Insurance professionals have long been familiar with the myriad uses of life insurance in estate planning, particularly for charitable gifting. Less appreciated is the role that deferred annuity contracts can play in charitable planning.
One application for deferred annuities is as a funding vehicle for a special type of charitable remainder trust, known as a net income make-up charitable remainder trust (NIMCRUT). A NIMCRUT is a variation of the well-known charitable remainder unitrust.
The charitable remainder unitrust has long been a popular tax-planning vehicle for wealthy taxpayers with strong charitable interests. Appreciated property may be donated to the trust, and then sold, with no capital gains tax. The reinvested proceeds can be invested in a diversified portfolio to fund distributions to the donor and/or spouse for a fixed term of years or life.
In addition, the donor receives a partial tax deduction based on the age of the beneficiaries (or duration of the trust, if other than a life payout), the payout rate of the trust, and the prevailing federal interest rate, also known as the AFR or 7520 rate.
Many wealthy donors, however, dont need distributions paid by the CRUT for current living expenses. While they are unwilling to give up the right to receive the income in the future, they dont need it now. Also, they still must pay taxes on the distributions as they are paid out.
A NIMCRUT is one solution to this dilemma. Unlike a standard CRUT, which can make distributions from both income and principal, a NIMCRUT distributes only income generated by the trust assets. If trust income is not sufficient, the unpaid income is accumulated in a make-up account.
The idea is to invest the trust initially in assets that produce little or no income. When, and if, the donor desires distributions to start, the trust can be reinvested in assets that produce a high amount of income, which can be used to cover current distributions, plus distributions from the make-up account.
The advantage to the donor: He or she can take little or no income now, yet have the flexibility to generate a higher amount of income later, when needed.
NIMCRUT assets are commonly invested in a deferred annuity contract. Since the annuity pays no income currently, distributions are not paid to the beneficiary. The unpaid distributions accumulate in the make-up account. If the beneficiary wishes to start taking distributions years later, the annuity can generate the income at that time, funding both the regular distributions and the distributions from the make-up account.
As with any CRT, remaining trust assets go to the designated charity upon the beneficiarys death. The make-up account, if not depleted, will produce a higher amount for charity.
A donor who is concerned about the assets not going to the family can purchase a life insurance policy in an irrevocable life insurance trust (ILIT). In the early years, the donor would fund the premiums from personal assets. Later, the NIMCRUT could fund premiums through distributions.
To illustrate the merits of a NIMCRUT relative to a unitrust, consider Mary C., a 70-year-old widow with substantial assets and who is the beneficiary of her late husbands deferred compensation plan. For the next 10 years, she will receive $60,000 per year from the plan, after which the payments will stop. This income, combined with Social Security, pension and investment income, is more than adequate for her present needs.
Mary has a strong interest in supporting local charities. Yet she is reluctant to commit large sums to the charities today, for fear of falling short of her personal needs after 10 years, when the deferred compensation payments stop. Marys family history suggests that she might have a longer than normal life expectancy, so her assets may need to support her for a long time.
A traditional charitable remainder unitrust is one option she might consider. Table 1 illustrates the basic results of establishing such a trust with a $1 million gift of highly appreciated stock that she inherited years ago.
Because she used appreciated securities to fund the trust, Marys deduction for the current years is limited to 30% of her adjusted gross income; the balance is carried forward for the next 5 years. Marys CPA has indicated she will be able to absorb these deductions, based on her present income.
Her CPA also has pointed out that the income from the charitable trust currently will be taxable to her. Each year, the trust assets will be re-valued, and she will be paid 6% of whatever the trust is then worth. Depending on the nature of the income earned by the trust, Marys distribution will be taxed as ordinary income, dividends or capital gains. The CPAs concern is that Mary will be taxed on income she does not presently need.
As an alternative, Mary can consider the NIMCRUT. Table 2 illustrates the results.
As with any unitrust, Marys payments will depend on the performance of trust assets. While 7% was assumed for illustrative purposes, her actual results will vary, and may be higher or lower than shown here.
In summary, by using a NIMCRUT, Mary gets the benefits that she needs today, namely a sizable tax deduction, avoidance of capital gains tax and the satisfaction of knowing that she has made future provisions for her favorite charities.
In addition, she can trigger income from the trust when and if she needs it by re-allocating from low or no-income producing assets to high income producing assets.
A nonqualified, tax-deferred variable annuity is one vehicle for funding a NIMCRUT. Since no current income is generated by a deferred annuity, no current income is payable to Mary. When Mary wants to start taking income, she can redeploy readily the annuity assets into income-generating assets.
, CFP, ChFC, CLU, is senior vice president and manager of the Rockefeller Center Complex in New York City for Advest, headquartered in Hartford, Conn. He may be reached at [email protected].
Reproduced from National Underwriter Edition, December 10, 2004. Copyright 2004 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.