Some potential charitable donors are faced with quite the dilemma: how to give to charity while still maintaining wealth and financial security for their own family. The concern is that a substantial charitable gift could end up depriving their family members of funds they may need for future emergencies. But the longer the potential donor stalls, the longer their charity of choice goes without their beneficial contribution, not to mention the donor misses out on potential income/estate tax savings.
A possible solution? For some donors, it’s the “wealth replacement technique”.
What is Wealth Replacement?
The wealth replacement technique addresses a donor’s concern for the wellbeing of their family should they also donate to charity. Wealth replacement involves the use of three financial instruments: a charitable remainder unitrust, (CRUT), (or another charitable vehicle), a life insurance policy, and an irrevocable life insurance trust.
With these three tools, a donor would ideally be able to donate to charity, then use the savings from their charitable tax deduction along with the payout from their CRUT to purchase life insurance that would replace the assets that were given to the charity.
Explaining the Wealth Replacement Technique
The wealth replacement technique first involves a charitable remainder unitrust. This trust provides for annual, or more frequent, payouts to the donor or specified beneficiary of the plan, such as a spouse or family member. The second step comes into play if the donor is likely to be subject to federal estate tax, or if the donor wants to protect their beneficiaries from creditors, then an irrevocable life insurance trust (ILIT) should be considered. The trustee of the ILIT purchases a life insurance policy on the donor’s life with a death benefit equal to the value of the assets transferred to the CRUT. The donor can then use the a portion of the income payout from the CRUT and estate tax savings to make a charitable gift to the ILIT in the amount of the insurance premiums the trustee must pay.
If done properly, after the death of the second spouse, the life insurance death benefit will go to the heirs, which replaces the funds that pass to their charity from the CRUT. And because the life insurance policy is owned by a trust, the policy will generally not be subject to estate taxes at either spouse’s death.
Is Wealth Replacement the Right Strategy for You?
There are some factors to consider before choosing to use wealth replacement. Cost and availability of life insurance depends on various factors such as age, health condition, and the specific type of insurance you’re looking for. Before using this strategy, it would be wise to make sure you are insurable!
While trusts provide numerous advantages for preserving family wealth, they do have up-front costs and continual administrative fees that you will have to account for. Trust also come with a set of complex tax rules, so an experienced estate planning professional is advised.
Charitable giving can be a rewarding experience, and the wealth replacement method could be a way for your family to both give and receive. We highly recommend speaking to your financial and legal advisors before employing this technique regarding your specific situation. This “Wealth Replacement” strategy may not be suitable for all investors.
Have questions? Feel free to contact the advisors here at Walsh & Associates, we’re happy to help.
Walsh & Associates and LPL Financial do not provide legal or tax advice or services. This information is not intended to be a substitute for individualized legal or tax advice.
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