Case Study: Using a Charitable Lead Trust to Meet Multiple Personal Planning Goals

Case Study: Using a Charitable Lead Trust to Meet Multiple Personal Planning Goals

Case study posted in Charitable Lead Trust on 21 July 2009| comments
audience: National Publication | last updated: 18 May 2011


Nongrantor charitable lead trusts are designed to pay an income stream to charity for a term defined in the trust instrument with the remainder interest passing to noncharitable remainder beneficiaries, often the trustor's children, upon termination of the trust. This case study describes how an inter vivos nongrantor charitable lead annuity trust can be used creatively to accomplish many of the trustor's philanthropic and estate planning objectives.  

The Facts

Tom Jackson, 49, has been recently divorced. He has two children, ages 16 and 14. The childrens' current needs will be adequately provided for through child support, so Mr. Jackson feels no need to provide more to his children at this point in their lives. He would, however, like to assure that his children receive a nice gift from him in their early 30s at a time when it might be helpful to them after they have already had an incentive to get a good "start."

Mr. Jackson, an only child, has inherited wealth from several sources and has done quite well financially.  He has a net worth of over $15,000,000 following the divorce. He has been asked to consider funding a chair as his commitment to a capital campaign at his alma mater.  This will require an amount sufficient to assure earnings of $75,000 per year.

A Solution

It is suggested that he consider a charitable lead annuity trust (1) funded with $2,000,000 that will pay 7.5%, or (2) $150,000, for a period of 17 years. One half of the annual payment, or $75,000 would be used to immediately fund a chair. The remainder of the annual payment would be used to create a permanent endowment for the chair.

At the end of the 17-year period, (3) the two children would receive $1,000,000 each, assuming the trust has achieved a total return of 7.5% or more each year. If the trust earns less, they will "inherit" less. If it earns more, they will receive more with no additional gift or estate tax due on the excess. If they receive appreciated assets at the termination of the trust, they will hold appreciated property with the same basis as the property had when owned by the trust.

The lead trust will pay out $150,000 per year.  If, as Mr. Jackson directs, half of that amount were used to fund the chair and the remainder were placed in an endowment fund that paid out 3% per year and grew 4.5% per year, the following would result:

Note that as a result of this plan, Mr. Jackson is providing for outright gifts of $1,275,000 to the University over the 17-year period. These gifts will not "flow through" his income tax return and will thus not be subject to 30% or 50% limitation rules. The endowment fund would receive the same amount and grow to $1,939,131 over that period of time, while distributing some $442,754 in income over the period the trust is in existence. At the end of 17 years, the University could switch the spend rate on the endowment to 3.9% and produce $75,000 per year, effectively replacing the $75,000 in annual payments that would cease with the termination of the lead trust. If a portion of the earnings of the endowment was used to supplement the annual $75,000 payment, and the remainder added back to principal each year, the endowment could produce enough to protect the income stream for the chair from inflation in perpetuity.

Mr. Jackson has completed a $2,000,000 taxable gift to his children at the time the trust is funded. Given the relatively low federal discount rate (2.4% at the time of completion of his gift), (4) the deduction for the charitable interest in the lead trust is slightly more than $2,000,000 resulting in no gift tax being due.

Mr. Jackson and his children would arguably be better off financially if no gift were made, but through structuring the gift in this way, he has provided for the gift he would like to make to the University, while assuring that his children will receive a nice gift in their early thirties, or sooner if he desired.

Many persons in Mr. Jackson’s situation now have substantial sums of cash available to fund charitable lead trusts after liquidating investments in securities over the past few years. Others still have significant amounts of assets in the form of highly appreciated properties that yield little or no income and would not be “missed” from an income standpoint if used to fund a charitable lead trust.

Aside from the numbers above, might it make sense in light of capital gains tax rates as low as 15% to transfer highly appreciated assets to a lead trust and, in effect, pay a transfer tax of 15% on a portion of the value of the property rather than 45% on all of it.

Disclaimer: This case study is intended to provide information of a general nature only and is not intended to provide legal, accounting, investment or other professional advice. Persons mentioned within this case study are fictional with any resemblance to real persons, living or dead, coincidental. Tax law rates and federal discount rates used in examples are based on those rates in effect at the time of publishing. Those viewing this case study should always check for latest tax and other relevant state and federal laws and regulations prior to completing charitable gifts.

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