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Financial Planning > Trusts and Estates > Trust Planning

Lead By Example While Leaving A Legacy

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A charitable lead annuity trust can be a useful tool in reducing the value of a client’s taxable estate while providing financial assistance to the charity of choice. A CLAT functions similarly to a charitable remainder annuity trust, except that the current payments are made to the charity instead of the trust grantor. Grantors of CLATs not only benefit charities, they also benefit themselves and their families both financially and philanthropically.

Meet the Browns

The Browns, both age 60, have an estate currently worth over $5 million, which includes $1 million of highly appreciated stock. The Browns are avid supporters of a local charity that is dedicated to environmental preservation, and they make substantial gifts to this cause each year.

They would like to continue such gifting for the remainder of their lives–and longer, if possible. While the Browns could establish a charitable remainder trust, they would prefer to maintain gifts to the charity initially, with their 2 children receiving their inheritance later.

Their children are ages 32 and 35, and Greg and Judy want them to continue working and building successful lives. At the same time, Greg and Judy do not want their children to wait until they are gone to receive their inheritance. Instead, the Browns would like to witness some of the joy an inheritance will bring. Ideally, the Browns would prefer a plan that would permit them to stagger payments to their children.

The Browns seek the counsel of an advisor and decide to create an inter-vivos, non-grantor, charitable lead annuity trust and fund it with the stock. The process starts with the irrevocable transfer of the asset to the CLAT. Unlike a transfer into a CRT, the Browns will not receive an immediate income tax deduction and the trust itself is not exempt from taxation. After the transfer, the trustee is free to sell the assets and invest the proceeds.

Within the trust document, the Browns determine how much money, as a fixed dollar amount, will be paid to the charity each year. Each year thereafter, as distributions to the charity are made, the trust receives an income tax deduction for such amounts.

Since the trust is not exempt from taxation, the trustee should make investment choices that will not unduly burden the trust from an income tax perspective. Once assets transfer to the trust, the Browns will face the immediate burden of either paying a gift tax or at least filing a gift tax return for the gifts to their children. However, they will also be eligible for a gift tax deduction against this amount for the present value of the distributions that eventually will be paid to the charity.

After further discussions with an advisor, the Browns create 3 CLATs of different durations. This will allow the Browns to continue their current gifts to charity while achieving their desire to stagger payments to their children.

CLAT #1 has a duration of 10 years and is to be funded with $250,000 of stock. The trust will terminate near the time when the adult children may need additional funds to pay for the educational needs of their own children.

CLAT #2 has a duration of 20 years and is also funded with $250,000 of stock. Termination of this trust should coincide nicely with the pre-retirement plans of the Browns’ children.

CLAT #3 has a duration of 30 years and is funded with the remaining $500,000 of stock. These proceeds follow termination and should provide the children with a comfortable retirement supplement.

Once the CLATs are created, appropriate investments need to be chosen. While stocks and mutual funds are often used, the purchase of an annuity and life insurance may fit well in the CLAT due to their tax deferral attributes. The annuity can provide a source of current income, and a life insurance policy can provide a tax-free death benefit while currently leveraging trust dollars.

CLATs #1 and #2 use traditional investment strategies, including an annuity, for income. CLAT #3 uses traditional investments, plus an annuity and life insurance policy, with the trust as beneficiary.

Result: The Browns have successfully reduced their taxable estate while providing a benefit to the charity of their choice and to their children. If the Browns do not survive beyond the termination of CLAT #3, a portion of the benefit received by their children is the tax-free death benefit from the life insurance policy.

If the Browns survive the terms of any of the 3 trusts, they will have the privilege of seeing both the charity and their children benefit from their planning, even though the premiums for life insurance may still have to be paid. Finally, after both Browns have passed away, their children will receive any additional assets determined by Greg and Judy via wills, trusts and beneficiary designations.


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