Adventures in Charitable Planning. Robert W. Dietz, CFA Director Wealth Strategies

Transcription

1 2018 Adventures in Charitable Planning Robert W. Dietz, CFA Director Wealth Strategies

2 Bernstein does not provide tax, legal, or accounting advice. In considering the information contained in this presentation, you should independently verify all conclusions before implementing any strategy on your own behalf or on behalf of your client. 1

3 Tax Cuts and Jobs Act ( TCJA ), Charity s Worst Fear? This May Be The Last Year You Get A Charitable Tax Deduction (January 31, 2017) Why charitable giving could slow under proposed tax changes c (November 16, 2017) The GOP tax reform will devastate charitable giving c (December 27, 2017) 21 Million Taxpayers Will Stop Taking Charitable Deductions Under the Tax Law (January 11, 2018) Recent tax reforms in America will hurt charities (February 15, 2018) 2

4 The GOP s Blueprint for Tax Reform: A Better Way reduce the number of taxpayers who itemize their deductions from about one-third under current law to approximately 5 percent (Page 19) the elimination of all itemized deductions except the mortgage interest deduction and the charitable contribution deduction. (Page 20) eliminate the estate tax and the generation-skipping transfer tax, so that the death of a family member or loved one no longer will be a taxable event. (Page 16) 3

5 Most Charitable Gifts Are Made by Taxpayers That Itemize Deductions $300 Charitable Giving Over Time USD: Billions, Nominal $250 $200 $150 $100 $50 Itemized Deductions $ Sources: IRS and Giving USA

6 Tax Cuts and Jobs Act of 2017 ( TCJA 2017 ) Standard deduction doubled through 2025 State and local tax deduction (SALT) capped at $10,000 through 2025 Mortgage interest deduction limited to interest on $750,000 of acquisition debt through 2025 Suspension of most itemized deductions through 2025 Increase AGI limitation for cash gifts to 60% through % deduction on qualified business income from pass through entities through 2025 Increase in basic estate tax exclusion to $10 Mil. Charitable deductions for electing small business trusts (ESBT) Suspension of Pease limitation through 2025 Public Law No: ; An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year

7 Proportion of Taxpayers Expected to Itemize Deductions Proportion of Taxpayers Itemizing Deductions 30% 13% 5% Pre-TCJA TCJA Blueprint Sources: IRS and Giving USA

8 TCJA 2017: Estate Tax Implications 50 Number of Taxable Estate Tax Returns Thousands, Nominal 7 Forecasted Number of Taxable Estate Tax Returns Thousands, Nominal* Pre-TCJA TCJA Sources: IRS and Tax Policy Center *T Estate Tax Returns and Liability Under Current Law and the House and Senate Versions of the Tax Cuts and Jobs Act, : 7

9 Charitable Bequests and the Estate Tax $40 Charitable Bequests Over Time USD: Billions, Nominal $35 $30 $25 Estate Tax Repealed $20 $15 $10 $5 Charitable Estate Tax Deductions $ Sources: IRS and Giving USA

10 Charitable Planning Considerations After TCJA 2017 Accelerate bequests into lifetime gifts Restructure bequests as IRD assets Restructure bequests as incomebased charitable bequests 9

11 Not All Charitable Gifts Offer the Same Tax Savings $10,000 Gift (Donor in Top Income Tax Bracket) $3,700 $3,700 $3,700 $1,190 $2,380 $6,300 $5,110 $3,920 Benefit of Deduction Benefit of Embedded Tax Avoided Effective Cost of Donation Cash 50% Basis Stock 0% Basis Stock Deduction limited to 60% of AGI in year of cash gift or 30% of AGI in year of gift of appreciated public stock. Benefit of Deduction assumes full use of deduction against income otherwise taxed at 37% tax rate. Benefit of Embedded Tax Avoided assumes that the gain would otherwise be taxed at 23.8% (20% long-term capital-gains tax and 3.8% Medicare surtax). Assumes gift is made to a public charity. Source: IRS Publication 526 and Bernstein 10

12 Bunching Annual Gifts Continue with $10,000 Annual Giving Mortgage Interest $6k $6k $6k $6k SALT $10k $10k $10k $10k Charitable Gifts $10k $10k $10k $10k Total Deductions $26k $26k $26k $26k Excess $2k $2k $2k $2k Mortgage Interest $6k $6k $6k $6k SALT $10k $10k $10k $10k Charitable Gifts $20k - $20k - Total Deductions $36k $16k $36k $16k Excess $12k $0 $12k $0 For $10,000 Annual Donation: Annual tax savings: $740 $2,960 over 4 years For Bunched $20,000 Donation: Tax Savings of $4,440 (Year 1 & 3)* $8,880 savings over 4 years Source: AB *Under the Tax Cuts and Jobs Act, the standard deduction was increased to $24,000 for taxpayers married filing jointly (from $12,700 in 2017). This is set to expire after December 31, Assumes donor contributes a cash gift and is subject to the 37% federal tax bracket. Bernstein is not a legal, tax or estate advisor. Investors should consult these professionals as appropriate before making any decisions. 11

13 Qualified Charitable Distribution ( QCD ) Must be made directly from IRA trustee to charity Not taxable when distributed and can satisfy RMD requirements Maximum amount of $100,000 and no charitable income tax deduction Must be 70 ½ years of age or older In addition to the benefits of giving to charity, a QCD excludes the amount donated from taxable income. Keeping taxable income lower may reduce the impact to certain tax credits and deductions, including Social Security and Medicare. The charity must be a 501(c)(3) organization, eligible to receive tax-deductible contributions. QCDs cannot be made to private foundations, supporting organizations, or donor-advised funds (DAFs) but can be made to field of interest funds and designated funds offered by some organizations For informational purposes only. AB does not provide tax, legal or accounting advice. Source: IRS 12

