Combining Charitable Lead and Remainder Trusts to Create a Temporary and Permanent Endowment

Combining Charitable Lead and Remainder Trusts to Create a Temporary and Permanent Endowment

Case study posted in on 31 July 2009
audience: National Publication | last updated: 20 May 2014
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Abstract

Charitable remainder trusts and charitable lead trusts are often used independently to accomplish a broad variety of personal and philanthropic planning objectives. In this case study, we see how these trusts can be used in combination to provide substantial current annual gifts to charity, a large remainder gift that will fund an endowment, and a large tax-free gift to the donor's heirs.

Facts

Charles Swenson, age 78, has been asked to consider a significant naming opportunity. Guidelines call for a $10 million gift to name a particular building. Charles has no children. His wife recently predeceased him. He is interested in naming the building for himself and his wife.

The Goal

As part of his plans he would also like to leave a significant fund to eventually be split among his grand nieces and nephews.

The Solution

After working with the institution and his advisors, Charles decides to (1) transfer $10 million to a charitable remainder unitrust that will (2) make payments to him of 5 percent of the value of the trust corpus each year for a term of 20 years or his lifetime, whichever is shorter. He thus creates a stream of income for himself that will last until his death, but in no event would the institution have to wait more than 20 years to receive the remainder of the trust.

Charles funds the trust with highly appreciated, low yielding securities. The securities will subsequently be sold by the trust and reinvested by those who had assisted Charles with investment advice in the past.

If the trust earns a total return of 8 percent and the donor lives for his ten-year life expectancy, his income would grow from $500,000 the first year to some $671,000 over that time and the (4) institution will receive more than $13 million at his death. Because of the future charitable gift, Charles is entitled to an immediate (3) income tax deduction of more than $6.5 million.

The Lead Trust

At the same time the unitrust is funded, (1) Charles transfers $10 million to a charitable lead annuity trust that will make annual (2) payments to the institution of 8 percent, or $800,000 per year for 20 years. At the end of 20 years, the balance of the lead trust will be (3) transferred to Charles’s grand nieces and nephews at its then market value.

While Charles must report a gift of $10 million to his heirs at the time the trust is created, he is entitled to an (4) offsetting charitable deduction of $10 million, resulting in no taxable gift.

When the dust settles, the institution will have named the building in exchange for a “temporary endowment” in the form of the charitable lead trust that pays $800,000 per year for 20 years. If institution policies called for a 5 percent spend rate on its endowment, this amount would be equivalent to immediately increasing its endowment by some $16 million.

If the donor lives to his life expectancy of 10 years, the institution will receive over $13 million from the remainder of the unitrust at his death. Remember that in no event will the institution have to wait more than 20 years for the unitrust to terminate. Whenever the unitrust terminates, even if Charles lives to the age of 98 and the trust does not terminate until the end of 20 years at the same time as the lead trust, the “temporary endowment” represented by the lead trust would be “replaced” by a permanent fund consisting of the amount received from the termination of the unitrust. At the end of 20 years, the CRUT balance would be more than $18 million.

At a 5 percent spend rate, the institution would then have $900,000 in annual earnings to replace the lead trust payments. As it is statistically likely that the unitrust will terminate as much as 10 years before the lead trust, for a period of time the institution can expect to have both the payments from the lead trust and the earnings from the remainder received from the unitrust.

Charles is pleased that his advisors will continue to manage the funds in both trusts and he will continue to benefit from their expertise as will the institution and his heirs. The institution enjoys the security of knowing that its payments from the lead trust are fixed for 20 years and the risk of management of the remainder for the heirs is in the hands of others.

From a fundraising perspective, the institutions will have named the building in exchange for a “pledge” of $16 million, payable at a rate of $800,000 per year for 20 years. As a bonus, a permanent multi-million dollar endowment is being pledged in the form of the unitrust remainder at the death of the donor or 20 years, which ever is sooner.


Disclaimer: This case study is intended to provide information of a general nature only and is not intended to provide legal, accounting, investment or other professional advice. Persons mentioned within this case study are fictional with any resemblance to real persons, living or dead, coincidental. Tax law rates and federal discount rates used in examples are based on those rates in effect at the time of publishing. Those viewing this case study should always check for latest tax and other relevant state and federal laws and regulations prior to completing charitable gifts.

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