By Van Pate, Wealth Strategist at RBC Wealth Management-U.S.
Every year, graduation season brings with it a spate of articles on the crushing debt students and parents take on to fund higher education. The numbers are indeed staggering.
According to the Federal Reserve, student loan debt in the United States now exceeds $1.36 trillion. Average indebtedness for graduates of four-year programs is more than $33,000, and seven out of 10 students have at least some sort of loan to repay when they finish.
Student debt is considered such a problem that an increasing number of colleges no longer include loans in the financial aid packages they offer, though many families still turn to the private market for financing.
While many argue that the rising cost of a college education is an issue for individual families to address, others see it as a societal problem, which, if not solved, could have a broad and lasting negative impact.
That’s likely why we are seeing a growing number of affluent and high net worth individuals elect to steer a portion of their charitable giving dollars toward the funding of higher education scholarships, whether that be at their alma mater, local university or college with which they may not have any ties.
For many families, the availability of these scholarships is critical and often the only way their child is able to afford school. As a former college admissions and financial aid officer, I have witnessed this firsthand.
Today, after 30 years in the wealth management business, I also know that if structured properly, these gifts can have significant tax and financial benefits for the donor as well.
Funding a scholarship? Here’s where to start
If you want to create a scholarship in your family’s name or to honor a former professor, it’s likely to take something in the $1-million range to fully endow a scholarship that will cover a student’s expenses at a $50,000-a-year college. Most endowment managers assume they can spend 5 percent per year and still maintain growth, so $1 million allows them to spend $50,000 a year; $500,000 would produce $25,000 a year, and so forth.
Those are big numbers, and not everyone is prepared to make that sort of commitment, but there are alternatives. First of all, not all colleges cost $50,000 a year, and secondly, scholarships don’t have to provide a full ride. Many are established to cover just tuition or to fund a special research opportunity or to offset the cost of study abroad. And of course, you don’t have to do everything all at once. You can endow an educational fund over a period of years or even arrange for the bulk of the funding when you die.
Think before you write that check
Many people automatically reach for their checkbook when it’s time to make gifts to charity, but most financial advisors will tell you there are more efficient ways of gifting. Donating $10,000 of appreciated securities will provide the same tax benefits as making a gift of $10,000 in cash, even if your original cost was only $500 or $1,000. As long as you’ve held the investment for at least 12 months, you’ll still be able to deduct $10,000, you will avoid capital gains tax on the appreciation, and you can hang on to your cash and use it for living expenses or other investments.
Cash and appreciated securities are easy choices for charitable donations, but in some situations, other assets may provide greater benefits. A valuable piece of art, the mythic “30 acres out by the airport,” or maybe even an insurance policy you no longer need might be the perfect choice – in the right circumstances. There’s even a way for donors who meet a certain age requirement to make charitable gifts directly from an Individual Retirement Account, or IRA.
Retirement plan participants are required to start taking distributions from their plans once they reach age 70.5, and in most cases those distributions are 100 percent taxable as ordinary income. Some people really resent being forced to tap their retirement accounts, especially if they don’t need the money or if they might end up in a higher tax bracket as a result of the distribution. Fortunately, recent legislation allows direct distributions of up to $100,000 a year from IRA accounts to charity, as long as you’ve reached that magic age of 70.5. The donor does not get an income tax deduction for the direct distribution, but also does not have to recognize the income, possibly avoiding what accountants call “bracket creep.”
Create your own charitable fund
Many donors will establish a donor advised fund, or DAF – think of it as a low-cost, low-hassle alternative to a private foundation – through a financial services firm or a community foundation and use it as the primary distribution point for annual gifts. Some of those gifts could be used to support students in a particular department or field of study. Simply notify the custodian of your DAF that you would like to make a grant to the chemistry department at your favorite university, or that you would like to add to the scholarship fund your graduating class established at its 20th reunion.
In fact, you can put those gifts on auto-pilot, so that if you should die unexpectedly, the DAF will continue making gifts in the future. Gifts to a donor advised fund, including gifts of appreciated assets, provide the same tax benefits as a direct gift to the institution.
Certain gifts offer both a tax write-off and an income to the donor – for life
Colleges and universities that have healthy finances and substantial endowments sometimes offer charitable gift annuities as part of their development plan. The donor transfers cash or appreciated assets to the college in exchange for the institution’s promise to provide an annual income to the donor for life. When the donor dies, what’s left in the pot goes to the school for whatever purpose the donor and institution agree upon, and could fund a new scholarship or be added to an existing endowment. Annual distributions – and an immediate income tax deduction – are based on the size of the gift and the donor’s life expectancy, so older donors will receive more generous payouts and a larger tax deduction than younger ones.
Most institutions that offer gift annuities are looking for minimum gifts in the $10,000 to $50,000 range, but for donors who can commit half a million or more, a charitable remainder trust (CRT) could be a better alternative. In concept, it’s very similar to the gift annuity, except in this case the donor transfers appreciated assets to an irrevocable trust rather than directly to the college or school. The trust provides an income for life – usually 5 or 6 percent of the annual market value of trust assets – and when the donor(s) die, the assets remaining in the trust go to designated charities, which could include your favorite college or a donor advised fund that will support it for many years.
Since the CRT is irrevocable, and since all the assets will go to charity at death, the trust itself is a tax-exempt entity. That means it is possible to diversify even highly appreciated assets without having to recognize an immediate capital gain, leaving the entire amount for reinvestment. As is the case for a charitable gift annuity, the donor receives an immediate income tax deduction when the CRT is established. Again, the amount of the deduction is based on life expectancy, and older donors enjoy bigger write-offs than younger ones.
Reduce estate tax liability with a charitable lead trust
Another trust technique called a charitable lead trust, or CLT, makes distributions to charity for a period of years, and then the trust assets come back to the family when the trust terminates. It is possible to structure a CLT to provide an upfront charitable deduction, assure a steady income to a scholarship program or donor advised fund, and ultimately transfer assets downstream to family or friends with little or no gift or estate tax liability. A CLT can be ideal for families that want to support charity and who also need to minimize estate tax liability.
Sometimes simple is best
These trust techniques may seem complicated, but there are some really simple things you can do that can also have a major impact.
For example, you can fund a scholarship or DAF at death by including appropriate language in your will or revocable living trust. And you can accomplish the same thing with beneficiary designations that will transfer retirement accounts or payable-on-death accounts to a fund that you set up during your lifetime, or that comes into effect when you die. Retirement accounts are an especially good choice for gifts at death, since educational institutions or donor advised funds do not have to pay income tax on distributions they receive from tax-deferred accounts, whereas individuals do.
At over $1.36 trillion, no one person is going to solve the national student debt problem – not even Warren Buffett or Mark Zuckerberg. But every dollar students receive in grant aid is a dollar they don’t have to borrow. Talk with your financial advisor or a development officer at your favorite college about how you can help. You might be surprised at the kind of impact you can have and at the very real benefits such a gift can create not just for the recipient, but also for the donor.