Helping parents accomplish financial and charitable objectives

One in four parents between the ages of 70 and 79 is charitably inclined and one in two care about leaving a financial legacy as part of an estate plan, according to a survey conducted earlier this year by Mathew Greenwald & Associates.

The survey, sponsored by Hartford Financial Services Group, also found that 59% of parents believe it is important to help children improve their lifestyles. But accomplishing both charitable and family objectives simultaneously, especially when clients have other pressing financial needs such as retirement income, can seem practically impossible for all but the ultra-affluent.

It need not be so, especially if parents work with a skilled planner who understands the value of combining a charitable remainder trust (CRT) with variable universal life insurance. A CRT can help a client achieve multiple financial goals such as generating income, avoiding capital gains taxes on highly appreciated assets and making a tax-deductible gift to a favorite charity. Adding VUL to the mix can help a parent replace the value of a donated asset in his or her estate or even enhance the amount passing to heirs.

Variable universal life insurance policies have charges such as premium-based loads, cost of insurance, administrative and issue charges, and surrender charges. These charges are different for each product and some may vary by age, gender, face amount, underwriting class, premiums and policy durations. These charges will have a significant impact on policy account values.

VUL policies also have a mortality and expense risk charge and underlying fund operating expenses that include fund management fees and 12b-1 fees, if applicable. These expenses also have a significant impact upon policy account values.

Together with the additional charges, these expenses are reflected in each product’s prospectus and should be reviewed with your client. Policy account values for VUL policies vary with actual underlying fund performance. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost.

The best way to understand the dynamics of combining a CRT and a VUL policy is to consider an example. Let’s help the fictitious Martha Pillsbury, a 68-year-old widow with three children and one grandchild.

Martha owns a large tract of Vermont farmland that has been in her family for many years, originally as part of a former dairy. Although Martha generates a small income from haying her now cow-free fields, she could sell her property for $1 million to a developer who has built several new neighborhoods around her.

Martha could use additional income to travel more often, including trips to visit with her children. But selling her property would generate a substantial capital gains tax and reduce the amount she could reinvest for income. That’s a shame because Martha would like to make a meaningful gift to her church and leave a financial legacy for her family.

CRUT Consultation

After consulting with a local financial professional, Martha learns that she can use a special type of CRT–a charitable remainder uni-trust (CRUT)–to accomplish her goals. Finally, Martha’s cows have come home.

She decides to gift the $1 million worth of land to the CRUT. The trustee sells the land and reinvests the proceeds in a diversified portfolio, earning an estimated 7% annually. Since the CRUT will benefit a charity–Martha’s church–the sale does not generate capital gains.

The CRUT stipulates that Martha receive 7% of the fair market value of the trust annually for life, approximately $70,000 in the first year. Current law requires that the income beneficiary be entitled to at least 5% of the initial fair market value of the gift.

The charity’s remainder value–the trust’s value upon Martha’s death–must be estimated to be no less than 10% of the initial fair market value. The actual income paid by the CRUT will fluctuate annually according to the value of the trust’s underlying assets.

In return for her generous gift, Martha receives a federal income tax deduction of approximately $407,000 for the estimated CRUT value. The deduction is based on IRS formula with a Sec. 7520 rate of 4.8%. The deduction is subject to the overall limits of adjusted gross income. Unused portions may be eligible for a five-year carryover.

Upon Martha’s death, her church receives the remainder value of the CRUT. But what is left for Martha’s family?

VUL for Wealth Replacement

A critical part of Martha’s charitable planning strategy is to establish a legacy for her loved ones. To do so, she must be able to replace most, if not all, of the value of the land gifted to the CRUT. Using a CRUT in conjunction with an irrevocable life insurance trust (ILIT) for wealth replacement can help protect the value of her estate for her beneficiaries.

Martha uses part of the $70,000 income generated by the CRUT to make gifts to the ILIT, which purchases a variable universal life insurance policy on her life. The policy’s death benefit is $1 million, equal to the value of her land. No federal gift tax will be due because her premiums are less than her annual gift tax exclusions.

The VUL policy provides several benefits for both Martha and her family. First, the cash value within the policy can be allocated to a wide range of investment options, providing broad diversification. Because many of the investment options are equity based, the cash values are exposed to the growth potential of the stock market. If the market performs well in the long term, Martha’s beneficiaries could receive an enhanced death benefit.

Before speaking with her financial professional, Martha had fretted that she would never be able to accomplish her financial goals for herself, her family and her church. Learning about the benefits of a CRUT, especially when combined with a VUL policy, opened a new world of financial possibilities for her.

Patrick Smith, J.D., CLU, is assistant vice president and director of advanced markets for the Individual Life Division of The Hartford Financial Services Group, Simsbury, Conn. He can be reached at Patrick.smith@hartfordlife.com.

A Charitable Remainder Trust can help a client achieve multiple financial goals