September 23, 2021

Leading Charitable Trusts Do Good While Lowering Estate Taxes

What is a charitable giving technique that also serves as a wealth transfer technique to avoid inheritance taxes and at the same time works particularly well in a low interest rate environment (as we currently find)?

The main charitable trust.

First, let’s set the scene.

This type of trust is usually implemented after other basic elements are completed, such as your will, powers of attorney, and health care guidelines. In addition, it generally (but not always) falls under the category of trusts formed during your lifetime and not after your death.

It is a separate and autonomous trust. Suppose we have a couple with a little extra cash that wants to benefit a charity, here’s how it might work.

The couple have a lawyer who draws up a Charitable Lead Trust (CLT). The terms of the trust state that for the lifetime of the couple (or surviving spouse), the CLT will pay 5% of the trust each year to a qualified charity.

When the surviving spouse dies, the money left in trust will (presumably) go to the couple’s children.

Because of the way it is set up, this is a “shared interest” donation where part of the donation to the trust goes to charity and part will ultimately go to the children.

Where do interest rates come in? The current interest rate is used to actuarially determine the amount of the donation going to the children, which the parents will use to file an income tax return.

Of course, with a few exceptions, there is no actual tax on such a gift, it is just mandatory to report gifts of this size to the Internal Revenue Service.

Thus, in low interest rate environments, the calculated (i.e. actuarially determined) amount accruing to children will appear less, but the actual amount could be much higher, depending on the performance of the assets of the child. the trust. And, for the calculation, because the amount going to the children seems less, the calculated amount going to the charity must be higher.

Neither the parents nor the children receive anything from the trust during the parents’ lifetime. In this sense, the technique is similar to a will – nothing goes to the children until the parents die. What makes this technique compelling is the added ability to donate to charity and engage in potential wealth transfer tax mitigation.

Now for a quick illustrative example.

Suppose the parents are 65 and 66 and contribute $ 1 million to a CLT.

The terms of the CLT provide that for the remainder of their life together, 5% of the trust is donated annually to the charity of their choice. The math changes all the time, but let’s say he shows the kids a “gift” of about $ 350,000.

The small donation amount is based on the current low interest rate. So if the trust achieves long-term average market returns of, say, 8-9%, but the trust pays only 5%, then the trust should actually grow over the life of the trust.

In this case, while the calculation shows a small donation of around $ 350,000, the actual donation could be well over $ 1 million. On the flip side, there is always the possibility that the trust assets will underperform the estimated growth and lead to less (if any) for the children. Of course, there is uncertainty about how the stock market will perform, so the technique is not for the faint of heart.

Parents should file an income tax return showing a donation of this actuarially determined value to the children: $ 350,000.

Now, most people don’t have to worry about inheritance tax as it only applies to people with large estates.

But, if a couple has an estate subject to both Washington State Estate Tax and Federal Estate Tax, the approximate aggregate tax burden could be as high as 50% (RCW 83.100.040) .

Therefore, in the illustration above, assuming the historical performance of the market, the transfer tax savings could amount to hundreds of thousands of dollars. And, while some people are put off by complex estate planning techniques, the savings speak for themselves. Maybe a little complexity is worth the estate tax savings?

In addition to the ability to mitigate or eliminate inheritance taxes, the trust offers another benefit – it potentially provides a consistent and reliable stream of income for your favorite charity for years to come.

So, in addition to acting as a legally sanctioned wealth transfer technique, it offers a tremendous benefit to worthy organizations.

Many ask if they would get a tax deduction for this type of gift, and while the answer to the question is “maybe”, the explanation is longer and more complex than this article allows.

This is a hypothetical example and not representative of a particular situation. Your results will vary.

The assumed rates of return used do not reflect actual current or future interest rates.

Lawyer Beau Ruff works for Cornerstone Wealth Strategies,

a complete independent investment management and financial planning service company in Kennewick.


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