14 Not All Charitable Gifts Offer the Same Tax Savings $10,000 Gift (Donor in Top Income Tax Bracket) Benefit of $3,700 $3,700 $3,700 $3,700 Deduction $6,300 $1,190 $5,110 $2,380 $3,920 Benefit of Embedded Tax Avoided Effective Cost of Donation $6,300 Benefit of Embedded Tax Avoided Effective Cost of Donation Cash 50% Basis Stock 0% Basis Stock QCD For illustrative purposes only. Deduction limited to 60% of AGI in year of cash gift or 30% of AGI in year of gift of appreciated public stock. Benefit of Deduction assumes full use of deduction against income otherwise taxed at 37% tax rate. Benefit of Embedded Tax Avoided assumes that the gain would otherwise be taxed at 23.8% (20% long-term capital-gains tax and 3.8% Medicare surtax). Assumes gift is made to a public charity. Source: IRS Publication 526 and Bernstein 13

15 Pass-Through Business: Qualified Business Income Deduction Qualified Business Income ( QBI ) deduction (IRC 199A) Allows a 20% deduction on domestic qualified business income for 2018 through 2025 Below the line deduction but not an itemized deduction (i.e. can be claimed regardless of whether the taxpayer itemizes or claims the standard deduction) Lesser of 20% of QBI or 20% of taxable income (not including capital gains) Top marginal rate on QBI is 29.6% (37% top marginal income tax rate * 80%) Available to any business entity that is not a C corporation QBI is defined as net income of US trade or business after all business deductions QBI is NOT salary or reasonable compensation, capital gains, or investment income (except REITs) See IRC 199A for detailed requirements and definitions. For a more complete summary description see: LISI Income Tax Planning Newsletter #125 (January 4, 2018) at 14

16 QBI Deduction Limitation: Specified Service Businesses Specified Service Trade or Business* Accounting Actuarial science Athletics Brokerage services Consulting Financial services Health Law The performing arts Investing and investment management Trading Dealing in securities, partnership interests, or commodities Whose principal asset is the reputation or skill of one or more employee or owners but not engineers or architects! *See IRC 199A(d)(1), (2) 15

17 Qualified Business Income Deduction Income Zones Taxable Income Specified Service Business Qualified Trade or Business Zone 1 Below: $157,500 (Single) $315,000 (Joint Filer) Eligible to deduct the lesser of (1) 20% of the taxpayer s qualified business income or (2) 20% of taxable income less any net capital gain. Zone 2 Between: $157,500 - $207,500 (Single) $315,000 - $415,000 (Joint Filer) Deduction subject to phase-out Subject to phase-in of limitation based on wages paid or on wages paid plus capital element Zone 3 Over: $207,500 (Single) $415,000 (Joint Filer) Not eligible for deduction Limitation based on wages paid or on wages paid plus capital element is fully phased in Deduction is limited to the lesser of 20% of the taxpayer s qualified business income with respect to the qualified trade or business or (1) 50% of the W-2 wages paid by the business to its employees during the calendar year and (2) the sum of 25% of the W-2 wages paid plus 2.5% of the unadjusted basis of certain tangible property used in the business. For a more complete description see: LISI Income Tax Planning Newsletter #125 (January 4, 2018) at 16

18 QBI Limitations for Taxpayers in Income Zone 2 or Zone 3 Where a taxpayer is over the taxable income threshold, strategies to reduce taxable income include: Contributions to defined contribution plans (e.g. 401(k)) and defined benefit plan plans (e.g. Cash Balance) Separating service activities not eligible for the deduction from those that do qualify for the deduction (e.g. spinning out real estate from SSB) Charitable contributions for taxpayers who itemize deductions Shifting ownership (and income) to a separate taxpayer such as a complex trust or multiple complex trusts Source: AB 17

19 Charitable Gifts for Taxpayers in Income Zone 2 or Zone 3 $10,000 $9,000 $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 $310,000 $340,000 $370,000 $400,000 $430,000 For illustrative purposes only. Effective Cost of $10,000 Donation Married Joint Filer Benefit of Deduction Effective Cost of Donation Taxable Income Pre Donation 18

20 QBI Limitations for Taxpayers in Income Zone 2 or Zone 3 $10,000 $9,000 $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 $310,000 $340,000 $370,000 $400,000 $430,000 For illustrative purposes only. Effective Cost of $10,000 Donation Married Joint Filer 20% Qualified Business Income Benefit of Deduction Effective Cost of Donation Taxable Income Pre Donation 19

21 Restructure Bequests as IRD assets Income in respect of a decedent (IRD) assets trigger taxable income to the beneficiaries when they receive payment IRD assets can be the most attractive property to fund charitable bequests The entire pre-tax amount of IRD can be transferred tax-free to tax-exempt charities IRD assets include: Uncollected salaries, wages, bonuses, commissions, vacation pay, and sick pay Qualified pension plans, profit sharing plans, IRA, and other retirement plan assets Annuity contracts and payments in excess of decedent's investment in the contract Structuring bequests of IRD assets* IRD is taxed to the person who is legally entitled to receive it For retirement plan accounts, this can be achieved by naming the charity as the beneficiary on the beneficiary designation form For IRD assets owned by an estate or trust, the governing instrument must contain instructions to distribute assets in-kind to a charity or the personal representative must have the power to distribute assets in a non-pro rata fashion among the multiple beneficiaries As a fallback strategy, the will or trust instrument should require a charitable bequest to be made first with IRD so that the estate or trust is entitled to a income tax deduction For informational purposes only. AB does not provide tax, legal or accounting advice. *See: Income Tax Deductions For Charitable Bequests of IRD, Christopher R. Hoyt 20

