Posted April 1st, 1997

Using the Charitable Lead Trust to Create a “Retirement Plan” for Children

Experienced development professionals will occasionally encounter wealthy donors whose first priority does not include making their children wealthy. In many cases, such persons are entrepreneurs who have accumulated wealth during their lifetime. In fact, as many as 85% of millionaires have created their wealth from their own endeavors and have not experienced the benefit of an inheritance. (See March 97 Give & Take, page 1, for a review of The Millionaire Next Door.)

Many people who have been successful in life hope that their children will have the same pleasure of making their own way. They are parents concerned about their offspring and want to help them become financially responsible.

Given these facts, advisors often recommend a private foundation for the very wealthy, and perhaps, an advised fund at a community foundation for those with lesser means. This strategy offers a way to shield assets from estate taxes while giving their adult children the opportunity to make charitable gifts to organizations and institutions of their choosing.

How one plan would work

Recently I met with a couple in their mid-70s who had amassed total wealth in the range of $10 million. They were understandably unhappy to learn that they would ultimately pay $5 million or more in estate taxes if they did not make plans to minimize or eliminate this tax. They had expressed a desire to “do something” for their children (whose ages range from 35 to 42), but they didn’t want to give them “too much, too soon.”

An advisor recommended that they make gifts to their children in a trust totaling $1.2 million using their combined unified credit equivalent amounts of $600,000 each. They would then add amounts each year that they could give under their $10,000 per donee annual exclusion amounts. This amount would be invested to grow over the years and would distribute to the children in 15 years when they reach ages 50 to 57.

With the balance, they were advised to fund a private foundation at their deaths, and thereby eliminate the taxes that would otherwise be due. Their children would be named as trustees of the Foundation and be given the right to make gifts to the charities they choose as a group.

Neither parent was particularly happy with this plan because they felt they were substantially reducing their children’s inheritance in order to save taxes. Although this bothered them, they could see no other way out. Is there a better way?

An alternative plan

Suppose instead they were to create a charitable lead annuity trust today, funding it with $5 million? If the trust were established to pay 8.5%, or $425,000 to charities of the donors’ choosing each year for 15 years, the donors would enjoy a gift tax deduction of some $3.8 million, leaving a taxable gift of $ 1.2 million in the year the trust is created.

Their unified credits could be used to offset this gift, resulting in a gift of $5 million (more or less depending on the performance of the trust assets) to their children at a “cost” of their $ 1.2 million unified credit equivalent amount. If they wished, the parents could direct that the lead trust payments be made to an advised fund at their local community foundation or elsewhere, and the children could make suggestions for the distribution of the funds from the advised fund.

The net result is to retain $5 million the donors’ may use for the remainder of their lives, provide an income stream of $6,375,000 to charities of their choice, and provide a $5 million tax-free “retirement account” for their children at a time when the parents initially wanted them to receive their inheritance. They have, in effect, temporarily “disinherited” their children in a way that fulfills their charitable intentions and eliminates $2.5 million or more in potential estate tax liability.

If they wish, they can continue their annual giving program to their children, and leave the remainder of their estate at death to a charitable foundation that the children will manage or to an advised fund, as the case may be. In that event, they will have totally eliminated tax on a $10 million estate while leaving at least half of their assets to their children when they want them to have it.

This is only one example of how understanding the inter-relationship between donors’ philanthropic and other motivations can lead to significant gifts that might not otherwise be possible.

The publisher of Give & Take is not engaged in rendering legal or tax advisory service. For advice and assistance in specific cases, the services of your own counsel should be obtained. Articles in Give & Take may generally be reprinted for distribution to board members and staff of nonprofit institutions and other non-donor groups. Proper credit must be given. Call for details.

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