Insurance Trusts

While economic conditions, interest rates and tax uncertainties, do affect charitable giving, philanthropy is still very much a part of the American character. In 2010 Americans made donations of over $300 billion to charity.

Charitable remainder trusts (CRTs) are a very good way to provide benefits to a favored charity. A charitable remainder trust is an irrevocable trust created by a settlor which provides an annual income stream back to the settlor or to someone else for a term of years or for the beneficiary’s life. At the expiration of the income stream, the remainder interest in the trust passes to the charity designated by the settlor.

The remainder interest that ultimately passes to charity from a qualified remainder trust is a gift subject to gift tax. The gift tax annual exclusion cannot shield the contribution from gift tax because the gift is a future, rather than a present interest gift However, since the gift qualifies for the charitable gift deduction, no gift tax is due as long as the settlor or settlor’s spouse retains the income interest.

A charitable remainder annuity trust (CRAT) is designed to pay a fixed amount or a fixed percentage of the fair market value of the assets transferred to the trust to a noncharitable beneficiary at least annually. This payment must be no less than 5% and no more than 50% of the fair market value of the transferred assets. After the initial contribution, no additional transfers to the trust are permitted. The annuity payment can be paid for a term of years not to exceed 20, or the annuity payment can be made for the life or lives of the designated beneficiary(ies). At the end of annuity payments to the beneficiary, the remainder interest in the trust is distributed by the trustee to the designated charity or charities. When the trust is established, the calculated value of such remainder interest must be at least 10% of the fair market value of the property transferred to the trust. Also when the trust is established, the trust will meet the regulations only if there is a 5% or less chance that the beneficiary will outlast the principal, i.e., that the charity will receive nothing.

When the trust is established, the settlor will receive a gift tax deduction, as well as an income tax deduction equal to the computed present value of the remainder interest which will pass to charity. The income tax deduction is subject to the percentage of AGI limitations applicable to all individual charitable deductions. If the settlor cannot deduct the entire amount in the year of contribution, any remaining deduction can be carried forward up to an additional five years.

A charitable remainder unitrust (CRUT) is similar to a CRAT except that a fixed percentage of the fair market value of the trust, redetermined annually, is paid at least annually to the noncharitable beneficiary for the term of the trust. The settlor may make additional contributions to the CRUT after the initial transfer. The 10% test for the charitable remainder interest must be met when the trust is established, but the 5% or less probability test does not apply to a CRUT because the unitrust’s noncharitable payments are based on the value of the trust’s assets redetermined annually and there should always be some assets left to distribute to the charity.

In charitable trust planning, often it seems there is a paradigm shift in one’s thinking about financial wealth. Financial wealth is seen less as control over certain assets, but rather as an ability to generate additional income and pass even greater wealth to successive generations. Establishing a charitable remainder trust can accomplish both objectives. Assume an individual has highly appreciated assets which generate little or no income. The individual is reluctant to sell the assets because of the capital gain. If he transfers such assets to a CRT, the trust can liquidate the assets and the trust settlor will defer the capital gain. A portion of the annuity or unitrust payment back to the settlor will represent a portion of the gain and therefore the settlor spreads out the gain over a longer period. Settlor increases her cash flow, receives a current income tax deduction and is more diversified with less risk. Often a settlor will use the increased cash flow to purchase additional life insurance. The increased cash flow is used to make transfers to an irrevocable life insurance trust, which in turn has the effect of transferring more wealth to successive generations without transfer tax costs. When the mathematics are reviewed with clients, the numbers often seem like magic. Everyone wins.

In a charitable lead trust (CLT) the trust provides an income stream to a charity for a fixed term and at the end of the term the principal of the trust passes either back to the settlor or to a named beneficiary. For example a settlor might establish such a trust to benefit a favorite charity with an annuity stream for a period of 20 years with the remainder then passing to settlor’s children to assist them in their retirement years.

Contact us to discuss establishing a Charitable Trust as part of your estate plan.