22 Creating and Optimizing IRD Using Non-Qualified Variable Annuity Case Assumptions Non-qualified annuity, purchased 8 years ago Contract value: Cost basis: Gain: Living benefit: $2.5 million $2.0 million $0.5 million Guaranteed minimum withdrawal benefit (GMWB) rider; benefit base guaranteed to double to $4 million within 10 years (over 7% guaranteed return) GMWB benefit base: $3.5 million Fees and expenses: 1.55% mortality & expense charge 1.05% living benefit rider fee 2.60% total fee Past performance does not guarantee future results. The case study example presented are not to be considered investment recommendations by AllianceBernstein L.P. It is to illustrate a type of charitable giving structure and not indicative of any specific AllianceBernstein L.P. product or investment advisory service. 21

23 Not All Charitable Gifts Offer the Same Tax Savings $10,000 Gift (Donor in Top Income Tax Bracket) Benefit of $3,700 $3,700 $3,700 Deduction $3,700 $6,300 $1,190 $5,110 $2,380 $3,920 Benefit of Embedded Tax Avoided Effective Cost of Donation $6,300 Benefit of Embedded Tax Avoided Effective Cost of Donation $10,000 Effective Cost of Donation Cash 50% Basis Stock 0% Basis Stock QCD NQ Annuity For illustrative purposes only. Deduction limited to 60% of AGI in year of cash gift or 30% of AGI in year of gift of appreciated public stock. Benefit of Deduction assumes full use of deduction against income otherwise taxed at 37% tax rate. Benefit of Embedded Tax Avoided assumes that the gain would otherwise be taxed at 23.8% (20% long-term capital-gains tax and 3.8% Medicare surtax). Assumes gift is made to a public charity. Source: IRS Publication 526 and Bernstein 22

24 Creating and Optimizing IRD Using Non-Qualified Variable Annuity $9.0 $8.0 $7.0 $6.0 $5.0 $4.0 $3.0 $2.0 $1.0 $0.0 Pre-Tax Accumulation Value USD: Millions, Nominal Year Taxable Current Annuity Current Annuity includes 2.6% annual contract charges. Bernstein is not a tax, legal, or insurance advisor. Investors should consult these professionals as appropriate before making any decisions. Based on Bernstein's estimates of the range of returns for the applicable capital markets over the next 20 years. Data does not represent past performance and is not a promise of actual or range of future results. Asset values represent the estimated market value; if the assets were liquidated, additional capital gains or losses would be realized that are not reflected here. See Assumptions and Notes on Wealth Forecasting System in Appendix for further details. Source: AB 23

25 Creating and Optimizing IRD Using Non-Qualified Variable Annuity $10.0 $9.0 $8.0 $7.0 $6.0 $5.0 $4.0 $3.0 $2.0 $1.0 $0.0 Pre-Tax Accumulation Value USD: Millions, Nominal Year PPVA Taxable Current Annuity PPVA includes 0.55% annual mortality and expense (M&E) risk charge; Current Annuity includes 2.6% annual contract charges. Bernstein is not a tax, legal, or insurance advisor. Investors should consult these professionals as appropriate before making any decisions. Based on Bernstein's estimates of the range of returns for the applicable capital markets over the next 20 years. Data does not represent past performance and is not a promise of actual or range of future results. Asset values represent the estimated market value; if the assets were liquidated, additional capital gains or losses would be realized that are not reflected here. See Assumptions and Notes on Wealth Forecasting System in Appendix for further details. Source: AB 24

26 Restructure Bequests as Income-Based Charitable Bequests Charitable income tax deductions for trusts and estates Section 642(c) requires that the payment of income to charity must be made pursuant to the terms of the governing instrument The payment to charity must be traced to income A typical bequest of corpus will not qualify for the charitable income tax deduction Distributions to charity are not deductible as a distribution of distributable net income (DNI) (Treas. Reg (a)-2) Charitable bequests should be moved to the income section of the governing instrument See: Tax Savings with Income-Based Charitable Bequest; Probate & Property, September/October 2017 (Christopher R. Hoyt) 25

27 CRTs 26

28 How a Charitable Remainder Trust Defers and Avoids Taxes Contribution of appreciated assets Donor Immediate charitable income-tax deduction* Charitable Remainder Trust Liquidate assets and reinvest tax deferred Remainder when trust expires Charity Annual cash payouts: percentage of trust value (CRUT) or fixed-dollar amount (CRAT) Recipient For illustrative purposes only. *The income-tax deduction is not the total amount contributed, but rather the present value of what is expected to pass to charity. The calculation of the present value takes into account the value of the contributed assets, the discount rate (based on the Section 7520 rate) and the term of the trust (for lifetime trusts, a life expectancy table is used). See Sections 7520 and 664 of the Internal Revenue Code of 1986, as amended, and the Treasury regulations thereunder. Source: AB 27

29 Types of Charitable Remainder Trusts (CRTs) Annuity Trust (CRAT) Pays fixed dollar amount between 5% and 50% of initial fair market value of trust Unitrust (CRUT) Standard Pays fixed percentage between 5% and 50% of net fair market value determined annually Net income (NICRUT) Pays lesser of unitrust amount or trust income Net income with make-up provision (NIMCRUT) Pays lesser of unitrust amount or trust income while allowing deficiencies between net income and unitrust amount to be made up in future years, when net income exceeds unitrust amount Flip NICRUT or NIMCRUT Trust switches from NICRUT or NIMCRUT to standard CRUT after triggering event occurs (can be a specific date or a single event that s not in control of trustee or any other person*) *Reg (a)(1)(i)(c) 28

