When people wish to provide an inheritance to their children or grandchildren and make a significant charitable gift through their estates, a vehicle known as the “charitable lead trust” is an excellent method to accomplish both objectives.

A charitable lead trust is a trust that the estate owner establishes either during life (an inter vivos trust) or at death (a testamentary trust). The income from the trust flows to a charitable organization, like The Foundation for Evangelism, typically for a stated number of years. After that period, the assets inside the trust are then distributed.

This article highlights the charitable lead trust, an estate planning instrument that has become more popular, particularly among families with high net worth.  The charitable lead trust is available to people who want to provide immediate financial support to help The Foundation for Evangelism achieve our mission and, at the same time, protect their estates from substantial erosion due to taxes.

What Is a Charitable Lead Trust?

Individuals who wish to make substantial current contributions to support the development of leaders with a passion for evangelism while controlling the eventual distribution of their assets may want to consider the charitable lead trust.

A lead trust can be appropriate when you and your family have little need for the current income an asset is generating and wish to transfer the asset to heirs with reduced tax consequences. Lead trusts can be established during an individual’s lifetime or can be created at death to reduce the taxable estate. There are no minimum payout requirements with a lead trust and no specific limitations on the trust’s term.

The charitable lead trust comes in two versions, unitrust and annuity trust, and has been used by philanthropists for years as a way of passing along large portions of their estates to heirs without significant erosion of assets due to gift and estate taxes.

A lead trust can be established with one of two types of payout and with or without an income tax deduction for the donor at the time the trust is funded.

In a charitable lead annuity trust, the charity’s income interest is in the form of an annuity or a fixed payout.  In a charitable lead unitrust, the income interest is determined based on a fixed percentage of the value of trust assets, valued annually.

Simply put, a charitable lead trust is akin to lending income-producing assets of cash to the foundation for a predetermined period of time.  Our foundation would receive annual income from the trust assets over a specific number of years determined by you and your advisers.  At the end of a term of years, the income-producing trust asset(s) returns to you or, more commonly, to your children, grandchildren or other family members.  The advantages are substantial savings in gift tax, estate tax and/or generation-skipping transfer taxes that otherwise may come due whenever you try to give substantial amounts of property to your heirs.  You may also save on income taxes, if the trust is set up during your lifetime, and your beneficiaries will not be subject to income tax on the income that passes to The Foundation for Evangelism.  While for a number of years the trust’s income is paid to charity, eventually the trust’s assets can pass to family members.  Here are the basic considerations in arranging a lead trust:

Type of Lead Trust	Income Tax  Advantages	Gift/Estate Tax Advantages
1)   Lifetime trust – assets pass to heirs when trust ends	Donor’s taxable income reduced after gift	Substantial potential gift tax savings in passing assets to heirs
2)   Trust in will – assets pass to heirs when trust ends	Heirs are not taxed on trust income	Substantial potential savings in estate tax/generation-skipping transfer tax
3)   Lifetime trust – assets return to donor	Upfront tax deduction – but donor taxed on trust income*	Income paid out to charity avoids gift and estate taxes

*Adverse federal income tax results can be reduced if trust is funded with growth stocks and tax-free bonds.

Lead trusts pay annually either a fixed amount (annuity trust) or a variable amount, based on a set percentage of trust assets (unitrust), to our institution.  Deductions depend on how many years the trust lasts (the longer payments are made to charity the higher the donor’s income tax deduction) and the amount of foundation’s  income (larger payments mean higher deductions).  For a lead annuity trust, a further critical factor in determining the amount of the charitable deduction is the federal interest rate that is applicable at the time the trust is created.  For a lead annuity trust, it is possible for the donor’s family to “beat the tables” — any actual investment return earned by the lead annuity trust over and above the applicable federal interest rate factor that was in effect on the date the trust was created will benefit only the family.  (By the same token, the family alone would suffer the detriment of a poor investment performance in a lead annuity trust.)  By contrast, the benefit (or detriment) of the actual investment performance of a lead unitrust is split on a pro rata basis between the charitable lead interest and the family.

Interest rates are currently low by historic standards, which increase the attractiveness of a lead trust in many donor situations.

