Estate Planning: The N+1 Strategy
In the Spring 2007 issue, we wrote on estate planning issues in the modern era. We mentioned the attitude towards wealth as viewed in ancient Greece, where the wealthy had a moral and societal duty to help fund projects that benefited society at-large. We closed with the modern thought that estate plans could add one residue beneficiary in one’s will, designated in some fashion as the public good, which we’ll call the “n+1” strategy. In other words, for instance, one’s three children would receive 3/4ths of the estate and the other 1/4th would go to “society”. While the hyper-wealthy often do this, e.g. endowing universities with vast sums (sometimes in exchange for a “naming” tribute), we believe that the middle class could do so as well.
An estate donation strategy is particularly productive when the deceased leaves a large RRSP/RRIF, which is otherwise wholly taxed at death (assuming no surviving spouse or dependent child). A case study is a recent example in our practice. The deceased father left an estate to his three surviving children with a principal residence of $1.2M and a RRIF of $800,000. The former is tax-free and the latter is fully taxable. The death tax on the RRIF depends upon some other real facts, however, we’ll use the least-tax scenario, which would be approximately $333,000 (the most-tax scenario would be approximately $348,000). So, the after-tax estate to the family would be approximately $1,667,000, or $556,000 per child. If the “n+1” strategy was used in the will, there would be a charitable donation of $500,000, which would generate a large tax break to mitigate the tax on the $800,000 RRIF. The after-tax estate decreases by the $500,000 gift but increases by the tax saving. The net result is an after-tax estate of approximately $1,385,000, or $461,000 per child. In the end, the $500,000 donation cost the heirs approximately $281,000.
Another aspect to this is the law related to making charitable donations in-kind, rather than in cash, e.g. donating a security. We have written on this in the past and the article can be referenced on our website. In summary, the law creates an incentive to do this and relieves from tax the entire capital gain that you would have had, had you sold the security first and then donated the cash proceeds. Lets consider this in the previous case study. Imagine that the deceased also had an investment portfolio of, say, $200,000, of which half had become unrealized gains over the years. The entire estate in this case is now $2.2M. The extra death tax on this would be approximately $22,000. Thus, the higher estate value to the heirs is the extra $200,000, less the $22,000, or $178,000. But now, lets revert to the “n+1” strategy AND direct that the charity, which mow receives $550,000, will receive the investment portfolio worth $200,000 plus $350,000 in cash. While the heirs must now give up an extra $50,000 to the charity, the tax saving is substantial because a) the capital gain of $50,000 is excused from tax AND b) the full extra $50,000 donation receives a large donation credit. The result is that the after-tax cost to the heirs of the extra $50,000 is in fact only $6,300. The cost to the heirs of the entire $550,000 donation is only $288,000, slightly more than half the endowment.
This “n+1” estate planning strategy leaves a double legacy, one to the public good of charitable giving and one to your young heirs, for whom you set an example of melding private gain and public good.