Juggling Appreciated Assets and Bequests

During your lifetime, donating appreciated assets to charity can make sense. As long as you have held those assets for more than one year, you’ll get a deduction for the assets’ current value. The paper gain will avoid income tax.

Example 1: Ava Fitzgerald wants to donate $10,000 to her favorite charity this year. Instead of writing a check, Ava donates $10,000 of stock that she bought years ago for $4,000. Ava receives a $10,000 tax deduction for the donation and the $6,000 gain is never taxed. At the same time, Ava leaves her traditional IRA untouched, for ongoing tax deferral

Reversing course: When Ava prepares her estate plan, she decides to switch tactics. Ava intends to make a much larger bequest to her favorite charity, but she will not use appreciated assets for this donation from her estate. Instead, she will make this large bequest from her traditional IRA. Why the change? Consider the following scenario, which would have been the case without a switch.

Example 2: At Ava’s death, her only assets are a $100,000 traditional IRA and $100,000 in appreciated stocks. She leaves her traditional IRA to her son Brad and her $100,000 of appreciated assets to charity.

After Brad inherits the traditional IRA, he will have to pay income tax on all distributions from that IRA. If his effective income tax rate is 40%, Brad’s net inheritance will be only $60,000 (60% of $100,000) after tax.

Instead, Ava could make the switch mentioned previously, leaving her $100,000 traditional IRA to charity and the $100,000 of appreciated assets to Brad. The tax-exempt charity would not be affected because it can withdraw all the money from Ava’s IRA and not owe any income tax.

Brad, on the other hand, would be much better off inheriting the appreciated assets. Under current law, those assets would get a basis step-up to fair market value on the date of Ava’s death. Brad could sell those assets for $100,000 and owe no tax.

Learning About Mutual Fund Share Classes

Although some mutual funds are “no load,” meaning that there is no sales charge, others are load funds, with some type of sales charge. Many load funds have multiple share classes, with various compensation arrangements. If you’re buying a fund that has more than one share class, you should know which is best for your style of investing.

Upfront fee In general, mutual fund “A” shares have a front-end load that’s deducted from your initial investment.

Example 1: Wayne Goldbug invests $20,000 in Mutual Fund XYZ, which offers several share classes. This fund’s A shares have a 5% sales commission, which Wayne pays immediately. Therefore, the initial charge is $1,000 (5% of $20,000), and Wayne has $19,000 of XYZ shares in his account.

Obviously, starting with a lower account value will hinder your returns. On the other hand, A shares usually have no charge when they’re sold, so shareholders have more flexibility in their investment strategy. In addition, 12b-1 fees, which are ongoing charges for distribution and other services, tend to be relatively low for A shares.

In our example, Wayne intends to hold onto XYZ for many years. He is willing to pay an initial charge in order to have no further sales charges and reasonable recurring costs.

Pay later, not sooner

Investors who prefer to invest $20,000 to buy $20,000 worth of mutual funds might select B shares. These shares impose other charges, though.

Redemption fee. B shares usually have a contingent deferred sales charge (CDSC), which investors pay if they sell within a certain period of time.

Example 2: Terri Smith does not want to pay upfront fees, so she buys B shares of fund XYZ. The fund will impose a 5% CDSC if Terri sells within 1 year. Over time, the CDSC will decline gradually to 4%, 3%, etc. After 6 years, the CDSC will disappear.

Higher 12b-1 fees. B shares may charge the maximum 12b-1 fee of 1% per year. In our example, Terri will pay that fee for 6 years. At that point, when the CDSC no longer applies, Terri’s B shares will become A shares, with an annual 12b-1 fee of only 0.25% a year.

Short-term solution

Yet another option is to buy C shares. Not only will you have all your money working for you at the start, you’ll soon be free of redemption fees.

Example 3: Stan Roberts puts his money into the C shares of fund XYZ. He accepts a 1% CDSC that will disappear after one year. Stan realizes that C shares charge a maximum 1% 12b-1 fee, year after year, but he doesn’t expect to hold fund XYZ for very long. Stan believes that if he sells the fund after holding for a year or two, he will have paid less in fees than he would have paid with A or B shares.

Our office can help you determine which share class of a chosen mutual fund will be best suited for your investment goals

Loading Up  

To figure the gain or loss on a sale of mutual fund shares held in a taxable account, you must know the cost basis of those shares.  

If there were no sales charges, the cost basis is your purchase price.  

If you paid fees or commissions at the time of purchase, they are included in your basis.  

Say you purchased 100 shares of a fund at $9.50 per share and paid an upfront sales charge of 5%, or $50 on a $1,000 outlay. The total cost would be $1,000, and the cost basis for each share would be $10.