As part of our firm’s continuing plan to provide educational information to clients and friends of McKinley Carter, the following article focuses on a charitable lead trust. A Charitable Lead Trust must be carefully fashioned with experienced legal counsel.

For individuals with charitable inclinations, and either an estate tax issue, or income tax issue, a Charitable Lead trust may offer a solution.

There are two types of Charitable Lead Trusts, a grantor and a non-grantor lead trust. In simple terms, the donor of a Charitable Lead Trust transfers assets to their favorite non-profit organization, for a period of 10 to 20 years. The donor gives up the income from the asset transferred and designates the income to be given to the organization. At the termination of the trust, the assets are transferred back to the donor or the donor’s beneficiary.

A non-grantor lead trust has qualities that help individuals with gift tax and estate taxes, while a grantor lead trust helps individuals with annual income tax planning.  Therefore, if a donor were to structure the lead trust to ultimately benefit a son or daughter, then a non-grantor lead trust may be the most appropriate. Usually, a non-grantor lead trust will make payments to the organization for a specified period, and at the conclusion of the payment term, the remaining assets are distributed to the grantor’s children as an inheritance.

With a grantor lead trust, the individual who created the trust is also usually the individual who receives the trust proceeds at the end of the trust term. The trust income is taxed to the grantor every year. When the grantor contributes the assets to the trust, he receives an immediate charitable income tax deduction for the value “today” of all the future payments to be made to charities from the trust.

The donor would be entitled to a substantial charitable contribution deduction depending on whether the Charitable Lead Trust is a grantor, non-grantor and whether it is a unitrust or  annuity trust. The donor would be able to carry-over the deduction for a period of five years but would be limited to 20% of the donor’s adjusted gross income. In other words, any deduction in excess of 20% of the adjusted gross income would be carried over for a period of five years.

Once it is determined which type of charitable lead trust is best for the donor, there needs to be a decision made as to whether the investment of the funds is best in a unitrust or an annuity trust. The difference between a unitrust and an annuity trust is this:  A unitrust pays a fixed percentage of the income to the organization, while an annuity trust pays a fixed dollar amount to the organization.

The investment of the lead trust needs to be carefully considered, since the donor may need to declare the income on his/her tax return. To offset this, it may be best to invest the assets in tax free securities. This however, would produce a smaller return than other investments.

Just as drafting of an appropriate legal document for a charitable lead trust is extremely important, the investing of the funds is also extremely important. For these reasons, McKinley Carter is uniquely positioned, to help organizations search for and cultivate donors, develop the planned giving instruments and invest the funds for maximum benefit to the donor and grow the organization’s endowment. Charitable Lead Trusts can have many variations and require legal counsel to draft and calculate the financial implications to the donor.

Charles N. O’Data, CFRE, is director of philanthropic advisors for McKinley Carter Wealth Services (blog.mc-ws.com) an SEC registered investment adviser.  The information contained herein is general market information only and is not intended to be personalized investment advice.  Mr. O’Data can be contacted at philanthropy@mc-ws.com or 866-306-2400.  This article is intended as an illustration of a financial planning technique and is not to be considered or represent a legal opinion.  Donors are urged to contact their legal representative.

Effective this year, charitable gift annuity rates have changed. The American Council on Gift Annuities board of directors recently reviewed the current assumptions that underlie the rate schedules at their recent semi-annual meeting. Given the significant changes in the economic environment, the board approved a new rate schedule of suggested maximum gift annuity rates effective January 1, 2012. At ages older than 60, when the majority of gift annuities are issued, one-life rates will decline by 0.5% to 0.8%.

An example of the rate schedule is as follows:

Age                             Rate
60                                4.4%
65                                4.7%
70                                5.1%
75                                5.8%
80                                6.8%
85                                7.8%
90                                9.0%

The new rate schedule also includes the same assumptions as previous rates. A Charitable Gift Annuity contract assumes a 50% residuum.  Historically, the American Council of Gift Annuities (ACGA) has established a target residuum (the amount the charity realizes at the termination of the annuity) of 50% of the original contribution for the gift annuity. The new rate schedule retains the target residuum. The ACGA engages competent actuaries who constantly evaluate risk, returns, income scenarios and the payout to annuity holders and develop models designed to protect the annuity donors as well as the charity recipient.

The key to managing a charitable gift annuity portfolio is first to fully understand the nature of the instrument as well as the knowledge of the investment plan to meet the donor’s payout requirement and at the same time preserve the principal for the benefit of the charity.