30 Today: CRUTs Up, CRATs Down Maximum Allowable Lifetime Unitrust Percentage* Age 3.2% 7520 Rate 7.0% 7520 Rate % 7.404% % % % % % % % % *Assumes annual payout. Source: AB Maximum Allowable Lifetime Annuity Percentage* Age 3.2% 7520 Rate 7.0% 7520 Rate % % % % 8.342% % 9.941% 29

31 Tier Rules of Accounting Tiered rules of accounting under Code Section 664(b) and Treasury Regulations Section (d)(1) Previously deferred and current taxable income is allocated among three categories or tiers Each tier includes different classes of income As a general rule, the highest tax-rate income in each category and class is deemed to be paid out first but not always Category Class Rate Ordinary Income Interest 37.0% Qualified Dividend 20.0% Capital Gain Short-Term Gain 37.0% Other Income Long-Term Gain 20.0% Tax-Exempt Interest 0.0% Corpus Basis n/a For informational purposes only. AB does not provide tax, legal or accounting advice. 30

32 Reminders When Contributing Securities to a CRT Contribution of long-term capital gain property to a CRT with private foundation as remainder beneficiary Deduction reduced by amount of appreciation (i.e., limited to cost basis) [IRC 170(b)(1)(B)(ii)] Subject to 20% of AGI ceiling [IRC 170(b)(1)(D)] Marketable securities exception [IRC 170(e)(5)] Can deduct fair market value only if market quotations are readily available on an established exchange [IRC 170(e)(5)(B)] Not available for stock contributions in excess of 10% of the outstanding stock of the corporation (including related persons) [IRC 170(e)(5)(C)] 31

33 When Is Crossover Achieved? Personal Wealth Over Time Median Case* (Real, $ Millions) Outright Sale % CRUT 8% CRUT 5% CRUT CRUT Payout (%) Years Until Crossover** Years 5 23 *Wealth values include charitable deduction based upon joint lifetime of two 65 year olds and a Section 7520 rate of 3.2%. ** Crossover defined as the point at which more personal wealth is accumulated from the CRUT relative to an outright sale. Results displayed are based on the median case (50% probability). Based on Bernstein s estimates of the range of long-term returns for the applicable capital markets. Data do not represent past performance and are not a promise of actual future results or a range of future results. See Notes on Wealth Forecasting System in Appendix for further details. Source: AB 32

34 CRUT Can Enhance Personal Wealth, if Payout Percentage Is High and Grantor Has Lots of Runway $10 Million Outright Sale Median Personal Wealth Year 25* (Nominal, $ Millions) $10 Million Lifetime CRUT $27.6 $19.2 $9.1 CRT Benefit Personal Wealth $1.8 $3.6 $4.0 CRT Cost No CRT 5% 8% % CRUT Payout Percentage *Wealth values include charitable deduction from CRT based upon joint lifetime of two 65 year olds and a Section 7520 rate of 3.2%. Based on Bernstein s estimates of the range of long-term returns for the applicable capital markets. Data do not represent past performance and are not a promise of actual future results or a range of future results. See Notes on Wealth Forecasting System in Appendix for further details. Source: AB 33

35 Conversely, Charity Benefits More When Payout Rate Is Low $10 Million Outright Sale Median Total Wealth Year 25* (Nominal, $ Millions) $10 Million Lifetime CRUT Total Wealth $48.6 $27.6 Charity s Interest $19.2 $40.3 $9.1 $35.6 $4.0 CRT Benefit Personal Wealth $1.8 $3.6 $4.0 CRT Cost No CRT 5% 8% % CRUT Payout Percentage *Wealth values include charitable deduction from CRT based upon joint lifetime of two 65 year olds and a Section 7520 rate of 3.2%. Based on Bernstein s estimates of the range of long-term returns for the applicable capital markets. Data do not represent past performance and are not a promise of actual future results or a range of future results. See Notes on Wealth Forecasting System in Appendix for further details. Source: AB 34

36 CRUTs Work Best When Contributed Assets Have Lots of Built-In Capital Gain Odds of More Personal Wealth Year 25* 8% CRUT vs. Outright Sale >98% 93% 76% 48% 20% 6% 0% 10% 20% 30% 40% 50% Cost Basis/Fair Market Value *Includes charitable deduction from CRT based upon joint lifetime of two 65 year olds and a Section 7520 rate of 3.2%. Based on Bernstein s estimates of the range of long-term returns for the applicable capital markets. Data do not represent past performance and are not a promise of actual future results or a range of future results. See Notes on Wealth Forecasting System in Appendix for further details. Source: AB 35

37 Inter Vivos CLTs 36

38 Charitable Lead Annuity Trusts Contribution Donor Charitable Lead Annuity Trust Remainder when trust expires Beneficiaries Annual Annuity Payments Charity For illustrative purposes only. Charitable Lead Trusts, as defined under Sections 170, 170A, 2055 and 2522 of the Internal Revenue Code of 1986, as amended from time to time (the Code ), and the Treasury Regulations thereunder. 37

39 Rev. Proc , IRB 89 Guaranteed Annuity Determinable amount Paid periodically Not less than annually Payment Requirements Not subject to any minimum or maximum payout May provide for an annuity amount that is: o Fixed dollar o But increases during the annuity period o Provided that the value of the annuity is ascertainable at the time the trust is funded 38

40 Possible Guaranteed Annuities ($10 Mil. CLAT for 20 Years) Value ($ Mil.) Cumulative to Charity Level: $13.2 Mil. 120%: $15.3 Mil. 150%: $16.6 Mil. Level 120% 150% Final Annuity $5.5 Mil. $2.6 Mil. 2.0 Initial Annuity $660k $82k $2.5k $660k For illustrative purposes only. Current analysis and estimates do not guarantee future results. 39

