Charitable Estate Planning: A Reverse Charitable Bucket

Charitable Estate Planning: A Reverse Charitable Bucket

Article posted in Charitable Lead Trust on 27 June 2003| comments
audience: National Publication | last updated: 18 May 2011
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Summary

In a previous article from the Journal of Practical Estate Planning, Kansas gift planner Ronald D. Philgreen, CLU, ChFC shared the "charitable buckets" concept he developed to educate clients about charitable remainder trusts. What is a "reverse" charitable bucket? Click through and Ron will "lead" the discussion.

The following article appeared originally in the April/May 2003 issue of the Journal of Practical Estate Planning, published by CCH INCORPORATED.

by Ronald D. Philgreen

Ronald D. Philgreen, CLU, ChFC, is Founder and Executive Director of The Charitable Tax Planning Center, Inc., in Shawnee Mission, Kansas.

CCH INCORPORATED

A recent case brought to my attention a most powerful, but little used charitable tax planning strategy that should be looked at again, particularly in light of the current low charitable mid-term federal rates (CMFR) in the lowest interest rate environment we've seen in 40 years.

The Case

A national nonprofit organization that quite often refers its qualified donors to us for advanced charitable tax planning asked me to call upon a wealthy gentleman whose wife had read an article that I had written in the charity's monthly magazine. After sending him some preliminary information to catch his attention, and after he had revealed to me over the telephone that his primary concern was significant exposure to federal estate taxes, I flew to a first conference with him in his beautiful home on the West Coast.

This 82-year-old gentleman had availed himself of many good traditional and even charitable tax planning strategies already. He had a marital, nonmarital estate distribution plan-the classic "A" and "B" trust-as well as an irrevocable life insurance trust (ILIT) with $10 million of joint life insurance. He had utilized the annual exclusions for years and years, having gifted closely held stock in one of his companies to his children and grandchildren, which when sold a few years ago, made all of them multimillionaires. He even had a charitable remainder unitrust-albeit a 10-year fixed term trust that had only eight years left to go. Even after all of this, he was still looking at paying federal estate taxes at the top rate on his still sizeable taxable estate. Both he and his wife were uninsurable, and he was laboring with concern about how much of his lifelong work was going to be lost to taxes.

I told him on the phone that I thought I could help him, and then proceeded to demonstrate that to him when I got there. I call it a "Reverse Charitable Bucket" Strategy (which is my visual analogy language based upon my published educational video and DVD that teaches how a charitable remainder unitrust, that which we call "Charitable Buckets", works.) This strategy is the "flip-flop" or the "reverse" of a charitable remainder trust, and it works as follows.

chart 1
Chart 1 - A Reverse Charitable Bucket Strategy


A Reverse Charitable Bucket Strategy is a visual analogy for a nongrantor, nonreversionary charitable income lead annuity trust (what attorneys refer to as a Type 1 CLAT), which is designed to pay an annual income to charity for a term of years or the lifetime of one or more individuals. Upon conclusion of the measuring term, the trust assets are transferred to individuals other than the donor. (A Type 2 CLAT in contrast is a grantor, reversionary CLAT in which the trust assets revert back to the donor upon conclusion of the measuring term.)

The trust can be created during the lifetime of the donor or by direction of the donor's will. The purpose of creating a nongrantor, nonreversionary CLAT-what I call a Reverse Charitable Bucket Strategy-is to discount, for gift or estate tax purposes, the value of the asset that will eventually pass from the trust to the donor's heirs, usually the children.

When an individual creates a Reverse Charitable Bucket a gift tax deduction (not an income tax deduction) is generated, which is equal to the present discounted value of the income interest paid to the charity during the trust term. The value of the transferred asset less that gift tax deduction represents the portion of the principal that is subject to unified transfer taxes at the time of the funding of the trust, which in effect, takes into account the time value of money based upon the current CMFR-the value of the future remainder in today's dollars. The actual value of the remainder could be more or less, depending upon the actual yield and/or any income taxes that the trust might pay on its net taxable income (excess income over distributed dollars to the charity) over the years.