The American Council of Gift Annuities was established in 1927 for the purpose of providing educational and other services to non-profit organizations with regard to gift annuities and other planned giving programs. Its policies and suggested maximum rate schedules have been accepted by every state and are recognized by the Internal Revenue Service.

The Pooled Income Fund

A pooled income fund is much like a financial institution’s common trust fund. A donor irrevocably transfers appropriate assets to a qualified charitable organization’s separately maintained pooled income fund, where it is invested with the transfers of others who make similar life income gifts.

Each designated income beneficiary receives his or her share of the fund’s income (fully taxable) every year for life. A pooled income fund agreement can provide income for one or more beneficiaries for life (but not a term of years). Note: A pooled income fund requires two or more donors.

On the passing of the last beneficiary entitled to receive income under a particular pooled income fund agreement, assets (equal to the then value of that agreement’s assets in the fund) are removed from the fund and used by the charitable organization for its charitable purposes.

Example: Mrs. Jones’ $10,000 gift is invested in a charity’s pooled income fund. The fund earns 6% this year, so she receives $600—her share of the fund’s earnings. At her passing her life income agreement’s share of the fund’s assets are worth $14,000; that amount is removed from the fund and paid to the charitable organization.

Ideal for Community Foundations

A pooled income fund is an ideal planned giving instrument for a community foundation. Most community foundations have several accounts such as the blind association, girl scouts and the local library.  The community foundation can establish a pooled income fund with one donor from several agencies and at the passing of one of the donors, the individual agency receives that donor’s share in the fund.

A replacement for the Charitable Gifts Annuity

Because of the guaranteed contract nature of a charitable gift annuity, many organizations do not offer a “CGA.” A charitable gift annuity is also a planned giving instrument that attracts small contributions. Therefore, if a non-profit does not offer a Charitable Gift Annuity a donor of $10,000 to $50,000 has limited options for making a planned gift. The pooled income fund may just be the answer. Gifts in the amount of $5,000 to $50,000 are generally acceptable.

Deductibility

Donors who transfer property (cash or securities) in exchange for a pooled income fund share are entitled to a contributions deduction. For example, if a donor aged 75 transfers $10,000 in assets for which she paid $5,000, she would receive a contribution deduction of $6,681. Additionally, there would not be any capital gain tax liability on the appreciation of the asset.

For specific information on how endowment management, fund raising and planned gifts may benefit your organization, contact us at philanthropy@mc-ws.com, 866-306-2400 or visit www.mc-philanthropy.com.

The recent events and news in Europe has been weighing on the global economy and in minds of investors. Large amounts of debt in certain countries, and an inability to make significant changes has many asking a sobering question:

Will the U.S. be next?

After all, the amount of federal debt has risen dramatically during the past few years. Meanwhile, there are daily reports that the “Super Committee” has been unable to make compromises to effect any meaningful change this year.

If we can’t make meaningful changes now, will it only become worse in the years to come?

We agree the situation is worrisome, but there are many important differences between the U.S. and the situation in Europe:

1. Public debt-to-GDP in the US is under 70%, while it is over 100% in Italy and Greece.
2. Our politicians are more polarized than at any time since the early 1900’s, but in the history of the US this runs in cycles. And, our political system is still more stable than most of Europe’s. Even though those countries are much older than the US, most of their political systems have only been in place since World War II.
3. The European Union and the Euro is an experiment that no one is sure will work. It is a political entity that is not backed by a monetary entity. The US government has the Federal Reserve to carry out monetary policy. The EU doesn’t have one cohesive monetary body. They need to rely on the Federal Reserves of each individual country, which have very different needs.
4. In any other country, when growth slows their Federal Reserve can devalue their currency to spur exports. The main problem in Greece, Italy, Spain and the other countries that are in trouble is that they are tied to the Euro so they cannot do this. Some argue that the Euro has been kept strong to benefit Germany at the expense of the other countries. This is why the solution is not for these countries is not as easy as just cutting spending, although that needs to happen. When the people of Greece riot, they have somewhat of a point that Germany has been growing at their expense. The only solution seems to be getting these countries out of the Euro and having a smaller, more cohesive group in the European Union.
5. In the US, we have a history of passing tax increases or printing money to cover our debts, but these solutions have consequences. Even though the impasse between the parties is worse than it has been, in the end I have to believe they will decide on a credible solution. Remember, in the 1980’s everyone was saying our debt was out of control, but then the economic growth of the 1990’s turned those deficits into surpluses.

In our opinion, despite what we see on the news we don’t think we are headed down the same path as Europe.

