Charitable Lead Annuity Trust Case Study
Estate Plan Concerns
Mary would like to make a large gift to her children. The asset that Mary has in mind is presently worth $1,000,000, but is expected to grow in value at a high rate (9%) and produce significant income (5%) for the foreseeable future.
► Gift to Children Could Save Taxes But Use Entire Exemption
She has been informed that gifting this type of asset, now, could save a large amount of estate taxes at her death. However, she also is aware that such a large gift would require her to use her entire $1,000,000 lifetime gift tax exemption to avoid gift tax, and she wonders whether there might be a better way to transfer the asset to her children.
► Charitable Interest, Too
Mary also is interested in providing financial support for her favorite charity.
Estate Plan Solution
After some consideration, Mary decides to implement a planning technique known as a Charitable Lead Annuity Trust (CLAT). Conceptually, Mary will create an irrevocable trust for the benefit of her favorite charity and her children.
► Initial Charity Annuity Follwed By Distribution to Children
An annuity will be paid to the charity for a specified period (10 years was chosen for this particular CLAT). At the end of this period, the charity’s interest ends and the remaining assets are distributed to Mary’s children (or retained in trust for their benefit).
Charitable Lead Annuity Trust Process
Charitable Lead Annuity Trust Process
- Mary creates an irrevocable Charitable Lead Annuity Trust under which her favorite charity will receive an annuity in the amount of $129,505 for 10 years, with the remaining trust assets to be transferred to her children (or retained in trust for their benefit) at the end of the 10-year period.
- Upon creation of the CLAT, Mary transfers a selected asset worth $1,000,000 to the trustee of the CLAT. For federal gift tax purposes, the amount gifted to the trust is divided into 2 separate gifts, valued under IRS actuarial tables. The charity’s portion is gift tax free. The children’s portion of the gift is a taxable gift, which can be shelter from gift tax by Mary’s gift tax exemption. In this scenario, Mary designed the CLAT so that the taxable gift to the children is only $1.
- The annuity is paid to Mary’s favorite charity for 10 years, after which time the charity’s interest in the trust ends.
- At the end of year 10, remaining assets of the CLAT are transferred, estate and gift tax free, to the Grantor’s children outright or are retained in trust for their benefit.
- Charity Served: Income stream for grantor’s favorite charity (which could include grantor’s private foundation).
- Estate and Gift Taxes Reduced: Assets eventually transferred to children with estate and gift taxes dramatically reduced or eliminated.
- Integrates with Other Techniques: Can be used effectively with other planning techniques to enhance results.
A Charitable Lead Annuity Trust (CLAT) is a special type of irrevocable “split interest” trust in which a fixed annuity is payable to a qualifying charity for a specified period of time, with the remainder of the trust’s assets to be transferred to one or more non-charitable beneficiaries (e.g., the grantor’s children) after the charity’s annuity ends.
► Focus on Tax Reduction When Assets Transferred
Creative use of the CLAT offers the potential for dramatic estate and gift tax savings. Properly designed, the CLAT allows the grantor (i.e., creator) of the trust to accomplish philanthropic goals (which could include funding his or her own private foundation) and eventually transfer a large amount of wealth to his or her children, free of estate and gift taxes. It is possible to design the trust to provide income tax benefits for the grantor; however, tax planning with the CLAT typically focuses on minimizing or eliminating estate and gift taxes on the trust assets transferred to the grantor’s children.
► Offers Asset Growth Potential and Flexibility
Generally, the trust should be funded with assets that can produce a substantial stream of income, while having strong potential for significant future growth in value. Note that this technique can be implemented either during the grantor’s lifetime or at the grantor’s death (via a testamentary trust). Other planning techniques may be used with the CLAT to enhance charitable benefits and the amount of wealth that is ultimately transferred to the children.
► Calculations Will Vary According to Current Market
Unless otherwise stated, actuarial calculations are based on the assumptions that the client is 65 years old and the Applicable Federal Rate (AFR) is 5.00%.
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The following notice is required by the IRS: Any U.S. Federal tax advice contained in this communication is not intended to be written or used, and cannot be used or relied upon, to avoid tax-related penalties under the Internal Revenue Code, or to promote, market or recommend to another any tax-related matter addressed herein.
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