41 Possible Guaranteed Annuities ($10 Mil. CLAT for 20 Years) Value ($ Mil.) Cumulative to Charity Fixed: $13.2 Mil. 120%: $15.3 Mil. 150%: $16.6 Mil. Level: $17.3 Mil. Level 120% 150% Shark-Fin Final Annuity $17.3 Mil. 6.0 $5.5 Mil. $2.6 Mil. Initial Annuity $660k $ For illustrative purposes only. Current analysis and estimates do not guarantee future results. 40

42 Back-Loading Increases Wealth Transfer...Only to a Point Median Wealth Transferred* $10 Million, 20-Year Term CLAT (Nominal, $ Millions) $10.3 Mil. $13.6 Mil. $13.5 Mil. $12.5 Mil. Annuity Structure Fixed 120% 150% Shark-Fin Probability of Success: 82% 83% 80% 76% For illustrative purposes only. *Median inflation-adjusted non-grantor CLAT remainder assuming $10 million zeroed-out 20-year CLAT funded at the February 2018 Section 7520 rate of 2.8%, invested 100% global equity. Probability of success defined as remainder interest >$1,

43 Intentionally Defective Grantor Charitable Lead Trusts BENEFICIARIES Remainder Annuity GRANTOR CHARITABLE LEAD ANNUITY TRUST CHARITY Contribution 170(a) Deduction GRANTOR For illustrative purposes only. Charitable Lead Trusts, as defined under Sections 170, 170A, 2055 and 2522 of the Internal Revenue Code of 1986, as amended from time to time (the Code ), and the Treasury Regulations thereunder. 42

44 Grantor CLATs Median Wealth Transferred* $10 Million, 20-Year Term CLAT (Nominal, $ Millions) $18.4 Mil. $21.8 Mil. $24.6 Mil. $11.5 Mil. Annuity Structure Fixed 120% 150% Shark-Fin Probability of Success: 84% 88% 88% 90% For illustrative purposes only. *Median inflation-adjusted non-grantor CLAT remainder assuming $10 million zeroed-out 20-year CLAT funded at the February 2018 Section 7520 rate of 2.8%, invested 100% global equity. Probability of success defined as remainder interest >$1,

45 CLATs Compared to Other Planning Techniques Median Wealth Transferred* $10 Million, 20-Years (Nominal, $ Millions) $17.9 Mil. $28.1 Mil. $21.8 Mil. $24.6 Mil. Sales & Loans GRAT 150% CLAT Shark-Fin Taxable Gift? Yes No No No Mortality Risk? No Yes No Yes Income Tax Deduction? No No Yes Yes For illustrative purposes only. *Median inflation-adjusted remainders. For the sale to IDGT, assumes $10 million intra-family loan to intentionally defective grantor trust with a promissory note paying interest only at the appropriate applicable federal rate for February 2018 with a balloon payment at the end of the term. For comparability the strategy does not include a seed gift. For GRATs, assumes $10 Mil. funded at the February 2018 Section 7520 rate. Assumes zeroed-out rolling two-year GRATs. For CLATs, assumes $10 million zeroed-out 20-year grantor CLATs funded at February 2018 Section 7520 rate. All assets assumed to be invested in 100% global equity. Based on Bernstein estimates of the range of returns for the applicable capital markets over the periods analyzed. Data do not represent past performance and are not a promise of actual future results. See Notes on Wealth Forecasting at the end of this presentation for further details. 44

46 Is a Shark-Fin Advisable? Annually increasing annuities (e.g., 150%) should be used under most circumstances: Income tax mortality risk (grantor to non-grantor trust) Lifetime CLATs with annually increasing annuities have little or no mortality risk Perception that a Shark-Fin is too good to be true Shark-Fin CLATs might be advisable: Lifetime Shark-Fin CLATs are superior ways of fulfilling a testamentary charitable bequest Nature of the assets: Lack liquidity Volatile Limited diversification opportunities 45

47 Asset Allocation: Tradeoff Between Probability and Magnitude of Success Median Wealth Transferred* $10 Million, 20-Year Term CLAT Fixed Annuity Payment (Nominal, $ Millions) $4.0 Mil. $6.4 Mil. $8.6 Mil. $10.3 Mil. Allocation 40/60 60/40 80/20 100/0 Probability of Success: 81% 84% 83% 82% For illustrative purposes only. *Median inflation-adjusted non-grantor CLAT remainder assuming $10 million zeroed-out 20-year CLAT funded at the February 2018 Section 7520 rate of 2.8%, invested 100% global equity. Probability of success defined as remainder interest >$1,

48 Testamentary CLTs 47

49 Testamentary Charitable Lead Annuity Trust Case Assumptions Single Client with a taxable estate wants to revise his testamentary estate plan Client s goal is to pay no estate tax while providing substantial benefits to both children and charity Client s planner is considering a testamentary charitable lead annuity trust (T-CLAT) in lieu of an outright residuary bequest to charity Problem: Annual payouts to charity from the T-CLAT are dependent upon the Section 7520 rate as of Client s death. The annuity payout schedule and the likelihood of success cannot be determined until after Client dies Key Research Question: How sensitive is a T-CLAT to the Section 7520 rate? 48

50 Testamentary Plan Featuring a Zeroed-Out * T-CLAT Client s Estate Client s Estate $0 Government Remaining Applicable Exclusion Amount Balance Credit Shelter Trust T-CLAT *If present value of annuities payable to charity equals value of contribution to trust no estate tax will be created because of the estate tax charitable deduction; CLAT is said to be zeroed-out. Bernstein does not provide tax, legal, or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions. See Appendix, Details and Notes on Wealth Forecasting, for additional information. Source: AB 49