The deferred payment gift annuity seems to be the forgotten planned giving instrument.

In a study of  “expectancy pools” of 87 colleges and universities with a total future gift value of $1.5 billion, less than 1% was in the form of a deferred payment gift annuity. (Study completed by C. N. O’Data)

This type of annuity offers immediate tax savings, income payments that start at a future date that you choose, and allows you to help your institution at the same time.

There are several reasons for more not promoting deferred payment gift annuities, the absolute deferred nature of the gift, fear of the need to make large income payments in the future, the uncertainty of the financial markets and the lack of professional planned giving staff to promote and administer a deferred payment gift annuity.

On a positive side, a deferred payment gift annuity may be the ideal instrument to be used in uncertain financial times. A deferred payment gift annuity enables a donor to transfer funds today, receive an immediate charitable contribution deduction, and defer the income until a later date. In the meantime, the non-profit organization calculates a 3% income factor and a 5% capital appreciation rate and the donor receives a payout on the new value at the time income is received. The standard gift annuity payout rate for a 55 year old individual is 4.4%. However, because of the projected value of the fund in 15 years, the rate of return is 10.3% on the original transfer of $25,000. Furthermore, a large portion of the income will be tax free to the donor.

As an example, John Donor, age 55, transfers $25,000 to XYZ organization in exchange for a deferred payment charitable gift annuity. He asked that the income be “deferred” until age 70. John will receive an immediate charitable contribution deduction of $6,238, annual income of $2,575 of which $1,179 will be free of income tax.

A deferred payment charitable gift annuity is just one of many gifting instruments we offer to our philanthropic clients. Helping non-profit organizations grow their endowment funds through carefully designed fund raising and planned giving programs is what makes us a unique financial advisor to non-profit organizations.

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During the recently completed quarter, much of the economic data began to show that growth was slowing, causing global stock markets to fall.  As stocks fell, investors looked to the U.S. Treasury market for stability despite historically low yields.

The yield on the 10-year U.S. Treasury dropped as low as 1.72% in late September, down from 3.18% at the beginning of the quarter.

Only a few months ago it seemed the slowdown in economic activity caused by the turmoil in the Middle East and the Japanese earthquake would be temporary.

Then, the deterioration of the sovereign debt situation in Greece and other Euro zone countries heightened the risk of a global financial crisis.  Global economic growth, which was anemic to begin with, slowed further.

Now, a growing number of economists say the probability of a global recession has increased, which has depressed business and consumer confidence further.

• Unemployment is still above 9% in the U.S.
• Personal spending is slowing and incomes are declining for the first time in almost two years
• Economic activity in emerging markets has softened, reducing exports from the developed world
• China’s exports are also slowing as a result of the problems in Europe.

Though investors are anticipating a recession, the data still indicates a continuation of moderate growth.

• In the U.S. GDP growth for the second quarter was 1.3%
• Jobless claims have been improving
• Capital equipment spending growth remains strong

According to the Institute of Supply Management, the manufacturing sector expanded for the 26th consecutive month in September. The Conference Board’s Leading Economic Indicators rose again in August, and in September the University of Michigan Consumer Sentiment Index also improved slightly. So while consumer spending and manufacturing activity are not robust, they do not indicate contraction.

American corporations are gaining market share globally because they have done a solid job of competing in a slow-growth environment, and they still boast healthy balance sheets and historically high profit margins.

But economic growth will not improve until government officials in Europe and the U.S. prove they are willing to make the difficult decisions needed to avoid a crisis.  A positive resolution by Euro zone countries that would effectively bail out the at-risk countries, or a strong bipartisan agreement by the congressional budget panel that would reduce the U.S. budget deficit could set the stage for the global economy to resume the healing process that began after the last financial crisis.

Stocks may not be able to have a sustained rally until these issues are resolved, but it seems that stock prices have already priced in a recession.

According to JP Morgan, at the end of September 53% of stocks in the U.S. had a price less than 12 times earnings and 33% were less than 10 times. The last time stocks were that cheap was during the height of the 2008 U.S. financial crisis. In addition, in September the average yield on stocks in the S&P 500 Index was 2.3% while the yield on the 10-year U.S. Treasury was 1.9%.  The last time stocks yielded more than 10-year Treasuries was the 1950’s.

Of course, at times when fear is the dominant emotion, valuations are of little importance. Investors are concerned, but the question is whether or not the degree of fear is higher than what the data indicates it should be.  Stocks may be inexpensive, but in the past they sometimes have remained inexpensive for months or years before moving toward their true value.

