Beneficiary Optimization: 23% Increase in Charitable Giving Efficiency

Beneficiary Optimization: 23% Increase in Charitable Giving Efficiency

Executive Summary

A high-net-worth client sought to maximize the charitable impact of a significant portion of their estate while minimizing estate and income taxes for their heirs. Golden Door Asset conducted a comprehensive analysis of the client's assets, retirement accounts, and existing beneficiary designations. By strategically reallocating assets and optimizing beneficiary designations, we increased the efficiency of the client's planned charitable giving by 23%, enabling a larger donation to their chosen charities without impacting the inheritance intended for their family.

The Challenge

Our client, Mr. Robert Thompson, a 72-year-old retiree, had accumulated a substantial estate over his career, primarily composed of a $3 million brokerage account, a $1.5 million IRA, and a $500,000 Roth IRA. Mr. Thompson's primary goal was to leave a significant portion of his estate to his alma mater, a well-regarded university, while also providing for his two adult children. Initially, Mr. Thompson planned to distribute his assets equally among his children and the university, a plan that, while generous, lacked tax efficiency.

Specifically, the initial plan involved leaving $1 million from the brokerage account, $500,000 from the IRA, and $250,000 from the Roth IRA to the university. This approach presented several challenges:

• Income Tax on IRA Distributions: The university, as a tax-exempt organization, would not be subject to income tax on the $500,000 IRA distribution. However, if Mr. Thompson's children inherited the IRA funds instead, they would be required to pay income tax at their individual rates. Given their estimated combined tax rate of 30%, this would result in a significant reduction in their inheritance.
• Capital Gains Taxes on Appreciated Assets: Leaving highly appreciated assets in the brokerage account directly to the university would bypass potential capital gains taxes that his children would incur if they were to sell the assets after inheriting them. For example, some of the assets in the brokerage account had appreciated significantly – on average, 40% above their cost basis.
• Estate Tax Considerations: While Mr. Thompson's estate was below the federal estate tax threshold, strategic planning could still minimize potential state estate taxes depending on his state of residence.
• Suboptimal Asset Allocation for Heirs: The initial plan did not consider the tax implications of leaving specific assets to specific heirs. For example, providing assets with a lower cost basis to heirs who planned to hold them long-term would negatively impact their future tax liabilities.

Mr. Thompson expressed a desire to maximize the actual amount received by the university from his estate, while also ensuring his children received the maximum possible inheritance after taxes. He tasked Golden Door Asset with finding a solution that addressed these concerns.

The Approach

Our approach to optimizing Mr. Thompson's charitable giving plan involved a multi-faceted strategy that focused on asset allocation, beneficiary designations, and tax-efficient gifting.

1. Comprehensive Asset Analysis: We began by conducting a thorough analysis of Mr. Thompson's assets, including their cost basis, current market value, and tax implications. This included detailed reviews of his brokerage statements, retirement account statements, and estate planning documents.

2. Tax Modeling and Scenario Planning: We utilized advanced tax planning software to model different scenarios and project the impact of various beneficiary designations on both the charitable contribution and the inheritance for his children. This included scenarios where different assets were allocated to the university and his children and included projecting future tax rates.

3. Strategic Beneficiary Designations: Based on our analysis, we recommended the following strategic changes to Mr. Thompson's beneficiary designations:

   • Designate the IRA to the University: We advised Mr. Thompson to designate his $1.5 million IRA (pre-tax) to the university. Since the university is a tax-exempt organization, it could receive the full value of the IRA without incurring any income tax.
   • Leave Appreciated Assets to Heirs: We advised leaving the highly appreciated assets in the brokerage account to his children. This would allow them to receive the assets at their current market value, with a stepped-up cost basis. This eliminates the capital gains tax that would have been triggered if the assets had been sold immediately after inheritance or bequeathed directly to the university.
   • Utilize Roth IRA strategically: The Roth IRA, with its tax-free growth and distributions, was left entirely to the children. This ensured the most tax-advantaged asset passed directly to them, untouched by income or estate taxes.

4. Coordination with the University: Marcus Williams, the lead advisor on the case, worked closely with the university's development office to understand their specific needs and ensure the proposed plan aligned with their philanthropic goals. This involved explaining the tax benefits of receiving IRA assets directly and ensuring they understood the complexities of estate planning.

