Investment Strategy Patents for Charitable Vehicles?

Investment Strategy Patents for Charitable Vehicles?

News story posted in Investing on 12 March 2007| 8 comments
audience: National Publication | last updated: 18 May 2011


In early January, the Planned Giving Design Center received a press release from a Florida financial advisor announcing he had obtained a U.S. patent on the use of tax deferred variable annuities within pre-need funeral contracts, endowment funds (including donor advised funds), charitable remainder trusts, charitable lead trusts, and pooled income funds. In the wake of AICPA's call for legislation against tax strategy patents, we ask the question: Are investment patents of this type good for planned giving? We invite your comments and opinion.

by Marc D. Hoffman, Editor-in-Chief
Planned Giving Design Center

Full Text:

On February 28, 2007 the AICPA sent letters to congressional taxwriters and judiciary committee leaders urging them to take legislative action to curb the propagation of tax strategy patents for the reason they may limit the ability of taxpayers to utilize fully interpretations of the law intended by Congress to minimize their tax liability, undermine the public's confidence in the integrity of the tax system, and unfairly cause some taxpayers to pay more tax than others. See AICPA Urges Congress to Legislate Against Tax Patents.

In early January, the Planned Giving Design Center received a press release from Alan J. Lang, a financial advisor with Cantella & Co., Inc., located in Naples, Florida, announcing he had received a patent (# 7149712) that utilizes tax deferred variable annuities as investments within endowment funds (including donor advised funds), charitable remainder trusts, charitable lead trusts, pooled income funds and pre-need funeral contracts.

The release states:

For immediate release:

January 3, 2007
Press Release:
Alan J. Lang

A new twist to an old investment vehicle that will greatly benefit charitable entities with 501(c) (3) corporate charters is new to the market this month. Basically, the newly patented (patent # 7149712) process enables endowment funds to be invested in mutual funds for maximum growth potential, create a 5% annual cash flow and have the original principle insured against market loss. The investment vehicle is a variable annuity*.

The patent specifically covers funds invested in Endowment Funds, Charitable Remainder Trusts, Charitable Lead Trusts, Pooled Income Funds and Preneed Funeral Contracts.

While the pieces to building the investment vehicle are relatively simple, they require advanced skill to organize them correctly.

There are five basic steps the 501 (c) (3) corporate entity needs to take. First, secure an annuitant, preferably between the ages of 68 and 72. The only qualifications are their age and their willingness to support the charitable cause.

Second, a contract is selected with all of the appropriate riders, naming the charity as the owner and beneficiary with the volunteer/donor named the annuitant. With $500,000 (as an example) from the permanent endowment invested according to the process specified in the patent, the charity immediately receives a $25,000 cash addition to the endowment deposit. The total of $525,000 begins earning from day one.

Third, appropriate mutual fund investments are selected according to risk tolerance.

Fourth, annually on the anniversary date of the original contract, the death benefit will increase 5%. On the first anniversary date of the contract the charity can begin to withdraw 5% cash every year.

Fifth, upon death of the annuitant, the contract will pay a lump sum of either the guaranteed death benefit or the cash value of the mutual funds, whichever is higher.

Although these five steps seem simple enough, like most things, putting all the right features together at the proper time is a bit more complicated than meets the eye.

It is a new concept still unfamiliar to the professionals.

Alan J. Lang, a financial advisor with Cantella & Co., Inc., located in Naples, Florida, recently received a patent (patent # 7149712) for the process, and is now prepared to make it available to qualified tax-exempt non-profit organizations throughout the USA. Mr. Lang can be reached at 1-877-434-5264.

*Variable insurance products, including variable annuities are offered by prospectus only. The prospectus contains information about the product's features, risks, charges and expenses, and the investment objectives, risks and policies or the underlying portfolios, as well as other information about the underlying funding choices. Read the prospectus and consider this information carefully §Principal value, income payments, and investment returns of a variable annuity will fluctuate, and you may have a gain or loss when money is received?For illustrations purposes only. Does not reflect actual investment results and are not guarantees of future results?Securities and Investment Advisory Services offered through Cantella & Co. Inc., Member NASD/SIPC.

