Charitable lead trusts (CLTs) can be structured in a wide variety of ways. As a result, they are one of the more complex estate planning tools available. When well-structured to meet your individual estate plan, a CLT may significantly reduce your estate tax liability, while simultaneously benefiting a valued charity (or charities) for a number of years during your lifetime. Highlighted below are some key CLT concepts. For a full and complete discussion of CLTs and how they might fit into your estate and philanthropic planning, consider discussing the concept with your estate attorney or other tax advisor.
How CLTs Work
Under a CLT agreement, a designated charity receives an income interest for the lifetime of an individual living on the date the CLT is created or for a specified term of years. The income interest must be in the form of an annuity or unitrust interest.
The CLT must have at least one charitable income beneficiary, and one non-charitable remainder beneficiary. At the end of the CLT’s income term, any assets remaining in the CLT are distributed to the remainderman beneficiary(ies) (i.e., the beneficiary receiving trust assets at the time a trust income term ends).
If a CLT is structured so that for gift tax purposes a completed gift occurs at the time the CLT is funded, the CLT can be structured to produce a gift tax value close to $0.00. Because the gift tax liability occurs at the time a complete gift occurs, if the actuarially calculated value of the gift is near $0.00, no gift or estate tax is imposed at the trust income term ends even if the non-remainderman beneficiaries receive a distribution in excess of the calculated value. This is why CLTs are such powerful estate planning vehicles.
An Example of How CLTs Work
An example of how a charitable lead trust might work could be instructive:
Assume Mr. Jones, age 59, funds a charitable lead annuity trust with $500,000. The CLT has a 20 year term. He names a 501(c)(3) public charity as the income beneficiary, entitled to an annual annuity payment of $31,771.44 (6.3543% of the value of the cash transferred to the CLT). Mr. Jones’ daughter is the remainder beneficiary, entitled to any assets in the CLT when the charitable term interest ends in 20 years.
At the time the CLT is created, the applicable Internal Revenue Code interest rate used to actuarially calculate the value of a gift is 2.4%. For gift tax purposes, the gift to the Mr. Jones’ daughter is $0.14. Provided the CLT can earn an annual rate of return greater than 6.3543% during the CLT’s term interest, when the 20-year term interest ends Mr. Jones’ daughter will receive a distribution from the CLT. To the extent the amount received by Mr. Jones’ daughter exceeds the $0.14 taxable gift that occurred when the CLT was funded, the excess amount fully escapes estate and gift tax.
So, for example, if the trust earns an annual rate of return equal to 7%, at the end of the 20-year term the daughter will receive a $632,356 remainder distribution. For gift tax purposes, the gift is valued at $0.14.
CLTs and DAFs
Charitable lead trusts are excellent vehicles for funding a donor-advised fund account. When the trust’s annual payout is directed to a donor-advised account, the account advisor has the ability to recommend support of a variety of charities rather than being limited to supporting only those named in the trust agreement.
There is one important caveat, however. A CLT donor may not serve as the advisor on a DAF account that is the income beneficiary of a CLT. However, it is possible that members of the donor’s family or others close to the donor may serve in the advisor role. Though the CLT donor may not advise the donor-advised account, establishing a fund at a cause-related organization such as DonorsTrust will ensure a certain level of protection for the donor’s broader intent.