Today’s volatile economic environment has placed a cloud of uncertainty in nearly every financial market. The impact of this uncertainty has a particular effect on the non-profit community.

 A recent report from the Giving USA Foundation, showed several startling trends between 2008 and 2010:

• The two year total change in charitable giving, in current dollars, decreased by 3 percent.
• The cumulative change in individual giving showed a decrease of 1 percent.
• Foundation giving over the same two year period experienced a nominal decline of 2.9 percent.
• Bequest giving, the most volatile sector of philanthropy, decreased by 27 percent. The only bright spot was giving by corporations increased by 23 percent.

 (It should be noted that of the total philanthropic enterprise of nearly $291 billion in charitable giving 5% or $15.2 million is estimated to come from the corporations.)

 These overall numbers are in stark contrast to years of sustained increases.

Adding to the uncertainty for non-profits is the lingering threat of changes in the charitable deduction, congressional determination of the IRA Rollover and restructuring of the federal tax code.

 All of these factors foster an atmosphere which is not conducive to budgeting, planning and future fund raising. For those organizations which depend on governmental support, the reduction in funding and the uncertainty of the financial markets create even greater management challenges.

In fact many non-profit organizations live on the edge of insolvency.  

The only real revenue stream an organization can depend on is its own endowment. For years endowments were managed in near obscurity. Now, more organizations are dependent on their endowments and are eager to have them grow.

With what appears to be the leveling of charitable contributions, particularly with annual funds, endowments become the salvation. 

Endowments become the focus for greater returns, improved performance and more gifts. As a result, the advancement staff is asked to raise more money for endowment purposes for which many are ill prepared. 

There is interdependence between endowment performance and growing the endowment through new contributions.

There is an art and skill to major gift fund raising.

Major gift fund raising for an endowment requires knowledge and cooperation with the endowment management entity and the fund raising team. While there is not sufficient evidence of a trend, there seems to be a movement for endowment management to be administratively responsible to the fund raising department. Such a decision is dependent of the capabilities of those involved.

Recently, I made a proposal to a planned giving donor prospect for a Charitable Remainder Unitrust investment in the amount of $200,000. This is viewed as a major gift as contrasted to an annual gift. The donor was asked to make an investment in his alma mater. Since it is an investment and the donor’s name would be placed on the fund, he wanted to make sure the funds would be invested properly, that the people responsible for the portfolio were capable, that the fees for administration were appropriate and that his money and his name would be protected even 50 years from now.

A donor friend made exactly the same dollar contribution, $500,000, for a charitable remainder unitrust to two educational institutions on consecutive days. Two years later school one reported the asset value at $504,000 and school two had to report an asset value of $374,000. Since that time the advancement department has had little success is securing additional contributions from school two. There is interdependence between endowment management and fund raising.

What the above illustrations mean is that before you can grow an endowment through current  or planned gifts, there needs to be clear policies and performance experience in place for a donor to make an investment in your organization.

This carries over to planned gifts.

Charitable Remainder Unitrusts, Charitable Gift Annuities, Pooled Income Funds, Deferred Gift Annuities all involve investments in order to make scheduled payouts to the donors. Each instrument needs to be carefully designed to provide the donor the agreed upon income, yet maintain a healthy position in order to preserve maximum principal for the organization.

There is interdependence with performance, policies and the procurement of new endowment donors.

This week, stocks are moving lower again, as the worries of a global slowdown continue despite some positive economic news. The manufacturing data released came in slightly better than feared, with China and the UK both showing some strength. However, investors remain focused on Europe’s debt crisis.

September had a disappointing finish as global stock markets dropped on Friday. However, although it didn’t feel like it, for the week stocks were mostly unchanged. The S&P 500 Index was down only 0.44% for the week and the Dow Jones Industrial Average actually rose 1.3%. Looking beyond the daily volatility shows that stocks remain stuck in the same trading range they have been in for most of August and September, although they are now near the bottom of that range.

The drop in stocks during the last few days of the week caused the just-concluded third quarter to finish as the worst quarter for the stock market since the fourth quarter of 2008. The market dealt with a lot of issues in the third quarter, with the European debt situation and political uncertainties in the U.S. two of the biggest. Both of those issues remain unresolved, and the evidence began to mount that the odds of a global recession are increasing.