Download: Patent #7149712.pdf

A New Idea or Prior Art?

As we read the release, we were reminded of Ltr. Rul. 9009047 and TAM 9825001 in which the IRS permitted a net income charitable remainder unitrust to invest in a tax deferred annuity contract for the purpose of controlling the timing and amount of income distributions, and to otherwise provide a guaranteed death benefit payable to the charitable remainderman.

These rulings are no secret to members of the insurance community in particular, which have since facilitated literally thousands of annuity invested CRTs since 1990. Nor are they a secret to the IRS which issued them and then subsequently discussed such arrangements in its 1999 CPE text and added them to its annual no ruling list for a number of years as it studied if they conveyed an inappropriate tax benefit to taxpayers. Would the Service have gone to this extent if it was unaware that a significant amount of this activity was occurring? All of this happened well in advance of Mr. Lang's 2004 patent application date.

Did the Patent Office Do Its Homework?

One of the primary functions of the patent office is to determine if an invention or process is unique and new. Generally, inventions or processes that already exist in the public domain prior to the patent application date are referred to as "prior art" and are disqualified from patent protection.

After reading the claims and description of the Mr. Lang's patent, we couldn't understand how he satisfied the prior art test, at least with respect to charitable remainder trusts, so we contacted him for clarification. He stated that according to the research conducted by the insurance division of the patent office, there was no prior art.

We beg to differ. For example, in addition the aforementioned rulings and IRS commentary, this author's own book entitled, Harnessing the Power of the Charitable Remainder Trust, published originally in 1991, and the Planned Giving Design Center itself have since 1998 discussed and commented on this technique. Likewise, insurance companies and trust administrators have developed processes and procedures to issue annuity and administer annuity contracts within charitable entities.

Thinking About Using a TDA in a Charitable Vehicle?

When asked about the benefit of using a tax deferred vehicle within a tax exempt vehicle such as a CRT or endowment fund, Mr. Lang stated the primary focus of the patent request dealt with pre-need funeral contracts and that the charitable vehicles were a secondary consideration. He added the main reason for their use in a tax-exempt entity was to provide an insured death benefit.

According the Mr. Lang, those thinking about selling any tax deferred annuity contract to an endowment, CRT, CLT, or PIF better contact him first; otherwise, they will be infringing on his patent. Asked how he intends on servicing the theoretical nationwide demand for this strategy, Mr. Lang referred to his royalty agreement which licenses brokers and agents to use his patent for an initial fee of $300, an annual fee of $100, and 5% of the initial gross commissions. When asked how he intends to police such activities, he said it was a good question.

Who Wins?

When asked how this patent would be good for philanthropy, Mr. Lang stated that with his support it would open up a new market to those not currently in it. When asked why he went to the trouble of obtaining a patent, he quoted American economist Bernard Baruch who once said, "Millions saw the apple fall, but Newton was the one who asked why."

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Millions saw the apple fall...

By his use of the quote as being descriptive of his efforts, it would seem he, himself, admits to the existence of "prior art".

Patenting estate planning ideas

This engenders criticism of the patent process. Either the idea is not new or it is not legal or the patent depends on the exact manner, including specific order of steps, to implement and thus is useless to him. But this sort of patent engeders baseless litigation and thus is bad for the profession, which is hard enough as it is.

Alan Lang - Patent 7149712

With all due respect to Mr Lang, his idea is hardly new - I am astounded that it was considered patentable. Indeed, Mr. Hoffman's point is well taken; his ground-breaking book on harnessing the power of the Charitable Remainder Trust discussed the use of variable annuities in CRT planning quite some time ago. That book is a staple for anyone who is in the field of planned giving. By the way, it is worth a note of caution before considering a variable annuity as the sole funding vehicle for a CRT - While an annuity can stop 'tax leakage' in a NIMCRUT, it is not a panacea; if the value of the annuity drops below its original value in a bad market, the donor will not be able to take income from it until the market rebounds. In general, the zeal for personal gain and exclusivity on the part of a some advisors who have entered the charitable arena -and see it primarily as a source of their own personal enrichment- has done some severe damage to legitimate charitable planning. Congress has been forced to step in and put the 'cabosh' on various forms of abuse, perpetrated by those whose charitable interests have become secondary to their profit motive. Clients, advisors and charities have paid a significant price. People might want to pause and take a larger view of things going forward.

