‘Win-Win-Win’ Planning With Charitable Remainder Trusts

For years in the life insurance community, it seemed that charitable planning was much like the weathereveryone talked about it, but nobody did anything about it. In recent years, however, financial, economic, and social changes have resulted in a growing awareness and utilization of charitable planning techniques, particularly charitable remainder trusts.

The basic structure and operation of charitable remainder trusts are relatively simple. The donor creates an irrevocable trust with a written document, and transfers cash or other property to it. For a period of time chosen by the donor (lifetime or a stated term not exceeding 20 years), the donor or others (e.g. spouse or children), or both receive income payments from the trust at a rate chosen by the donor. At the end of the income period, the trust assets are transferred to the qualified tax-exempt organization(s) designated by the donor, which may include a private family foundation.

The trust can be designed as a Charitable Remainder Annuity Trust (CRAT) or a Charitable Remainder Unitrust (CRUT). Under a CRAT, the income payment is a stated percentage of the initial value of the trust assets, whereas under a CRUT, the income payment is a stated percentage of the current value of the trust assets when the payment is made.

A CRAT is simpler to administer and the income payments are predictable, but no additional contributions to the trust are permitted, and the purchasing power of the income payments may be eroded by inflation.

A CRUT is more complex to administer and income payments may fluctuate, but additional contributions can be made in the future, and it is more likely that the income payments will keep pace with long-term inflation.

A variation of the unitrust is the “Net Income with Make-Up” Charitable Remainder Unitrust (NIMCRUT). Ordinarily, the income payments from a CRT must be at least 5% of the trust assets, and the payments must be made at least annually. Under a NIMCRUT, the income payment can be the lesser of the stated percentage, or the actual income of the trust. Therefore, if the trust produces no current income, then no income payment is required.

Additionally, if the actual income payment in any year is less than the stated percentage, the cumulative deficit can be made up in future years.

Charitable remainder trusts have several tax advantages. The donor receives a current income tax deduction for a portion of the value of the assets transferred to the trust. Generally, the deduction will range from 30% to 70% of the value of the assets, depending on the amount and duration of the income payments and other factors.

In addition to the income tax deduction, the full value of the transferred assets will be deductible for purposes of federal gift and estate taxes. If the value of the transferred assets is greater than the donors cost basis, the donor will not have to recognize any gain or pay capital gains tax, and the untaxed gain will not be considered an item of “tax preference” for purposes of the alternative minimum tax.

If the CRT sells the appreciated asset, it will pay no capital gains tax because it is tax-exempt, thus resulting in more investable assets to produce income payments.

CRTs also have other financial advantages. If the donated asset produces little or no income (e.g. undeveloped real estate), the trust can sell the asset and invest the proceeds, which combined with the income tax deduction often results in a substantial increase in the donors after-tax income.

If the donors investments are heavily concentrated in only a few securities (for example, stock or options in the donors employer), greater diversification can be achieved by transferring the securities to a CRT, followed by the sale of the securities and re-investment of the proceeds in a more diversified portfolio.

CRTs have a great deal of tax and financial “sizzle,” and weve all heard the adage that if youre trying to sell a steak, you talk about the sizzle. However, theres a corollary that is often overlooked: Before you talk about the sizzle, make sure the person is not a vegetarian.

There are many motivations for charitable gifts that dont involve tax or financial “sizzle”–philanthropy, altruism, personal beliefs and values, community involvement and recognition, ego, etc. Unless some or all of these factors are present, the individual may be a charitable “vegetarian” and will not be motivated by the “sizzle.”

Assuming a person is not a charitable “vegetarian,” there are myriad planning opportunities with charitable remainder trusts that can effectively accomplish various financial and philanthropic objectives.

A technique that is gaining popularity among “baby boomers” is the use of a NIMCRUT as an “IRA Alternative” for additional lifetime savings for college funding, supplemental retirement income, or other lifetime needs.

The donor establishes the trust and makes regular, periodic cash contributions to it. By properly structuring the CRTs investments to produce minimal current income, the donor can postpone receipt of income payments to a later date, at which time the cumulative “make-up” payments, or regular income payments, or both can be received. A deferred annuity is an ideal investment for this type of NIMCRUT because it can act like an income “faucet”by taking (or not taking) withdrawals from the policy, the trustee can control both the timing and amount of income payments to achieve the donors specific needs and objectives.

A creative planning technique for closely-held business owners is a CRT “bailout.” If a business owner anticipates the eventual sale of the business interest to someone (e.g. children, co-owners, another company, etc.), rather than selling the business interest directly, the owner can transfer the interest to a CRT, and the trustee can sell the interest to the successor.

In either case, the desired successor will own the business interest, but with the CRT “bailout” the owner receives a current income tax deduction, eliminates federal transfer taxes on the value of the business interest, achieves greater diversification, and creates a stream of income that will not depend upon the future financial success of the business.

To achieve the desired tax results, there must not be a pre-existing, legally enforceable obligation to sell the business interest prior to transferring it to the CRT, and if the business is an S-corporation, the election will be terminated and “pass-through” status will be lost.

Because assets donated to a CRT ultimately will be transferred to organizations, life insurance in an irrevocable insurance trust can be used as a cost-effective and tax-efficient way to preserve or enhance the inheritance passing to family members and other heirs. The concept of “wealth replacement” life insurance, coupled with the use of deferred annuities in NIMCRUTS, have created tremendous sales opportunities for those able to capitalize on them, making charitable remainder trusts a “win-win-win” situation for clients, organizations, and insurance professionals alike.

David A. Scott, J.D., CLU, is assistant vice president, advanced sales for Penn Mutual Life Insurance Company, Horsham, Penn. David may be reached via e-mail at Scott.David@

pennmutual.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, December 3, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


Copyright 2001 by The National Underwriter Company. All rights reserved. Contact Webmaster