An old philanthropic planning technique is ready to explode in popularity. Parents have long used charitable lead trusts to make tax-free gifts to their children while using philanthropy as a way to prepare them for wealth. But as life expectancies rise and people become wealthier sooner, this obscure trust is enjoying a renaissance among young millionaires.
Affluent families used to either inherit wealth or earn it over a long career. Today, most wealthy individuals are self-made and an important subset, especially in the technology sector, is making millions before starting a family. Those who inherited wealth in the past often did so while building their own financial security. Now, some do not receive their inheritance until they are comfortable or even retired.
Most people know that the Internal Revenue Service provides an income-tax deduction for charitable donations. However, astute philanthropic planning can help minimize or avoid gift and estate taxes, and allow parents to pass assets on to their children during life in a tax-efficient way.
A lead trust allows a donor to put assets into trust and promises to make gifts from the trust to charity for a number of years. At the end of the trust term, the donor's children receive the remaining principal. The longer the trust and the higher the percentage given to charity, the lower the gift tax due on the transfer to the children.
Families can use these trusts to make large gifts to their children while they are still young. A trust set up on a child's fifth birthday could be designed to transfer $1m or more on the child's 25th birthday - free of tax. Many people find this far more useful than transferring money at death.
Many lead trusts name a single charity to receive the annual gifts. These grants may replace gifts the donor was already making or add to the amount of their annual giving.
One technique is to make the annual gifts to a donor-advised fund (DAF), a "charitable checking account" from which the donor can direct gifts to non-profit organizations of their choice. This set-up works well if the parents want to involve their children in the philanthropic process. Research shows that children involved with their parents' philanthropy from a young age handle money more responsibly. The time spent discussing which non-profit organizations are important to the parents and which causes the children care about are an opportunity to share family values.
Another twist on this technique is to let the gifts accumulate in the DAF and then put the child in charge of the fund at the same time they receive the disbursement when the trust terminates.
Parents are able to use the combination of the charitable lead trust and the DAF to channel both personal capital and social capital to their children, while educating them about how to handle wealth and give back to society.
In the book Heirs & Values: How Successful Families Are Using Philanthropy to Prepare Their Heirs For Post-transition Responsibilities, (Robert D. Reed Publishers, February 2005) authors Roy Williams and Vic Preisser write that their study of affluent families shows that philanthropy holds the key to families remaining unified and financially successful across generations.
Charitable lead trusts are most attractive in times of low interest rates. The lower they are, the larger the value the IRS places on the annual charitable gifts made and the gift tax due on the remaining principal is lower. While the financial crisis has had many negative consequences, one positive outcome has been a large drop in the interest rate the IRS uses to assess the taxability of charitable lead trusts.
Today's climate is ripe for an explosion of new charitable lead trusts. Too often people think of their charitable giving as somehow separate from the rest of their wealth. In fact, if philanthropic giving is an ongoing part of your life, your giving plans should be an integrated part of your wealth management.
By leveraging powerful tools you can give more to the causes you care about while enhancing your own financial wellbeing.
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