Guaranteed Living and Death Benefits in CRT's

This is absolutely not new. I have verification of my inquiry into the use of VA's in CRT's to utilize guaranteed riders over 3 years ago. The problem then was that the IRS would not use the guarantees as "real money" in income and remainder calculations, as I believe Elihu points out. However, in 2006, the IRS started requiring that these "incidental or additional" benefits be calculated into the RMD calculations for qualified accounts. They are counting them as "real money" now! (at least in IRA's) Anyone know of any utilization of the IRS's new treatment in the CRT arena?

Annuity in a 501(c) (3) Endowment

While arguably the application of a patent to this idea may be novel, the most critical issue is the prudent investment of the endowment fund. Under the Restatement of Trust 3rd, it would be difficult to justify the additional cost of the annuity contract (approximately 2.5% to 3.5% total) primarily for the death benefit and account value "protections." There are also surrender penalties and other considerations that may affect the ability of the endowment to distribute money each year. I challenge anyone to prove that over the infinite lifetime of an endowment fund this expensive approach would be superior to a lower cost option like index funds. Any takers?

Tax advantaged investment patents

The USPTO missed the mark on granting patent # 7149712. Had there been no prior art, and no prior concept....then our fan of physics would not have had to disguise his "concept and art". Turkey wrapped in bacon is still bacon and turkey, no matter how it is wrapped..., stuck or skewered it still tastes like bacon and turkey... and the result is the same....heartburn... So it is with our new patent nazi Lang... same old tyranny... wrapped in a new pitch... Insurance and annuities are "public" properties... government regulated and supervised with the idea that the purveyors will serve the public interest for the common good...3000+ companies got it! What happened to Lang and the USPTO...guess we can patent a new way to pour water, too....forget the gravity and apple thing...hold your glass upside down...and watch the water flow up.

Restatement 3rd and UPIA

I heartily concur. Not only are there VA costs that are unique to a V A, but the additional costs and risks of active management in the funds that populate most VAs are suspect according to the Restatement and the Uniform Prudentn Investor Act. Active funds take on non-systematic risk which, according to the Restatement, is to be avoided unless one can "reasonably" justify the additional risk. Since there is virtually no way of knowing that an active strategy will outperform its passive counterpart (in fact they usually don't) it would seem unreasonable to think one could "reasonably" justify these actions. Charles L Stanley CFP ChFC AIF

VA's: Friend or Foe?

The debate over VA's continue. The misconceptions on both sides persist. And for good reason. These contracts are complex. The differences between contracts are significant. And to complicate matters further, carriers change their contracts annually, sometimes more often. This isn't term life! To evaluate the efficacy and suitability of a VA in a specific application requires more than a cursory knowledge of the product in general. An in depth understanding of the intricacies of a particular contract is a prerequisite before that contract can be considered as a potential solution in the risk management puzzle. Some VA's can be powerful and effective. Others can be virtually worthless in the same scenario. It's important to know the difference. VA's can offer significant risk management benefits, particularily in portfolios where systematic withdrawals are planned or required, and some growth is also desired to maximize the remainder interest. The systematic risk in these portfolios due to the components that exhibit higher historical volatility can be effectively mitigated using the appropriate VA contract. The portfolio, since risk has been transferred, can be invested more aggresively, which, theoretically, more than offsets the costs of the "insurance". Moshe Milevsky has done excellent research in this area, and I'd suggest the study of some of his work. I'd be happy to share the results of my work with those motivated to educate themselves regarding a topic where knowledge is woefully lacking. Charities stand to benefit. Any takers?

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