Tuesday, April 28, 2015

A Plan to Avoid Capital-Gains Taxes


The woman’s late husband left her a portfolio of telecom stocks he had bought in the 1940s. It was worth $2 million dollars and had a cost basis of $600,000.

She wanted to use the portfolio for income during her lifetime, and then leave some of the money to her daughter as well as her favorite charity when she died.

But upon reviewing the portfolio, the adviser identified a more pressing problem than planning for its distribution. “My immediate fear was that she was in her 60s and 100% of these stocks were all in one sector,” Mr. Welch says.

He thought that the situation opened the woman up to risk should prices in the telecom sector fall. “But if we sold the stocks she would be stuck with a lot of capital-gains tax,” he says. The adviser devised a plan that addressed both his client’s concerns and his own with a charitable remainder trust.

When Mr. Welch suggested this trust, the estate-tax exemption was below $2 million. It was a good tool for an estate this size, says the adviser, and remains so for estates worth more than the current $5.43 million exemption for individuals.

The woman felt an emotional attachment to the telecom stocks and wanted to leave half of the shares to her daughter. So the adviser suggested that she place $1 million in a charitable remainder trust, and then sell the shares. The CRT would allow the woman to avoid paying $140,000 in capital-gains tax.

The woman could use the proceeds from the stock sale to create a diversified portfolio of stock and bonds. The investments would generate returns of about 7% a year, or $70,000, which the woman could use to fund her living expenses along with her Social Security benefits, pension and some savings she had in certificates of deposit.

Finally Mr. Welch suggested that his client put $17,500 of that income each year toward a $500,000 universal life-insurance policy, which would be held in an irrevocable trust for her daughter. The policy would help pay off any taxes the daughter would owe when she eventually inherits half of the telecom shares.

The adviser explained that the woman could name the charity of her choice as the beneficiary of the trust, and upon her death whatever money was left in the trust would go to the charity.

The woman agreed to the plan, happy to find a vehicle that would take care of her concerns while giving her an income from a diversified portfolio during her lifetime—as well as a charitable tax deduction.

When the woman died from cancer years later, her daughter inherited the $500,000 life-insurance policy and the shares. The client had decided to leave the remainder in her trust to the hospice organization that took care of her while she was sick. The organization received about $750,000.

“If you’re charitably inclined, a charitable remainder trust is a really good vehicle if you had an asset with a really low cost basis,” Mr. Welch says. “But the part that was really neat was being able to watch the daughter hand deliver a check to the organization that had been so important to her mother.”