5. Review and Refinement: The plan was reviewed and refined based on Mr. Thompson's feedback and evolving circumstances. This included addressing his concerns about ensuring his children would manage the inherited assets responsibly, by discussing options with professional financial advisors.

Technical Implementation

The technical implementation of our solution relied on a combination of financial planning software and expert analysis.

• Tax Planning Software: We used sophisticated tax planning software (specifically, Holistiplan, integrated with our CRM) to model different scenarios. This software allowed us to input detailed information about Mr. Thompson's assets, income, and expenses, and project the tax consequences of various beneficiary designations. The software calculated estimated income taxes, capital gains taxes, and potential estate taxes under different scenarios. We ran simulations over a 10-year period to account for potential changes in tax laws and investment performance.
• Cost Basis Tracking: We utilized tools within our portfolio management system (Black Diamond) to accurately track the cost basis of assets in Mr. Thompson's brokerage account. This allowed us to identify assets with the highest appreciation and determine the potential capital gains tax savings of leaving them to his children.
• Retirement Account Projections: We projected the future value of Mr. Thompson's retirement accounts using Monte Carlo simulations. This allowed us to estimate the potential income tax liability associated with different distribution strategies.
• Collaboration Platform: We used a secure online portal to share documents and communicate with Mr. Thompson, his children, and his attorney. This facilitated efficient collaboration and ensured everyone was informed throughout the planning process.
• Financial Modeling: We developed financial models to project the long-term impact of our recommendations on Mr. Thompson's estate and his children's financial well-being. These models considered factors such as investment returns, inflation, and tax rates.

The calculations involved determining the tax rate on IRA distributions to the beneficiaries, factoring in state and federal rates. Capital gains calculations were based on the average 40% appreciation of the assets in the brokerage account, which could have potentially faced a 15% to 20% federal tax rate, and applicable state capital gains tax.

Results & ROI

The strategic beneficiary optimization resulted in a significant increase in the efficiency of Mr. Thompson's charitable giving plan:

• Increased Charitable Impact: By designating the IRA to the university, the university received the full pre-tax value of $1.5 million. Under the original plan, only $500,000 would have gone to charity from the IRA.
• Tax Savings for Heirs: By leaving the appreciated assets in the brokerage account to his children with a stepped-up cost basis, we eliminated approximately $120,000 in potential capital gains taxes (40% appreciation * 20% tax rate on an estimated $1.5 million of the brokerage assets allocated to children).
• Overall Efficiency Gain: The combination of increased charitable giving and tax savings for heirs resulted in a 23% increase in the overall efficiency of Mr. Thompson's estate plan. This meant that for the same level of assets, a larger percentage went to the charity without diminishing the value of the inheritance for his children.
• Roth IRA Optimization: The Roth IRA, valued at $500,000, being left entirely to the children, ensures complete tax-free growth and distribution for their benefit, further enhancing their inheritance.
• Improved Peace of Mind: Mr. Thompson expressed a sense of satisfaction and peace of mind knowing that his charitable goals would be achieved in the most tax-efficient manner possible, and that his children would benefit from a well-structured inheritance.

Before Optimization:

• Charitable Contribution Efficiency: 62%
• Net Value To Heirs (After Taxes): $1,800,000

After Optimization:

• Charitable Contribution Efficiency: 85%
• Net Value To Heirs (After Taxes): $1,920,000

Key Takeaways

1. Prioritize Tax-Advantaged Assets for Charitable Giving: Retirement accounts (especially pre-tax IRAs) are often the most tax-efficient assets to donate to charity.
2. Leverage Stepped-Up Basis: Leaving appreciated assets to heirs allows them to receive a stepped-up cost basis, potentially eliminating significant capital gains taxes.
3. Coordinate with Charities: Working closely with the charitable organization can help ensure the donation aligns with their needs and maximizes their impact.
4. Utilize Advanced Tax Planning Tools: Tax planning software can help model different scenarios and identify opportunities for tax savings.
5. Review and Update Regularly: Estate plans should be reviewed and updated regularly to reflect changes in tax laws, investment performance, and personal circumstances.

About Golden Door Asset

Golden Door Asset builds AI-powered intelligence tools for RIAs. Our platform helps advisors identify tax-saving opportunities and create more efficient estate plans for their clients, leading to stronger client relationships and increased AUM. Visit our tools to see how we can help your practice.