Look at the grid in the upper right hand corner of Chart 1. If John and Jan R. Donors were to make a living gift of say $1 million in cash into a 20-year Reverse Charitable Bucket with an eight-percent fixed "Spigot," and the remainder would go to their designated heirs 20 years downstream, the question is "What portion of that transfer would be subject to unified transfer taxes?"

If you go into the grid (which, in this article, is based upon the four-percent CMFR as of February 2003) and look at the portion that would be subject to transfer taxes with an eight-percent Spigot and a 20-year term, the number is zero, "zero percent." Therefore, the portion subject to such a transfer 20 years downstream would be zero. The charity would receive an eight-percent fixed income stream ("Spigot Income") for 20 years.

In this Reverse Charitable Bucket/CLAT, the income leads the way to the charity with the remainder going downstream to the children. Hence, the title charitable income lead annuity trust. (That's in contrast to the CRT-the charitable remainder trust/"Charitable Bucket" in which the income goes to the donors and the remainder goes to charity.)

That $80,000 annual flow of "Spigot Income" into the John & Jan R. Donors Family Foundation, for example, as a Global Gift Fund under the administrative and tax umbrella of the MDRT Foundation or a donor-advised fund under any public community foundation, could be used to build an endowment fund that could receive the $1.6 million of trust payments.

If the yield on the funds inside this particular Reverse Charitable Bucket was also eight percent, the corpus would stay even, and $1 million. would pass tax-free to the heirs 20 years from now.

This particular strategy could also be funded at the donor's death. And, for example, in this case, if the estate of $30 million was placed into a 20-year Reverse Charitable Bucket with an eight-percent Spigot, there would be no federal estate taxes, and the children would receive the remainder20 years downstream estate tax free. But they would have to wait for 20 years after dad and mom died to get the remainder. This caused some concern on the part of these clients. Note that the actual amount of the remainderm will be more or less dependant on the actual yield of the invested assets.

chart2
Chart 2 -- A Laddered Reverse Charitable Bucket Strategy


So, is there anything we could do to make this strategy a little bit more palatable to his heirs as well as the clients? The answer is yes-and it entails creating a series of nongrantor, nonreversionary charitable income lead annuity trusts, or a Laddered Reverse Charitable Bucket Strategy.

In the example in Chart 2, we set up four Reverse Charitable Buckets with eight-percent fixed Spigots, allocating 25 percent of the contribution to each of the four trusts, and structuring the terms of the trusts to be "Bucket #1"-5 Years, "Bucket #2"-10 years, "Bucket #3"-15 years and "Bucket #4"-20 years.

So Bucket #1 would pay eight percent of $250,000 to the Family Foundation for five years-a total of $100,000-and this Bucket would then turn upside down in five years, and the remainder would be distributed to the children.

Bucket #2 would pay eight percent of $250,000 to the Family Foundation for 10 years-a total of $200,000-and this Bucket would then turn upside down in 10 years, and the remainder would be distributed to the children.

Bucket #3 would pay eight percent of $250,000 to the Family Foundation for 15 years-a total of $300,000-and this Bucket would then turn upside down in 15 years, and the remainder would be distributed to the children.

Bucket #4 would pay eight percent of $250,000 to the Family Foundation for 20 years-a total of $400,000-and this Bucket would then turn upside down in 20 years, and the remainder would be distributed to the children.

The Family Foundation would have received over that 20-year period a total of $1 million, and the children would have received $1 million in four installments every five years after the death of mom and dad (assuming the yield was equal to the "Spigot Size"-eight percent per annum).

So how much of this transfer would be subject to federal estate taxes? You would go into the grid (see insert box in the upper middle of Chart 2) and calculate that portion of each of the four trusts that would be subject to unified transfer taxes. In this case, a total of $271,675 would be subject to taxes, and if this donor still had an unused equivalent exemption of $271,675 or more, no taxes would be payable.

