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Tuesday, April 30, 2024
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Case Studies |
Saving Taxes on Savings Bonds
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Case:
Ethel Peters is an 80-year old grandmother and has an estate valued at $2 million. She has one son, age 55, who is married with three children. Her estate consists of her home valued at $750,000, an IRA with a current balance of $100,000 and United States Savings Bonds (Series EE) with a current value of $250,000. The balance of the estate is invested in securities. Ethel primarily lives on her Social Security income, the IRA distributions and a small pension inherited from her husband.
Ethel has reviewed a number of options with her CPA in regards to the savings bonds. She purchased these bonds over 30 years ago. If she redeemed them today, she would be required to recognize $150,000 of ordinary income. She has considered simply giving the bonds to charity. However, United States Savings Bonds are not transferable and must be cashed in prior to the gift. Due to the ordinary income recognition, she would have to pay thousands of dollars in income taxes. The taxes would be required because she would not be able to deduct a charitable gift of $250,000 with adjusted gross income of only $40,000 per year. If she gave the bonds to charity, her adjusted gross income would increase to $190,000 in year one and, therefore, she would be able to write off a charitable gift of $95,000. However, the remaining $155,000 of the $250,000 gift would be carried forward for the next five years. Based upon a projected AGI of $40,000 for the next five years, she would be able to write off another $100,000, leaving $55,000 of the gift "on the table" at the end of the carry forward period. Also, based upon the fact that she already gives $5,000 each year to charitable causes, even more of the deduction could be "lost."
Question:
Ethel has had some health problems and is very concerned about planning her estate. She would like to transfer most of her estate to her son and grandchildren, but as she says, "I absolutely do not want to pay a lot of estate taxes." Ethel supports charities and would consider making provision for charity in her estate plan. She has two charities in mind: to one charity she would like to leave a bequest of $100,000 when she passes away and to the other she desires to leave "substantially more," but not necessarily upon her death. Ethel desires for the latter charity to receive its bequest after her son passes away. She thought that possibly the way to handle this gift is to transfer the assets to her son and then "trust him" to make the gift later through his will. What are some estate planning options for Ethel to fulfill her objectives?
Solution:
Ethel decided to pose her questions to Ronald Moore, the Director of Gift Planning at one of her favorite charities. After discussing her goals and objectives, Ronald stated that there were a couple of options that would not only enable her to save estate taxes, but would also assist in saving income taxes as well. He went on to explain that if her IRA were transferred to her son and/or grandchildren, they would have to pay income taxes on the "income in respect of a decedent." Ronald stated that what she should do is change the primary beneficiary of the IRA to the charity. When she passes away, the charity may then receive the bequest of $100,000. In this way, not only will the charity not have to pay taxes on the IRD, but her estate will receive a charitable estate tax deduction of $100,000. In other words, both income and estate taxes will be saved - a dual benefit.
Ronald then suggested that the savings bonds be used to fund a testamentary charitable remainder trust for her son. Assuming that bonds valued at $250,000 are transferred to a 5% testamentary unitrust that will distribute income to her son for his lifetime, the estate will receive a charitable estate tax deduction of about $85,500.
An excellent benefit of using the savings bonds to fund the testamentary unitrust is that the $150,000 in untaxed ordinary income (also classified as IRD) will be allocated to the unitrust. Since the trust is tax exempt, it can redeem the bonds without payment of income tax. Therefore, the entire bond proceeds can be invested to produce income for the lifetime of Ethel's son. Based upon her son's life expectancy of about 29 years, the estimated distributions to him would total over $550,000, assuming a trust return of 8%. Also, coincidentally, the same projected amount would ultimately be distributed to charity.
Ethel was quite pleased with Ronald's planning concepts. She is able not only to save estate taxes but also income taxes on both the IRA and savings bonds. Also, she is able to fulfill her objectives of making her desired bequests.
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