51 Section 7520 Rate Projections: Next 10 Years* Probability 5% 10% 50% 90% 95% 5.4% 3.0% 3.2% 6.0% 3.6% 6.6% 3.8% 7.2% 7.8% 4.0% 4.2% 9.2% 8.2% 8.8% 4.4% 4.6% 4.8% 9.6% 5.0% 1.6% 1.6% 1.6% 1.6% 1.6% 1.6% 1.8% 1.8% 1.8% Projections as of 12/31/17* *Based on Bernstein's estimates of the range of returns for the applicable capital-market over the next 10 years. Data do not represent past performance and are not a promise of actual future results or a range of future results. See Assumptions and Notes on the Wealth Forecasting System in the Appendix for further details. 50

52 The Problem: Dependence on Section 7520 Rate Annual Annuity Amount $20 Million, 20-year T-CLAT* ($ Millions) $1.3 $1.6 $1.9 $2.2 Today 4.8% 6.8% 8.8% Section 7520 Rate *CLAT is zeroed-out using the Section 7520 rates in the display therefore the present value of annuities payable to charity equal the value contributed to the trust. Bernstein does not provide tax, legal, or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions. See Appendix, Details and Notes on Wealth Forecasting, for additional information. Source: AB 51

53 The Problem: Dependence on Section 7520 Rate Probability 5% 10% Range of Remainder Values Year 20 $20 Million, 20-year T-CLAT* (Nominal, $ Millions) 50% 90% 95% $72.4 $20.5 $59.2 $10.6 $45.1 $30.0 Section 7520 Rate 2.8% 4.8% 6.8% 8.8% Probability of Success 84% 68% 49% 30% *Investment allocation consists of 20% Intermediate-term diversified municipal bonds, 11.2% US diversified equities, 15.12% US value equities, 15.12% US growth equities, 5.60% US small and mid cap equities, 8.96% US low volatility equities, 13.66% developed international equities, 4.2% emerging market equities, and 6.14% high-risk international equities. The probability of having at least some assets remaining in the portfolio 20 years after the Client s death. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the next 20 years. Data do not represent past performance and are not a promise of actual or range of future results. See Appendix, Notes on Wealth Forecasting System, for details. Source: AB 52

54 Possible Solution: Fund T-CLAT with Discounted Assets Some estate planners believe that it may be possible to improve the probability of success in a T-CLAT by funding the trust at death with discounted assets often assets connected in some way with a family limited partnership or family limited liability company that was established during the decedent s lifetime If these planners are correct, then the annuity payments that the T-CLAT must make to charity each year should be lower than if the T-CLAT had been funded with non-discounted assets As a result, more value should remain working in the T-CLAT each year, thereby potentially increasing both: The probability that the remainder beneficiaries will receive at least some benefit The value that those beneficiaries are likely to receive 53

55 Assumed Facts for Funding T-CLAT with Discounted Assets Following Client s death, his children purchase family limited partnership (FLP) interests from his estate The liquidation value of those interests is $20 million, but due to lack of marketability and minority interest discounts, the fair market value of those interests for federal transfer tax purposes is assumed for purposes of this analysis to be $15 million (25% discount) The $15 million paid by Client s children to the estate for those FLP interests is used by the executor to fund the T-CLAT As a result, the annual T-CLAT payments to charity are less than they would have been had the T-CLAT been funded with marketable securities For purposes of this analysis, we assume that Client s children purchase the estate s FLP interests on an installment basis 54

56 Self-Dealing Excise Tax IRC 4947(a)(2) provides that self-dealing excise tax applies equally with respect to a charitable lead trust as if such trust were a private foundation. IRC 4941(a) imposes an excise tax on each act of self-dealing between a disqualified person and a private foundation. IRC 4941(d)(1) provides, in part, that the term self-dealing means any direct or indirect (A) sale or exchange, or leasing, of property between a private foundation and a disqualified person; (B) Lending of money or other extension of credit between a private foundation and a disqualified person; (E) Transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a private foundation Reg (d)-2(C)(1) provides that the lending of money or other extension of credit between a private foundation and a disqualified person shall constitute an act of self-dealing. Further, the regulations provide that an act of self-dealing occurs where a note, the obligor of which is a disqualified person, is transferred by a third party to a private foundation which becomes the creditor under the note. See IRC 4946(a) for a description of Disqualified Person Bernstein does not endorse these strategies, nor do we render legal or tax advice. Rather, we use our modeling tools to help the practitioner determine whether the legal and other risks associated with these strategies may be worth the potential economic reward to their clients. 55

57 Estate Administration Exception to Self-Dealing Reg (d)-1(b)(3) excepts certain transactions carried out during the administration of an estate or revocable trust from the definition of self-dealing if: (i) The administrator or executor of an estate, or trustee of a revocable trust either (a) Possesses a power of sale with respect to the property, (b) Has the power to reallocate the property to another beneficiary, or (c) Is required to sell the property under the terms of any option subject to which the property was acquired by the estate or revocable trust (ii) Such transaction is approved by the probate court (iii) Such transaction occurs before the estate (or trust) is considered terminated for Federal income tax purposes (iv) The estate (or trust) receives an amount which equals or exceeds the fair market value of the foundation s interest or expectancy (V) With respect to transactions occurring after April 16, 1973, the transaction either (a) Results in the foundation receiving an interest or expectancy at least as liquid as the one it gave up (b) Results in the foundation receiving an asset related to the active carrying out of its exempt purposes, or (c) Is required under the terms of any option which is binds on the estate See: Ltr. Rul Bernstein does not endorse these strategies, nor do we render legal or tax advice. Rather, we use our modeling tools to help the practitioner determine whether the legal and other risks associated with these strategies may be worth the potential economic reward to their clients. 56

