The Reluctant Benefactor

I met Ruth (not her real name) in 1999.  At that time she was a widow with two adult sons, and her estate was comprised of a home worth roughly $1 million and $2 million of Coca-Cola common stock that she and her husband had purchased in the 1960’s for less than $20,000.  When her husband died in 1994, she cashed in his entire 401(k) plan that she had inherited to pay off her mortgage, but the stock was always intended to be passed on to her boys.

When I asked her about her income she told me that she was living off Social Security ($12,000/year) and the dividends that the Coca-Cola stock was paying – roughly $40,000 a year. She told me that she would really like to do more traveling but her combined income of $52,000 made it tough.

Now I had a number of concerns – not least of which was the fact that, with all of her investment assets concentrated in one stock, she had no diversification and was exposing herself to some significant risk. But, if Ruth sold the stock just for the purpose of diversifying her portfolio, she would incur a capital gains tax of over $400,000!

But Ruth had another problem she wasn’t even aware of.  In 1999 the Estate Tax exemption was $600,000 per person. That meant when she died, the first $600,000 of her estate would be exempt from tax, but the remainder ($2.4 million) would be taxable to her sons at a rate of roughly 50% – or $1.2 million in Death Taxes! And those taxes would be due within nine months . . . in cash! So, it was highly likely that, after inheriting the $2 million of stock, the boys would have to sell 60% of that stock in order to satisfy the Estate taxes that would be due.

But I had an idea that I thought would help.

I asked Ruth if she was charitably minded . . . and she said, “Not really.”  I asked if she belonged to a church and she told me that she had been a member of the same church for years.  I got the name of her pastor and made an appointment to see him.  When I met with him I asked if he might be interested in a gift from one of his members of $2 million!! Amazingly, he was!

What I suggested to the pastor was that Ruth would do a “trade” with his church.  She would give him the $2 million of Coca-Cola stock if he agreed to put that money into a trust and give her an income of 6% of the value of that trust for the rest of her life, and that, when she died, the church would then keep the remainder of the money left over. This is known as a Charitable Remainder Trust and is a great tool to help people in a situation like Ruth’s.

Once the church received her stock, it was able to sell it immediately and avoid paying any capital gains taxes (churches and charities are not subject to taxation).  We were then able to reinvest the proceeds inside this new trust and truly diversify this portfolio. Now, Ruth’s annual income went from $52,000 to $132,000!  Plus she effectively reduced her taxable estate from $3 million to $1 million, lowering her expected estate tax from $1.2 million to $200,000. Not only that, but she received a significant charitable deduction on her 1999 tax return as well.

Over the years Ruth enjoyed this much greater income and used it to do all the traveling that she dreamed of.  She died a few years ago and left her estate to her boys.

But, wait a minute.  Weren’t they supposed to inherit her Coca-Cola stock?  Well, once she gave it to the church that option was no longer available.  What we did back in 1999, however, was to use roughly $17,000 of her new, higher annual income and we purchased a $2 million life insurance policy on Ruth’s life and placed it outside of her estate inside a Life Insurance Trust (no estate tax!). And the beneficiaries of the policy? You guessed it, her two boys!

So now, not only did the church receive a sizeable gift when she passed (roughly $2.2 million), but her sons also inherited $2 million completely tax-free (insurance proceeds are always tax-free), along with her home.

* These are case studies and are for illustrative purposes only. Actual performance and results will vary. These case studies do not constitute a recommendation as to the suitability of any investment for any person or persons having circumstances similar to those portrayed, and a financial advisor should be consulted.