How a flexible tool, the charitable remainder trust, helped one wealthy man honor his daughter's memory
When choosing the best gift vehicle for clients interested in philanthropy, it's important to see their whole picture. Rather than look at only two or three dimensions like the client's age, wealth or type of property, the most successful planners learn to see and accommodate the fourth dimension: the intangible.
Every charitable gift is made up of various combinations of five motivations: emotion, religion, politics and social theory -- as well as tax and economic benefits.
Knowing how to discern the mix in a given situation and how to plan in ways that satisfy the fourth dimension is the key to helping donors continue to give large amounts.
How does this play out in the real world?
Consider the case of Alex. (Note: this story is real, but names and some facts have been altered to protect identities.)
Alex, age 70, is a very successful businessman who recently sold his company, swapping his company's shares for $25 million of publicly traded stock of the acquiring company. Years ago, his daughter died unexpectedly while still in her 20s. Alex wants to make a sizeable gift in her memory using funds that he would otherwise have left to her. He has decided to create a permanent endowment fund in her name at the private secondary school that she had attended.
Alex is thinking of giving about $5 million to a school whose total endowment is just $10 million. So, his gift would instantly increase the endowment by 50 percent. That's quite a jump.
Alex has been a board member of the school and is aware that one of the school's greatest needs is for unrestricted reserve funds. But he's also concerned that the school has too few procedures to determine how to properly steward a gift of this kind. At a spend rate of 5 percent, the proposed endowment will generate in the range of $250,000 annually.
Ideally, Alex would like to fund the endowment now using the low-basis stock, have the school sell and diversify on a tax-free basis, and for himself generate an income tax deduction to help offset tax on his $1 million-plus annual income. But given his concerns about the school's governance, he'd also like to attach some strings to the endowment, including keeping the ability essentially to revoke the gift if he's dissatisfied with the board's endowment spending policies.How can he achieve all his goals?
The answer is: with a charitable remainder trust -- one of the most flexible of all gift planning tools. A CRT can be used to make larger gifts on a temporary or provisional basis. For example, donors like Alex can use a CRT to make a very significant contribution gradually over time in order to see how the charity utilizes those funds -- before the donor makes a permanent commitment.
How this CRT Will Work
Suppose Alex were to fund a $5 million charitable remainder unitrust (CRUT) with a payment to him of 5 percent of the value of the trust assets each year.
He then makes a pledge to the school of $250,000 per year for five years.
He plans to make the pledge payments using all, or a portion, of the amount he anticipates receiving from the trust. He will make up any shortfall from other sources. The trust is designed to last for his lifetime or 10 years, whichever is shorter.
Alex will report the income from the trust each year -- much of it as capital gains taxed at a federal rate of 15 percent under the tier structure of income reporting. But this income then will be deducted, creating a virtual wash for tax purposes. How's that possible? Well, because the trust is irrevocable, Alex is entitled to an income tax deduction of some $3.3 million in the year of his gift. After taking into account the 30 percent of AGI limit on charitable deductions of appreciated property, he will be able to take a deduction in the range of $550,000 in the year of the gift and up to five successive tax years.
Although the trust is irrevocable, it is drafted in such a way that Alex retains the right to change the charity that will receive the remainder.
So, when Alex notifies the school authorities of his "endowment," he also lets them know they're guaranteed the income from his "provisional endowment" for only five years and that he's under no obligation to continue the payments beyond that point. He can change the remainder of the trust at any time.
If at the end of five years Alex is satisfied with the school's performance vis a vis his donated funds, he could choose to give up his right to any further income from the trust and thereby cause it to terminate. In so doing, he'd permanently fund the endowment. This move would give him an additional charitable deduction of about $1 million.
If he is unhappy with the way the endowment has been handled, he can renew his annual gift commitment for one or more additional years, cease distributions to the school entirely and enjoy the income for his use in other ways, or change the remainder interest to one or more other charities -- informing those other charities that they'll receive a very nice gift in no more than five years!
The effect of Alex's gift to the school is to create a $5 million "endowment" on a provisional basis that gives the donor a large degree of control for the period he desires. From Alex's point of view, he's satisfied his primary objective: to memorialize his daughter. He's also achieved some immediate tax relief, effectively removing the funds in the trust from his taxable estate. Yet at the same time, he's also dealt with his concern that the school might not be able to handle a gift of this size.
From his financial advisor's point of view, Alex has diversified his position from a single stock and has no capital gains tax due at the time of sale. Such a move may be increasingly attractive should a new administration raise that tax rate. Also, Alex has created a new fund of $5 million that the financial advisor can manage within the trust for as long as 10 years. From the advisor's perspective, that's certainly preferable to overseeing the immediate transfer of $5 million to the school's endowment to be managed by others.
Keep in mind, also, that if Alex dies prior to 10 years and has not made any changes in the remainder recipient, the school will receive the corpus of the trust immediately. Alex is comfortable with that possibility, as he does not want to burden a successor trustee or others with judging the school's performance.
What complicated situations involving potential gifts and intangible factors are sitting on your desk?
Might any of them be solved by the flexible CRT?