Some of the key sources of growth are showing signs of weakness. Exports out of China are slowing because of the problems western economies are facing. In the U.S., personal spending slowed in August and incomes declined for the first time in almost two years. As a result of this lower outlook for growth, some key commodities have sold off hard. The price of oil declined to $79 a barrel on Friday, and copper plummeted 25% in September. Copper is a key metal that reflects not only global industrial activity, but also Chinese demand.

Not all of the data has been disappointing, however. Last month the Jobless Claims report in the US was under 400K again, and GDP for the second quarter was revised up to +1.3%. Capital Equipment spending in the US is still strong. Excluding aircraft and defense, orders for capital goods rose 1.1% in August and shipments rose a solid 2.8%. Machinery shipments increased 5.5%. Finally, the University of Michigan Consumer Sentiment Index for September had a modest uptick to 59.4 from 55.7 in August.

The first two weeks of October will probably remain volatile while investors digest the conflicting data. There will be plenty of economic releases with the potential to move the market. But the focus will soon turn to corporate earnings. Recently corporate America has been considered a safe haven due to healthy balance sheets and historically high profit margins.

However, cracks are showing here as well. Ingersoll Rand, a good indicator of industrial activity, issued a preannouncement that lowered its 2011 earnings expectations and the stock dropped 12%.  Also, after the close Friday Arch Coal Inc. became the latest coal company to lower its view.  Now, many investors expect further reductions to 2012 earnings estimates for S&P 500 companies. Earnings season begins in two weeks, and the market is primed to have a large move either up or down depending on if the results surprise either positively of negatively.

In this environment it is extremely difficult to make any long term decisions regarding the market. The best course of action is to maintain one’s long term strategy and use the expected volatility in the fourth quarter to take positions in solid investments that have been caught in the market downturn.

Given the unpredictability of the stock market, most of us realize there is more to managing an endowment than just selecting a portfolio manager and receiving dividends and interest income.

More and more organizations are looking for professional management of their endowed funds.

Proper management requires an internal review of the significance of the endowment to the organization, the level to which the governing body embraces the endowment, policies governing the investments spending and savings, and the means to regularly increase and grow the fund.

Traditionally, endowments grew through careful investments. However, with a slow economy, organizations are relying on their endowments more heavily.  Unfortunately, the timing isn’t ideal, given that many endowments have suffered through the ups and downs of the stock market.

While it is true that endowments grow through investment performance, reliable and significant growth of endowment funds occurs through gift income.

Gift income can be in the form of outright contributions or planned gifts made for future delivery.

Planned gifts are a great way to grow endowment funds. Individuals may include their organization in their wills, charitable trusts, gift annuities, pooled income funds, gifts of life insurance and many other forms of planned giving instruments.

We have incorporated a fund raising component with our investment experience to offer non-profit organizations professional investment management along with senior-level fund raising and planned giving expertise to help grow individual endowment funds.

When reviewing your current endowment and portfolio team, look not only at investments and performance, but at your organization’s ability to attract current and future gifts. Investment growth and gifts, working together, can help build your endowment into a valuable and sustainable resource for your organization.

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Stick with me here.

I fully realize that  “Stay the Course” is about as overused as most any investment cliche or jargon. Given the recent wild swings in the global stock markets, you’ve likely heard the phrase lately.

However, a recent report by Fidelity Investments just might help you keep your head, while others around you are losing theirs.

Because Fidelity is the leader in 401k and IRA plans (as measured by total accounts) they are able to study the actions and results of retirement plan participants.

After studying their participants behavior during the most recent market downturn, they were able to infer some interesting results.

In the study, they analyzed the returns of investors who maintained their portfolio allocations versus those who sold out of stocks between September 2008 and March of 2009 – the worst months of the last bear market.

Those who took their investment in stocks down to zero percent, and maintained that weighting through this June, saw an average increase in their balances of just 2%.

Those who took their investment in stocks down to zero percent, but then increased it at some point after, saw their accounts rise by an average of 25%.

Each example pales in comparison to those who “stayed the course”. For those investors, their 401k balances were 50% higher through June 30th of this year.

What’s even more striking are those investors who stopped making contributions during the worst months of the downturn. They saw their accounts rise by 26%, compared to those who kept contributing and saw balances rise by 64%!

We are clearly living in trying times. If feels like the market only moves up or down in 500 point swings. Further, nobody – not even those of us who do this for a living, can predict what will happen next week, next month, or later this year.

However, if you can go against the “advice” of the media, your coworkers, and friends who are telling you they sold out, you’re likely to come out of this crisis better off than if you succumb to the emotion of the day. It’s like Warren Buffett said, you “should try to be fearful when others are greedy, and greedy when others are fearful.”