You can take any size estate and by choosing any number of Reverse Charitable Buckets with any number of Spigot Sizes and changing the allocation into each of the Buckets end up with a taxable portion subject to unified transfer taxes equal to the unused equivalent exemption in the estate of the donors-and pay no federal estate taxes. Also, as the equivalent exemptions increase over the next seven years, these numbers look better and better with more monies sooner to the remainderman beneficiaries. The donor does not have to be insurable and therefore, you don't need the wealth replacement trust-an ILIT funded with life insurance to replace to the children what you're giving away to charity through the Charitable Bucket/CLAT or through a charitable bequest in the will.

I have one more idea for your consideration: how to perpetuate annual giving to your favorite charities forever. This does require insurability in connection with a Reverse Charitable Bucket Strategy, so this would not apply in the case at hand because, as noted, the clients were uninsurable.

chart3
Chart 3 -- A Reverse Charitable Bucket Strategy with Endowment Funding Option


Let's look at the same example that we used in Chart 1 with $1 million going into one Reverse Charitable Bucket with an eight-percent Spigot for a 20-year term.

Let's focus our attention on that eight-percent fixed Spigot Income stream of $80,000 per year. How about considering letting half of that income stream-$40,000 per year-flow right through the Family Foundation and be distributed to the designated nonprofit organizations, i.e., this example, $20,000 per year to their church, $12,000 per year to their alma mater, and $8,000 per year to their hospital. And this would occur each year for 20 years.

In the meantime, take the other half of the Spigot Income and use it to pay the premiums on a 20-pay-life insurance contract on the donor's life, owned by the Family Foundation-a straightforward bread-and-butter charitable life insurance contract. At the end of the 20 years, the Reverse Charitable Bucket would turn upside down, and the Spigot Income would cease. At that point in time, the three charities would have received $40,000 multiplied by 20 years for a total of $800,000. There would also be a paid up life insurance contract on the donor's life owned by the Family Foundation. When the insured dies, the Family Foundation could receive $1 million to create and fund an endowment fund, which might easily distribute four percent, or $40,000 per year to the same three charities-forever.

This same strategy can work with one Reverse Charitable Bucket and/or a Laddered Reverse Charitable Bucket Strategy as well.

In Closing

Hey you ... you estate planner, you financial planner, you registered investment advisor, you life insurance agent, you attorney, you CPA. Have you considered Charitable Tax Planning for your clients utilizing the Laddered Reverse Charitable Bucket Strategy? Come on in ... the water's fine.1




Copyright ©2003 by CCH INCORPORATED ("CCH"). Selected journal articles/columns from the Journal of Practical Estate Planning are provided under a license from CCH. All Rights Reserved. Copying without permission of CCH is prohibited. To order or obtain information regarding the Journal of Practical Estate Planning, please call 1-800-449-8114 or visit http://tax.cchgroup.com.


  1. One of the primary challenges facing any member of the legal, tax and/or financial services community when dealing with complex and complicated tools or techniques, such as charitable remainder unitrusts or charitable income lead trusts, is effective communication. For example, generic words created by attorneys, such as the word "unitrust" or "lead trust" do not communicate anything. And worse than that is the obfuscation created by acronymns, such as SCRUT or NIMCRUT or CLAT, which confuse and perplex and drive the normal individual to acrimonious distraction. No wonder so many professionals talk about charitable trusts, but very few actually ever "sell" one. The absolute key to my success in designing, selling and installing hundreds of charitable trusts is the visual analogy language and animated graphic images that have been incorporated into my published "Charitable Bucket" VHS Videos and/or DVD. When the client "gets it," he or she understands it and can then make a comfortable decision to implement the strategy. Accordingly, this article is written using this analogy language rather than the more technical legal terminology. You can order a free copy of the "Charitable Bucket" VHS Video or DVD at www.charitablebuckets.comback

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