
- Charitable Gift Annuity
Charitable Lead Trust
The charitable lead trust (CLT) has the ability to pass wealth to future generations but is susceptible to the IRS discount rate that changes monthly. Interestingly, month you establish the CLT (or the proceeding two months) determine the discount rate of the CLT.
CLTs are available both as an annuity and as a unitrust. Both types can pay a percentage of the trust’s earnings to the charity. In fact, any earnings not paid to the charity maybe taxable. Two options when establishing a CLT are grantor or nongrantor. If you choose a grantor trust, you receive a favorable tax deduction the year the trust is established. You remain the owner of the trust and all income earned (including that donated to charity) will be included and taxed as your income. At the end of the trust term, you receive the balance remaining in the trust. This type of CLT is frequently used to gain a large tax deduction in the year you establish the trust.
A nongrantor CLT gives up ownership of the trust. However, at the end of the trust term, your designated beneficiary receives the remaining balance in the trust. Because they do not own the trust, they are not eligible to take the tax deduction when it is established. For gift and estate tax purposes, your estate planner will reduce the value of the trust (property) by the amount of the tax deduction you could not take. This type of CLT is used to reduce gift and estate taxes.
Retained Life Estate
Some but not all charities offer the retained life estate. This charity gifting method allows you to obtain the charitable tax deduction of donating your home during your lifetime. However, you can still spend the rest of your years in your home. Ownership of the home transfers to the charity in exchange for the tax deduction.
Most personal residences qualify, including:
- Primary residence
- Farms with or without a house
- Vacation home
- Stock in a cooperative housing corporation
The retained use of the home can be either for the rest of a person’s life or for a set number of years. For instance, perhaps a donor has a vacation home they expect to use for another ten years before they wish to donate it. Maybe plans are in place to leave the primary residence for other living arrangements in a few years. These are the types of situations when it makes sense to obtain a favorable tax deduction and relinquish the home after a set number of years.
Charitable Gift Annuity
A charitable gift annuity provides the donor with an income stream and favorable tax deduction in exchange for a donation of appreciated stocks, cash, real estate, or other assets. In other words, rather than a trust, this is a contract between the annuitant and charity. Often, the total assets of the charity back the income stream of the annuity. Not just the value contributed by the annuitant. Some states regulate charitable gift annuities.
Generally, the American Council on Gift Annuities establishes the rate of return. Rates of return increase as the age of the annuitant increases. The payments are not income to the annuitant, rather a partially tax-free return of the annuitant’s gift. If funded with appreciated real estate, likely tax components of the payments include ordinary income, part capital gain, and partially tax-free earnings.
Above all, the charitable gift annuity can be set up for a single life, two lives, or two lives with right of survivorship. The person receiving the payments does not have to be the donor. Common versions of the charitable gift annuity are:
- Immediate Charitable Gift Annuity
- Deferred Charitable Gift Annuity
- Flexible Charitable Gift Annuity (start date is determined after the contribution is made)
- College Tuition Charitable Gift Annuity
Favorable Tax Deduction: Recap
Charitable remainder trusts and these other charitable vehicles can be very beneficial for eliminating or reducing taxes in addition to the gratifying accomplishment of helping others. These are all great opportunities for you to share your good fortune and wealth with others. However, it’s important you work with your CPA, counsel or estate planner to decide what options are best for you.
Have questions about your Solo 401k? Solo 401K experts at Nabers Group will help you get your retirement funds into your control, where they belong. Contact us here.
Disclaimer: These resources are provided as a convenience and for informational purposes only. They do not constitute an endorsement or an approval by Nabers Group LLC of any of the products, services, or opinions of any corporation, organization, or individual. Nabers Group LLC bears no responsibility for the accuracy, legality, or content.
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