04/30/99

The Charitable Trust

Yes, it can be advantageous to give your money away. No, I am not speaking of how your gift will lift your spirits as you help humanity. I am actually saying that you can improve your financial situation by making a charitable gift. At this moment, many of you may think I am dreaming. However, I assure you that what you are about to read could prove advantageous to you at this time or in the future.

As the title indicates, I am going to explain the Charitable Trust. There are Charitable Lead Trusts and Charitable Remainder Trusts with variations of each. For the sake of simplicity, I am going to explain and show you the financial benefits of using a Charitable Remainder Unitrust.

Alan and Sue Wright (fictitious names) both age 56, had a piece of land valued at $250,000 (or other highly appreciated asset -- stocks, vacation home, etc.) which they wanted to sell for a variety of reasons. However, if they sold the property (assets), they would have had to pay capital gain taxes. The taxes would have diminished their net cash from the sale and not provided them with the amount of principal they wanted to supplement retirement income. Furthermore, the Wrights are not fond of paying taxes.

What did Alan and Sue do? Simple, they gave the property to a Charitable Remainder Unitrust. The trust sold the property without incurring capital gains. Upon giving the property to the trust, they were entitled to a current income tax deduction for the future value of the gift. (The amount of the income tax deduction will vary with the payout rate the trust is scheduled to pay and the expected term of the trust.) However, the income tax deduction was significant, giving the Wrights an immediate financial benefit. They were also very pleased to have avoided the capital gain taxes!

They established a joint life trust. So the trust invested the proceeds from the sale and now pays income to both Alan and Sue for the remainder of their lives. Given that the land was not generating any income, Alan and Sue have increased their cash flow giving them greater immediate financial freedom. How much does the trust pay? Upon establishing the Trust, Alan and Sue had the option of choosing the percentage payout rate of the trust. The minimum payout rate allowable is 5%, which is the option they selected. The trust will be revalued annually, and the Wrights will receive 5% of that value every year. In projecting a modest growth rate of the trust corpus over their joint life expectancies, they could receive a total of over $750,000 from the trust. (Income from the Trust is taxable.) Could the Wrights’ have selected a higher payout rate? Yes, they could have chosen a rate between 5% and 50%. However, many high payout rates fail the 10% minimum charitable remainder value requirement.

Another advantage of making the gift is that the Wrights have removed the future value of the land from their estate, possibly reducing future estate taxes. The future value of the land could be $500,000 by the end of their lives, and depending on their overall estate size, removing this amount could be a very beneficial consideration. If the value of the land were greater , the potential estate tax savings could be tremendous. This estate reduction comes because a Charitable Remainder Trust is irrevocable. Once established the donor(s) cannot change their minds and take the asset back.

The Wrights made this transaction for financial reasons, but most transactions of this nature are made for charitable reasons. Yes, Alan and Sue have made a charitable gift in giving the land to the charitable trust and the "remainder" -- the value of the trust at death of the last survivor, will go to a charity or charities of their choosing. They may change the name of the charity or charities at anytime. The lower the payout rate chosen by the donors, the greater will be the remainder available for the charity and vice versa. With any rate choice, the remainder value of the trust should be substantial, and the charity will certainly be thankful and recognize this gift immediately upon learning of it. (The Wrights may or may not choose to notify the charity of the trust at inception.)

At this point you now realize that the charity gets the remainder value of the assets, and the Wrights heirs -- their children in this case -- do not. However, they anticipated this and they used the additional income from the trust to purchase life insurance within an irrevocable life insurance trust. The trust holds a life insurance policy in the amount equal to the future value of the asset. When they die, the children as beneficiaries if this trust, will get the full appreciated value of the land, via the life insurance, income and estate tax fee.

Alan and Sue may have elected a Net Income Unitrust, in which the trust only pays the net income earned. This election has two advantages. First, the trust does is not subject to a payout while the land is being sold and their is not income generated. Second, they could have limited income from the trust if the assets were all invested for maximum capital appreciation resulting in the actual net income being below the pay out rate. Many donors choose to do this in the early years when income is not needed, then switch the investments to income producing assets later.

In summary, by giving the land to the Charitable Remainder Unitrust, the Wrights have realized many advantages. They have:

- increased their current income,

Please send questions or comments to dcoffin46333@wradvisors.com.