Case Study:  Lifetime Lead Trust to Benefit Heirs

Margaret is the owner of a privately held company, who, like other professionals, knows she faces future transfer tax burdens — namely, federal gift or estate taxes.  She owns stock worth $500,000 that she plans eventually to transfer to her children.  She also wants to provide an important gift to The Foundation for Evangelism.  What can we suggest to Margaret that would satisfy most, if not all, of these aims?  A charitable lead trust that pays income for a period of years to The Foundation for Evangelism might be one solution.

Margaret could decide to establish a lead trust that pays a 6.5% annuity to (name of institution) for 20 years.  At the end of 20 years the stock will transfer to the children.  Margaret is considered to have made a taxable gift to her children on the day she creates the trust . . . but not of $500,000.  The gift is reduced by the value of our right to receive $32,500 a year for 20 years.  The charitable gift is $483,519, so Margaret will pay gift tax on only $16,481 ($500,000 – $483,519).  (Note:  Deductions vary each month according to federal interest rate factors; the interest rate for April 2011 is 3.0%.)    Note that Margaret can use a small portion of her gift tax credit (the credit shelters up to $5 million in taxable gifts under current law) to avoid paying any gift tax on the $16,481 gift.

Case Study:  Lead Trust in Will for Eventual Benefit of Children

Paul is a wealthy 70-year-old widower who supports The Foundation for Evangelism enthusiastically. Paul has two grown children and is concerned about federal estate taxes.  He is also concerned whether his son and daughter may be able to handle their inheritance responsibly.  Paul wants to do something truly significant for The Foundation for Evangelism through his estate plan, but he wants the bulk of his estate eventually to pass to his children.

We suggest that Paul establish a charitable lead trust which will save taxes and provide generously for The Foundation for Evangelism.   A charitable lead trust, contained in his will, can pay income to the foundation and also ultimately pass all trust principal to family beneficiaries, with significant estate tax savings.  Lead trusts are sometimes called “wait awhile” trusts.  The message to family members is:  “You’re going to get everything from my estate, with one caveat; you will merely have to ‘wait awhile’!” This form of charitable giving can be more attractive to surviving family members than outright bequests to charity.

Suppose that, without regard to any lead trust, Paul’s taxable estate totals $10 million.  The federal estate tax on this amount in 2011 (assuming that Paul has made no significant lifetime gifts) would be $1,750,000*.  Now suppose that Paul’s will creates a lead trust funded with $5,000,000, which is to make a payout to charity of $400,000 (8.0%) a year for 15 years.  At the end of the trust term all principal is to be distributed outright to Paul’s children.  Assuming a 3.0% federal interest rate, the charitable deduction allowed to Paul’s estate will be approximately $4,775,000.  This deduction could save $1,671,250 in federal estate taxes ($4,775,000 x estate tax bracket of 35%), which can be passed through to the children.  (35% is the estate tax rate in 2011.)  The children will “miss”, initially at least, only about $3.3 million as a result of the trust.

Furthermore, assuming the value of the trust assets neither increases nor declines during the trust term, and assuming the trust assets generate a return equal to the payout, the children will receive the $5 million at the end of the trust term.  What they lose is the use of $3.3 million during the trust term.  However, if they do not need the use of that amount during the trust term, the loss may not be critical to the children.  What is gained is (a) a substantial benefit to charity and (b) an estate tax deduction that helps to reduce taxes and eases the need for estate liquidity.

Summing up, who receives what from this arrangement?

Without lead trust:

1)   Heirs receive                        $8,250,000

2)   U.S. Treasury gets               $1,750,000

With lead trust:

1)   Heirs receive                        $9,920,000 — $ 2.46 million each when dad dies;
$5,000,000 15 years later

2)   Charity gets                          $6,000,000 over 15 years

3)   U.S. Treasury gets               $78,750 (vs. $1,750,000 without trust)

In Conclusion

The charitable lead trust is one of several income tax and estate tax planning tools to consider in financial planning.  Not only does it provide a substantial wealth preservation role for families, it is also very beneficial for the current funding priorities of The Foundation for Evangelism.  The “nuts and bolts” to remember about lead trusts are simple:

1)     A lead trust provides vital income annually for our institution for a period of years;

2)     A lead trust can create significant tax benefits for you and your heirs;

3)     Family members (or perhaps you, the donor) eventually recover property placed in trust, often at an increased value.

As always, please seek the counsel of your professional financial and legal advisers regarding all aspects of estate and gift planning.  If you would like to discuss any aspect of planned giving with someone from our development office, please call Jane Wood at 800.737.8333 and we will be pleased to speak with you in person or by telephone.