Time to take a closer look at the charitable lead annuity trust (CLAT). The CLAT comes in several flavors; we’re going to start with plain vanilla. The plain vanilla CLAT makes a fixed payout to charity at least annually (e.g., $25,000 a year) for a term prescribed by the donor and then, typically, distributes its assets to the donor’s children or grandchildren (these individuals are called the “remainder beneficiaries”).

What is a permissible CLAT term? A CLAT may make its payout for a fixed term of years (e.g., 15 years); for the life of the donor or the donor’s spouse; or, for example, for the life of the donor’s mother provided donor’s mother is an ancestor of each of the remainder beneficiaries.

Why might an individual create a CLAT? The usual reasons are (a) to fund some charitable project over time, and (b) to transfer significant assets to downstream family members at little or even no gift tax or estate tax cost. The individual who creates a CLAT is almost always quite wealthy; he or she may be of any age.

How does a CLAT serve to transfer assets downstream at little or no tax cost? In setting up a CLAT for the eventual benefit of the donor’s children, let’s say, the donor is deemed to confer a financial benefit on the children. Therefore, the donor is deemed to make a gift to the children for federal gift and estate tax purposes. If the donor funds the lead trust with $1,000,000, the gift (deemed to be made at the moment the trust is created) is equal to $1,000,000 minus the present value of the annuity payout to charity (designated here as “PVA”).

PVA is a function of (a) the annual annuity payment, (b) the trust term, and (c) the IRS discount rate in effect when the CLAT is created.

If the CLAT is to pay out $50,000 a year to charity for 15 years, here’s how the numbers play out:

IRS Discount Rate              PVA                        Gift to Children

2.0%                                       $647,280              $352,720

2.4%                                       $629,260              $370,740

2.6%                                       $620,500              $379,500

As seen from the table of numbers, the donor’s gift to the children rises and falls with the IRS discount rate. The lower the discount rate, the lower the gift to the children. More about all this next time.

By Jon Tidd

Read Pt 1 here
Read Pt 3 here
Read Pt 4 here
Read Pt 5 here
Read Pt 6 here