Charitable Lead Trusts


Women on the couch with her laptopA Charitable Lead Trust allows you to make philanthropic gifts to a charitable institution — and also provide the tax-advantaged remaining interest/balance to individual beneficiaries you name. This is accomplished in an irrevocable trust when asset growth in the trust outpaces the current IRS interest rate. If that occurs, when the initial trust term expires, any remaining trust assets pass to your preferred non-charitable beneficiaries, typically children, grandchildren, or other loved ones.

The money you contribute to a Charitable Lead Trust is considered a gift that is subject to the unlimited gift tax charitable deduction, but the remainder interest you gift to your loved ones is classified as a taxable gift. Because both portions of this gift are valued using an IRS-published interest rate, the creation of this type of trust is attractive in a low interest rate environment.

The basics of Charitable Lead Annuity Trusts and Charitable Lead Unitrusts

Under current tax law, in order for a Charitable Lead Trust to qualify for maximum tax benefits, the trust must be an irrevocable trust, and the income interest payable to charity must either be in the form of an annuity trust or unitrust.

The Charitable Lead Annuity Trust (CLAT):

  • Is a trust from which a fixed dollar amount, determined when the trust is created, is paid at least annually to one or more charitable institutions.
  • The charitable lead interest/term is either a specific number of years, or the life span of an individual chosen as a “measuring life.”
  • Flexibility in annuity payments is possible, since the annuity amount can be structured to increase or decrease during the trust term.

For example, a specified annuity amount may be paid for a certain term of years after which another amount is paid for the remainder of the trust term. The specified amount must, however, be paid by the trustee to the charity regardless of the trust’s actual income and earnings over the trust term. If trust income is insufficient to meet the annual annuity amount, the trustee must invade trust principal to make the required payment.

The Charitable Lead Unitrust (CLUT):

  • Is a trust from which a fixed percentage of the fair market value of trust assets is to be paid at least annually to one or more charitable institutions.
  • The charitable lead interest/term is either a specific number of years, or the life span of an individual chosen as a “measuring life.”
  • Since payment to the charitable institution is recalculated every year, payments will fluctuate from year-to-year as the market value of the trust assets fluctuate.
  • As the assets in the trust appreciate, the charitable institution receives a larger distribution from the trust since the annual distribution is figured as a percentage of current trust assets. Conversely, if the value of trust assets decreases, the charitable institution receives a smaller annual distribution.

Income tax benefits of a Charitable Lead Trust

Tax benefits from a Charitable Lead Trust depend on whether the trust is treated as a “grantor” trust, or a “non-grantor” trust. A non-grantor Charitable Lead Trust is the most common — with this design, the creator does not receive a charitable income tax deduction for contributions to charity. The benefit of this type of trust is that none of the trust income is taxable to you.

The grantor Charitable Lead Trust, is structured so that all income produced during the trust’s term is taxed to you. Since you are required to recognize the trust income, you will receive a one-time income tax charitable deduction in an amount equal to the present value of the payments to be made to the charity. This deduction is taken when the trust is established.

No matter whether a Charitable Lead Trust is designated grantor or non-grantor, there are gift tax benefits to consider. You will receive a gift tax charitable deduction equal to the net present value of the lead interest to be paid to charity.

  • CLUT example: A 70-year-old creates a non-grantor Charitable Lead Unitrust and funds it with $500,000 of depressed marketable securities. The trust provides for a distribution to a charitable institution equal to 5% of the annually determined value of trust assets.

    In the first distribution year, the charity receives $25,000. Upon the individual’s death, remaining trust assets pass to the individual’s children. If in the month the CLUT is established, the IRS interest rate is 1.44%, the present value of the stream of payments to charity during the individual’s projected life expectancy is $240,475.

    The present value of the amount that ultimately passes to the individual’s children is $259,525, and is considered a taxable gift. If trust assets grow during the set term at a rate that is higher than the IRS rate of 1.44%, the growth also transfers to the children, free of gift tax.
  • CLAT example: Assume the same facts as in the CLUT example above, except the trust is a Charitable Lead Annuity Trust with a fixed amount of $25,000 paid each year of the term to designated charities (and will not change with fluctuations in the market value of trust assets).

    Unlike a CLUT, in which payments to charitable beneficiaries increase or decrease as market values of trust assets increase or decrease, with a CLAT annuity payments are fixed — so as market values increase/decrease, the change in value impacts remainder beneficiaries, exclusively. During periods when the underlying trust assets are expected to appreciate significantly, this form of trust provides greater leverage for passing assets to your individual remainder beneficiaries, free from gift tax.

The following chart, using a 1.44% interest rate, illustrates values that would be available to remainder beneficiaries, and shows how varying the trust term can result in more assets being passed to your individual beneficiaries (assuming a constant investment return during the trust term).

Annual Payment to CharityTerm of YearsGift to CharityGift to Loved OnesInvestment ReturnBalance to Loved Ones at End of Term

In these examples, the investment return of 6% is hypothetical and is not intended to represent past or future performance of any specific investment.

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