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| Path: Main Street : Resources & Library : Research Articles : Feature Article |
Cash in on market volatilityby Craig Stevenson, CFP
We have been hearing stories lately about people who have made huge gains in the stock market and then decided to share their good fortune with others in the form of charitable donations. For example, in early March, Louise MacCallum and her husband Michael Barnstijn decided to do something to help the Kitchener and Waterloo Community Foundation. The two retired employees of Research in Motion Inc. donated US$13 million in RIM shares after seeing the stock price soar in a round of frenzied buying. That single contribution instantly doubled the Foundation's endowment fund.
While your donors may not be in the same category as these two individuals, there have been many smaller fortunes made (and lost) in recent stock market activity. If you have donors with hearts as big as their investment portfolios, there are opportunities to turn paper gains into cold hard cash for the client and the charity.
Lets look at a more typical situation as an example. When her husband passed away, Mrs. Lotta Money (not her real name) inherited shares in ABC Inc., a company listed on the Toronto Stock Exchange. She has no plans for cashing in the shares, which have an adjusted cost base of $14,000 and a market value of $110,000, since she depends on the annual dividends of $1,000 to meet her retirement income needs. Mrs. Money is 71 years old and in excellent health. Since her two adult children are financially well off, Mrs. Money wants to "spend her kids' inheritance" to get the most out of life for herself. She also wants to make a substantial gift to a charity that is near and dear to her. What should she do?
A. Bequeath $110,000 cash to the charity after liquidating the securities.
B. Bequeath the shares to the charity.
C. Sell the shares now and donate the cash.
D. Donate the shares now.
E. Sell all of the shares and use the cash to purchase a charitable gift annuity.
F. Transfer all of the shares to the charity in return for a charitable gift annuity.
G. Transfer a combination of cash and shares to the charity in return for a charitable gift annuity.Assumptions: Tax on ordinary income is 45%; tax on dividend income is 30%; dividends and market value remain constant; gift annuity option commences payments in 2001.
I would choose option G. I would recommend cashing in shares worth $15,000, using the proceeds to purchase a charitable gift annuity, and donating the other shares worth $95,000 to the charity. The chart below illustrates the impact on the donor's income, income taxes and gifting ability for each of the choices.
Choice
Annual Income
Tax on Annual Income
Immediate
Tax on Capital GainImmediate Tax Credit
Deferred
Tax on Capital GainDeferred Tax Credit
Charitable Gift
A
$1,000
$300
Nil
Nil
$28,800
$49,500
$110,000
B
$1,0001
$3002
Nil
Nil
$14,400
$49,5004
$110,0005
C
Nil
Nil
$28,8003
$49,5004
Nil
Nil
$110,0005
D
Nil
Nil
$14,4006
$49,5004
Nil
Nil
$110,0005
E
$7,370
Nil
$28,8003
Nil
Nil
Nil
$27,500
F
$7,3707
Nil
$28,8003
Nil
Nil
Nil
$27,5008
G
$1,0057
Nil
$16,364
$42,750
Nil
Nil
$98,750
Benefits to the donor:
- Slightly more annual income.
- The gift annuity provides a guaranteed source of lifetime income.
- There is no tax on the annuity income.
- There is a net tax benefit in the current year of over $26,000 (tax on capital gains minus tax credit) that the donor can spend, invest or donate as she pleases.
- Paper gains are converted to cash.
- There is the satisfaction of seeing the gift put to use during the donor's lifetime.
- There are no probate taxes with regard to the gift.
- There is less risk of a court challenge by family or creditors than there is for a testamentary gift.
Benefits to the charity:
- An immediate gift of $98,750 instead of a deferred gift of $110,000.
- The gift amount is known and not subject to uncertain future events.
(Note: A variation of this plan might also include the sale of a life insurance policy in the charity's name. The policy could be funded directly by the tax savings. Alternatively, the tax savings could be used to purchase a second annuity that funds the premiums on the life insurance policy.)
Summary
Understanding the donor's objectives is critical to helping them decide on the gift plan that is best for them. In this case, Mrs. Money wants to live well and leave a substantial gift to the charity. Her kids' welfare is not a concern as they are already well off. If her goals were different, the best choice may also be different.
Footnotes
[1] Annual dividend income from ABC Inc.
[2] $1,000 x 30% = $300
[3] ($110,000 - $14,000) x 2/3 x 45% = $28,800
[4] $110,000 x 45% = $49,500
[5] Value of shares or cash equivalent.
[6] ($110,000 - $14,000) x 1/3 x 45% = $14,400
[7] Based on the Schedule 3 gift annuity rates recommended by the Canadian Association of Charitable Gift Annuities.
[8] Charities retain at least 25% of the amount contributed by the donor and use the rest to fund the obligation to the donor.
[9] ($28,800 x $15,000 / $110,000) + ($14,400 x $95,000 / $110,000] = $16,364
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