58 The Note CLAT Assets During life: Client 1 FLP LP units 2 Sale or gift of option to purchase LP units Children At death: Client s Estate LP units 3 Note 5 Note payments Note 4 T-CLAT 6 Annual annuity payments Charity Source: Matthew J. Madsen, Financing a CLAT with a Note Can Accelerate the Transfer of Wealth to Heirs, 30 Est. Plan. 495 (Oct. 2003). 57

59 Possible Solution: Valuation Discount Annual Annuity Amount $20 Million, 20-year T-CLAT* ($ Millions) $1.3 $1.0 $1.6 $1.2 $1.9 $1.4 $2.2 $1.6 Today 4.8% 6.8% 8.8% Section 7520 Rate CLAT is zeroed-out using the Section 7520 rates in the display therefore the present value of annuities payable to charity equal the value of contribution to trust. Bernstein does not provide tax, legal, or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions. See Appendix, Details and Notes on Wealth Forecasting, for additional information. Bernstein does not endorse these strategies, nor do we render legal or tax advice. Rather, we use our modeling tools to help the practitioner determine whether the legal and other risks associated with these strategies may be worth the potential economic reward to their clients. Source: AB 58

60 The Problem: Dependence on Section 7520 Rate Probability 5% 10% Range of Remainder Values Year 20 $20 Million, 20-year T-CLAT* (Nominal, $ Millions) 50% 90% 95% $72.4 $20.5 $59.2 $10.6 $45.1 $30.0 Section 7520 Rate 2.8% 4.8% 6.8% 8.8% Probability of Success 84% 68% 49% 30% *Investment allocation consists of 20% Intermediate-term diversified municipal bonds, 11.2% US diversified equities, 15.12% US value equities, 15.12% US growth equities, 5.60% US small and mid cap equities, 8.96% US low volatility equities, 13.66% developed international equities, 4.2% emerging market equities, and 6.14% high-risk international equities. The probability of having at least some assets remaining in the portfolio 20 years after the Client s death. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the next 20 years. Data do not represent past performance and are not a promise of actual or range of future results. See Appendix, Notes on Wealth Forecasting System, for details. Source: AB 59

61 Possible Solution: Valuation Discount Probability 5% 10% Range of Remainder Values Year 20 $20 Million, 20-year Note-CLAT* (Real, $ Millions) 50% 90% 95% $89.7 $79.5 $68.5 $56.8 $32.0 $25.4 $6.4 $17.8 $8.9 Section 7520 Rate 2.8% 4.8% 6.8% 8.8% Probability of Success 97% 91% 80% 65% *Investment allocation consists of 20% Intermediate-term diversified municipal bonds, 11.2% US diversified equities, 15.12% US value equities, 15.12% US growth equities, 5.60% US small and mid cap equities, 8.96% US low volatility equities, 13.66% developed international equities, 4.2% emerging market equities, and 6.14% high-risk international equities. The probability of having at least some assets remaining in the portfolio 20 years after the Client s death. Based on Bernstein s estimates of the range of returns for the applicable capital markets over the next 10 years. Data do not represent past performance and are not a promise of actual or range of future results. See Appendix, Notes on Wealth Forecasting System, for details. Source: AB 60

62 Conclusions CLATs, in general, are sensitive to interest rates T-CLATs are particularly sensitive because the effective Section 7520 rate is not known until after Client dies Valuation discounts, if successfully incorporated into the testamentary estate plan, can: Reduce this interest-rate sensitivity Improve the probability that non-charitable remainder beneficiaries will receive at least some wealth Increase the median amount of wealth that non-charitable beneficiaries are likely to receive 61

63 Notes and Assumptions 62

64 Capital-Markets Projections: Next 20 Years Median 20-Year Growth Rate Mean Annual Return Mean Annual Income 1-Year Volatility 20-Year Annual Equivalent Volatility Intermediate-Term Diversified Municipals 3.0% 3.2% 3.3% 4.1% 5.5% US Diversified 6.6% 8.1% 2.5% 16.4% 16.7% US Value 6.9% 8.4% 3.0% 16.0% 16.5% US Growth 6.2% 8.1% 2.0% 18.2% 18.2% US Small/Mid-Cap 6.8% 8.8% 2.2% 18.7% 19.4% US Low Vol Equity 6.7% 7.8% 3.8% 14.2% 14.8% Developed International 7.7% 9.7% 3.3% 18.2% 18.3% Emerging Markets 5.9% 9.7% 3.5% 26.1% 26.7% High-Risk International 7.8% 10.8% 2.2% 22.1% 22.6% Inflation 2.9% 3.3% n/a 1.2% 9.5% Based on 10,000 simulated trials each consisting of 20-year periods. Reflects Bernstein's estimates and the capital market conditions of December 31, Does not represent any past performance and is not a guarantee of any future specific risk-levels or returns, or any specific range of risk-levels or returns. 63

