Charitable Planning Tools

Charitable gift annuities are contractual agreements between a donor and a charity, in which the charity receives funds and in return promises to make lifetime payments to the donor or to designated beneficiaries. The charity invests the funds, and at the death of the last beneficiary, the residuum will pass directly to the charity.

When incorporated into estate plans, the testamentary annuity is generally funded with tax-encumbered (IRD) assets, and the actual gift annuity agreement is typically structured with a charitable foundation instead of the specific charity. Utilized in this manner, the gift annuities can eliminate the IRD tax on these assets, remove a portion of the assets from the estate for tax purposes, and at the same time provide a benefit to heirs during their lifetimes.

To accomplish this, testamentary gift annuity agreements (typically one for each beneficiary) would be made between you and a charitable foundation during your lifetime. Your estate documents would specify that the gift annuities would be funded upon your death and stipulate that they be funded through tax-deferred retirement assets (or any IRD assets) to the extent these assets are available. The annuities would provide a source of income to personal beneficiaries for their lifetimes. The actual income paid would be based upon the size of the gift annuity, the age of the beneficiary, and prevailing interest rates. It is important to note that most foundations that administer gift annuities set minimum gift thresholds of at least $10,000 per annuity.

A charitable remainder trust is a charitable trust that makes payments to specific beneficiaries for their lifetimes or for a term of years, after which the remainder interest in the trust benefits specified charities. There are many types of charitable remainder trusts. For simplicity, here we will only address the testamentary charitable remainder unitrust (TCRUT).

When incorporated into estate plans, the testamentary trust is created within the estate documents, which typically stipulate that the trust be funded at death, with tax-encumbered (IRD) assets to the extent that these assets are available. The trust will pay out a prescribed percentage of the trust value annually to the heirs. This percentage and the duration of the payments are determined in the estate documents. The trust assets grow tax-free, and the TCRUT gives the estate an estate tax deduction on a portion of the assets that go into the trust. After the prescribed period of time for payments to heirs, the trust is terminated and the remaining balance is distributed to the designated charity or charities.

With a TCRUT many people choose to pay family members for a period of time that results in a total amount equal to the initial value of the property. For example, a trust that pays 7% for fifteen years will supply family members with income equaling approximately the initial fair market value of the property. By this method, the donor is able to double the total benefits from the property: once to the family through income payments, and once to charity through distribution of the principal after all income payments are completed.

One advantage of the charitable remainder unitrust is that the amount remaining in the trust grows tax-free. For example, if a person selected a 6% payout trust and the trust investments earned 8%, there would be 2% growth tax-free each year. This tax-free growth could substantially increase the value of the trust over time, and since the selected 6% payout is based on this value, distributions to personal beneficiaries would increase proportionally.

The ability of the unitrust to increase both in principal and in income payments over a period of years is frequently referred to as an inflation hedge. However, please understand that this benefit does not come without risk. In the above example, if the growth in the trust falls short of the payout (6% in this instance), the income payments to beneficiaries would actually decline with time.

In assessing the utilization of charitable remainder trusts, PhilanthroCorp generally recommends that this option only be considered if at least $100,000 is available to fund the trust; administrative expenses will likely negate much of the benefit otherwise.

A charitable lead trust (CLT) is often described as the reverse of a charitable remainder trust because the interests going to the charitable and non-charitable beneficiaries in a CLT are the opposite of those in a CRT.

With a CLT, you transfer assets to the trust, which pays one or more charities an income stream for a specified period of time. When that period of time ends, the remaining trust property returns to you or goes to other non-charitable beneficiaries, such as your spouse, children, grandchildren, or anyone else you name in the trust.

The lead trust is an excellent means for transferring principal to family members at a future time and saving substantial estate taxes while effecting this transfer. The donor directs that a portion of the estate be set aside into the lead trust. For the selected term of years, the trust pays income to charity; then, the principal is distributed to family members. Since a substantial income payment will be made to charity, a very large estate tax charitable deduction can be made.

The donor selects the initial trust payout percentage, the term of years, and the percentage of the estate to allocate to the trust. The initial lead trust payout percentage is multiplied by the initial net fair market value, and this amount is distributed to charity for that year. If there is any appreciation or accumulation in excess of the income amount, this can be retained in the trust and will eventually be passed through to family members. The Treasury tables are used to value the charitable deduction based upon the annuity percentage and the term of years selected. For many lead trusts, one-half to three-fourths of the initial value of the trust may be taken as an estate tax charitable deduction. In fact, these can be structured in such a manner that the full value of the initial trust can be taken as a charitable deduction.

The major benefit of the lead trust is the ability to transfer appreciating property to family members at a very low tax cost. The property is initially valued as of the date of creation of the trust, and as noted above, the trust may enjoy a very substantial charitable deduction. If the property appreciates substantially during the term of years, the value distributed to family members may be very much greater than the initial value of the trust. Many families have used lead trusts to transfer very large and valuable properties to family members at little or no tax cost. This trust is often used in conjunction with other trusts that provide income (such as a charitable remainder trust) while the family is waiting for the lead trust principal. It can be a truly dramatic way to pass great wealth to family members with little or no estate tax cost.