In tough economic times when everyone's focused on keeping what they have, giving freely is still important. Already, charities are feeling the pinch that comes with a severe recession, and many parents are wondering just how much they'll be able to pass on to their children. Since it's likely that you're focused on staying afloat—and working with less money—it's important to find the most efficient ways to give. With help from Debby Cochran, a lawyer and estate planning specialist at Cochran and Owen in Tysons Corner, Va., U.S. News offers advice on how to make sure your giving goes exactly where you intend with the least amount of hassle:
1. Giving to your children. Everyone wants to provide for their children and luckily, using gifts to transfer wealth is fairly straightforward.
The basics: Giving gifts to your children is a way to distribute your estate without taking a huge tax hit. But it's important to start early, since there are limits on how much you can pass on each year. If you're married, a couple can give up to $26,000 tax-free to as many individuals as they'd like each year (the limit is $13,000 for gifts from singles.) Above that limit, gifts are still tax-free but they count against a lifetime gift exemption of $1 million per individual as of 2009. Gifts over that limit can also overlap with estate taxes, and you'll have to file a Form 709 gift tax return. If you expect to hit that $1 million limit in your lifetime, Cochran says now might be the time for some extra giving, since assets that have fallen heavily in value lately but could later recover are counted at their market price at the time of the gift.
Consider a loan: Straightforward gifts are great, but for larger amounts, it might be a good time to consider a loan. Right now, low interest rates in general mean rates on inter-family loans are at rock-bottom levels: as little as 2 percent for medium-term loans (three to nine years) with longer-term loans in the still-cheap 3 percent to 4 percent range. Rates are usually set by the Applicable Federal Rate, published monthly by the IRS here. If loans are set at or above those rates, they can be given without incurring incurring gift taxes. If, for example, you son or daughter need a $300,000 loan to by a house, you can lend them the money at the low rate and then forgive the debt tax-free at the gift rates mentioned above. Bottom line: Family loans have a tax advantage and better rates than most banks are offering at the moment. "You can get rid of appreciation tax-free," Cochran says. As for finding a lender, inter-family loans are available online through "social-lending" sites like Virgin Money for relatively modest fees.
[See if a family loan makes sense for you.]
Unlimited gifts: One last reminder about other tax-free gifts: There's no limit on gifts that go toward educational expenses or medical bills as long as the gifts are paid directly to the educational institution or hospital rather than the individual.
2. Giving to Charity. Recessions almost always hit the philanthropic sector, and this one is no exception (although a recent USA Today/Gallup poll showed some surprising resilience among many Americans). "I feel bad for charities because people are so nervous right now," Cochran says. Here are two not-so-obvious ways to donate:
Retirement accounts: If you give an IRA or other retirement account to your family, they'll pay income taxes on it eventually. Charities, on the other hand, are exempt from such taxes. Plus, new laws passed under last year's economic stabilization bill reinstated some advantages for giving IRAs. Specifically, if you're over 70 1/2, you can give up to $100,000 directly from your traditional or Roth IRA before the end of this year. The fine print: You have to give to a public charity, not a charity's pooled income fund or to set up a new charitable trust, and you'll need a "substantiation receipt" to show the IRS.
Charitable lead trusts. Lead trusts work like this: You set up a trust that makes income payments to a charity, with the remainder returning to your heirs after your death or at a pre-determined time. Trusts that make regular payments to charities are becoming more popular as donors try to fulfill existing commitments and rebuild nest eggs, Cochran says. Lead trusts can cut gift and estate taxes substantially, although there's no income tax help when you set one up. Such trusts are more popular now since they give battered assets time to recover before returning to your heirs and they maintain a commitment to charity. They're essentially the opposite of charitable remainder trusts, which give heirs those regular payments with the remainder eventually going to a charity.