65 Notes on Wealth Forecasting System 1. Purpose and Description of Wealth Forecasting Analysis Bernstein s Wealth Forecasting Analysis is designed to assist investors in making their long-term investment decisions as to their allocation of investments among categories of financial assets. Our planning tool consists of a four-step process: (1) Client-Profile Input: the client s asset allocation, income, expenses, cash withdrawals, tax rate, risk-tolerance level, goals and other factors; (2) Client Scenarios: in effect, questions the client would like our guidance on, which may touch on issues such as when to retire, what his/her cash-flow stream is likely to be, whether his/her portfolio can beat inflation long-term, and how different asset allocations might impact his/her long-term security; (3) The Capital-Markets Engine: our proprietary model that uses our research and historical data to create a vast range of market returns, which takes into account the linkages within and among the capital markets, as well as their unpredictability; and finally (4) A Probability Distribution of Outcomes: based on the assets invested pursuant to the stated asset allocation, 90% of the estimated ranges of returns and asset values the client could expect to experience are represented within the range established by the 5th and 95th percentiles on box-and-whiskers graphs. However, outcomes outside this range are expected to occur 10% of the time; thus, the range does not establish the boundaries for all outcomes. Expected market returns on bonds are derived taking into account yield and other criteria. An important assumption is that stocks will, over time, outperform long bonds by a reasonable amount, although this is in no way a certainty. Moreover, actual future results may not meet Bernstein s estimates of the range of market returns, as these results are subject to a variety of economic, market and other variables. Accordingly, the analysis should not be construed as a promise of actual future results, the actual range of future results or the actual probability that these results will be realized. 2. Modeled Asset Classes The following assets or indexes were used in this analysis to represent the various model classes: Asset Class Modeled as: Annual Turnover Rate Intermediate-Term Diversified Municipals AA-rated diversified municipal bonds of 7-year maturity 30% US Diversified S&P 500 Index 15% US Value S&P/Barra Value Index 15% US Growth S&P/Barra Growth Index 15% US Small/Mid-Cap Russell 2500 Index 15% US Low Vol Equity MSCI US Minimum Volatility Index 15% Developed International MSCI EAFE Index (Unhedged) 15% High-Risk International Country Fund 15% Emerging Markets MSCI Emerging Markets Index 20% 64

66 Notes on Wealth Forecasting System (continued) 3. Volatility Volatility is a measure of dispersion of expected returns around the average. The greater the volatility, the more likely it is that returns in any one period will be substantially above or below the expected result. The volatility for each asset class used in this analysis is listed on the Capital-Market Projections page at the beginning of these Notes. In general, two-thirds of the returns will be within one standard deviation. For example, assuming that stocks are expected to return 8.0% on a compounded basis and the volatility of returns on stocks is 17.0%, in any one year it is likely that two-thirds of the projected returns will be between (8.9)% and 28.8%. With intermediate government bonds, if the expected compound return is assumed to be 5.0% and the volatility is assumed to be 6.0%, two-thirds of the outcomes will typically be between (1.1)% and 11.5%. Bernstein s forecast of volatility is based on historical data and incorporates Bernstein s judgment that the volatility of fixed income assets is different for different time periods. 4. Technical Assumptions Bernstein s Wealth Forecasting System is based on a number of technical assumptions regarding the future behavior of financial markets. Bernstein s Capital Markets Engine is the module responsible for creating simulations of returns in the capital markets. These simulations are based on inputs that summarize the current condition of the capital markets as of December 31, Therefore, the first 12-month period of simulated returns represents the period from December 31, 2017, through December 31, 2018, and not necessarily the calendar year of A description of these technical assumptions is available on request. 5. Expenses and Spending Plans (Withdrawals) All results are generally shown after applicable taxes and after anticipated withdrawals and/or additions, unless otherwise noted. Liquidations may result in realized gains or losses, which will have capital gains tax implications. 6. Tax Implications Before making any asset allocation decisions, an investor should review with his/her tax advisor the tax liabilities incurred by the different investment alternatives presented herein, including any capital gains that would be incurred as a result of liquidating all or part of his/her portfolio, retirement-plan distributions, investments in municipal or taxable bonds, etc. Bernstein does not provide tax, legal, or accounting advice. In considering this material, you should discuss your individual circumstances with professionals in those areas before making any decisions. 65

67 Notes on Wealth Forecasting System (continued) 8. Charitable Remainder Trust The Charitable Remainder Trust (CRT) is modeled as a tax-planning or estate-planning vehicle, which makes an annual payout to the recipient(s) specified by the grantor, and at the end of its term (which may be the recipient's lifetime), transfers any remaining assets, as a tax-free gift, to a charitable organization. Depending on the payout's structure, the CRT can be modeled as either a Charitable Remainder Unitrust (CRUT) or a Charitable Remainder Annuity Trust (CRAT). The CRUT's payout is equal to a fixed percentage of the portfolio's beginning-year value, whereas the CRAT's payout consists of a fixed dollar amount. In the inception year of the CRT, its grantor receives an income tax deduction typically equal to the present value of the charitable donation, subject to the applicable Adjusted Gross Income (AGI) limits on charitable deductions and phaseout of itemized deductions, as well as the rules regarding reduction to basis of gifts to private foundations. Unused charitable deductions are carried forward up to five years. Although the CRT does not pay taxes on its income or capital gains, its payouts are included in the recipient's Adjusted Gross Income (AGI) using the following four accounting tiers: Tier 1-Ordinary Income (Taxable Interest/Dividends); Tier 2-Realized Long-term Capital Gains; Tier 3-Other Income (Tax-exempt Interest); and Tier 4-Principal. CRTs are required to pay out all current and previously retained Tier 1 income first, all current and previously retained Tier 2 income next, all current and previously retained Tier 3 next, and Tier 4 income last. 9. Charitable Lead Trusts The Charitable Lead Trust (CLT) is modeled as a portfolio which receives its initial funding from the grantor and transfers payments to one or more charitable recipients each year for a specified number of years. The annual payments may be a fixed dollar amount (Charitable Lead Annuity Trust or CLAT) or a percentage of the trust's assets (Charitable Lead Unitrust or CLUT). In the case of a CLAT, annuities may be fixed (the same amount each year), or increasing. The annual payment is made first from available cash and then from other trust assets in kind. The trust will pay income taxes on retained income and will receive a charitable income tax deduction for income paid to the charitable recipient(s). Realized capital gains may be treated in one of two ways, as directed: 1) taxed entirely to the trust, or 2) included in the payment to charity and, therefore, deducted from the trust's income, to the extent the payment exceeds traditional income. When the CLT term ends, the remainder, if any, may be transferred in kind to 1) a non-modeled recipient, 2) a taxable trust, or 3) a beneficiary's portfolio. The transferred assets will have carryover basis