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Lead Trusts
Lead trust to the rescue?
Ahhhh…the graphic tells the whole story..right? Look at the cool chart and understand how charitable lead trusts work?
Sorry, not this vehicle.
Read this short piece about an actual situation and hopefully you’ll begin to see why it’s worth learning more about lead trusts!
Recently, a client of mine had a donor looking to fund a program that needed $80,000 a year to be fully running. The fundraisers even thought the donor was going to give $1 million to immediately endow it (they would find other funds operate it with more eventually coming from the donor’s future estate)!
But, as we know too often, the donor has the final say. So, when they met with the donor to close in on the whole gift, they were in for a surprise: donor’s advisors told him to put the $1 million into a charitable gift annuity.
Normally, a $1 million CGA is cause for celebration but not this time. What about the endowment to partially underwrite the program while the donor is still alive?
So, back to the donor they went. Donor says no problem, I’ll just give you the CGA annuity each year to fund the program.
Sounds interesting but there’s a few problems. #1 The CGA rate for this donor is 6% – that’s $60,000 a year – short $20,000 a year to fund the program. #2 If the donor is willing to give up the income each year to partially fund the program, why do a CGA? Just go back to the original plan and the donor gets a 100% income tax deduction with no future 1099 tax obligations (the CGA will cause taxable income with an offsetting annual deduction).
Also, this donor has no heirs and is essentially leaving the bulk of his estate to the charity.
Obviously, the donor’s advisors felt that he should hedge his bets – if need be, he could always keep the income. So, there is bit of concern that the donor might need the income or assets in the future.
The deduction is important but not overwhelming important as the donor was willing to take the lesser CGA deduction, only around 30% of the million.
Anyway, what does this have to do with lead trusts?? No heirs to send the assets to. A CGA.
But wait. Think about this option via a reversionary grantor lead trust we offered the donor in addition to the CGA option.
We ran a 10-year, 8% grantor lead annuity trust with remaining funds in the lead trust going back to the donor after the trust term (remember, most assets in the estate are going to the charity anyway). (“Grantor” also means the donor gets an upfront deduction, but has to pay taxes on any income/gains incurred in the trust during the term)
Look what this option offered the donor and the charity:
- $80,000 a year from the lead trust to fully fund the program.
- Higher income tax deduction than the CGA (from $300k range to $400k range)
- Donor control! The donor could trustee this himself (with help from his lawyers), meaning he could put an income producing asset in the trust like real estate which has enough income to pay the charity and upside growth potential!
- All remaining funds/assets in the lead trust go back to the donor at the end of 10 years.
Downsides of the Lead Trust here?
- Annual tax burden for the grantor lead trust significantly higher than the CGA (which has an offsetting annual income tax deduction for each year’s gift).
- Much more complex gift – would require active attorney involvement throughout the trust.
Think about the possibilities? Have you dealt with any unusual situations that could have been solved with a creative lead trust option?
Stay tuned for what actually happens (when I find out!).
CLICK HERE TO LEARN MORE ABOUT LEAD TRUSTS!
Planned Giving Advisors Now Offering Webinars!
Click here to learn more about upcoming Webinars on various planned giving topics from Planned Giving Advisors!
Following-up to our highly successful Planned Giving Boot Camp program, we are now offering webinars on timely topics to help broaden your knowledge base in planned giving. To kick off this program, we have two guest speakers on special topics and Jonathan Gudema discussing Lead Trusts in late October and early November.
As always, we aim to offer the most convenient and cost effective programs. For these special webinars, one registration can be used for as many people as you wish at one location and a link to the recording will be provided for all registrants, in case you or anyone on your team are unable to join the live session.
Thank you for reading the Planned Giving Blog!
Best regards,
Jonathan Gudema, Esq., Managing Editor of the Planned Giving Blog and Founder of Planned Giving Advisors
Why Lead Trusts are so rare
As I follow-up to my previous post, which proved from IRS statistics that very few charitable lead trusts are established annually, I want to briefly address the likely reasons for the small number of this wonderful giving option (thank you to those who commented for your input!). If you aren’t sure what Lead Trusts are, search this blog for various posts on them – this post is directed at those who already understand them fairly well.
Here are my top ten reasons why we see very very few lead trusts:
- The required payout rates to avoid all or most gift/estate tax are too high! Even under today’s mega-low AFR environment, your lead trust still needs to pay the charity at least 6% annually for a 20 year trust, 8% for a 15 year trust. Think about it – if your investment plan for the trust assets can’t guarantee well more than those rates, forget about a lead trust.
- The required terms to avoid all or most gift/estate tax are too long! Really the same point as the first point. Most people considering lead trust don’t want to use any of their lifetime gift/estate tax exemption. That being the case, your lead trusts need to be 15-20 years or more! Someone in the Hess family did a 35-year lead trust! Click here for article on that one.
- The investment returns to make lead trusts work are not realistic in most cases! This is also connected to the first two points. If you are ok with a 20-year term paying the charity a 6% annuity, you better feel confident that your trust can earn 8% or 9% or better. If not, this may not be worth doing – it could actually reduce the heirs’ inheritance!
- Finding the right funding asset/investment is close to impossible! Building on the previous point, you need to find an asset that will produce the cash flow to cover the 6%+ payout rate as well as grow. To me, commercial real estate sounds like a great option. Problem with commercial real estate is that most properties/interests in properties are leveraged in ways that prevent donors from using them for lead trusts (I had that happen to one of my perfect lead trust donors).
- Professional advisors are not knowledgeable about them. I am not talking about one’s ability to talk like you know what you are doing – I am talking about really knowing them! If you are an advisor, did you know that Lead Trusts are NOT done to avoid capital gains? Did you know they are NOT done for income tax deductions? If those two questions have you wondering, you DON”T understand lead trusts very well.
- Charity advisors aren’t knowledgeable about them. This doesn’t bother me that much because charities should NEVER act as trustee for a lead trust. In fact, while advice from a charity can help, a lead trust is a key piece of one’s estate plan which requires full participation of the estate attorney and very little practical help from the charity. Still, charity advisors could teach the estate planning and professional advisor worlds about lead trusts and maybe encourage more to happen.
- It may not even be the best planning option for ultra-wealthy philanthropists with heirs. I have one estate planning client who fits the bill for a lead trust – very charitable, concerned about estate tax, looking to pass assets to his heirs with a decent time delay and has assets that may soar in value. But, at the end of the day, GRATs worked better for him because he needed more flexibility to swap assets in and out of the GRATs and worst case for him, the assets all passed back to him and he starts new GRATs. He is setting aside assets for big giving and not bothering with lead trusts.
- Complex, complex, complex! Did you know that a charitable lead trust is not a “tax-exempt” trust? It is actually considered a complex trust for accounting purposes. And complex it is. And, the less people understand these things, the less likely they will happen. Just my theory but it seems to work that way.
- Did I mention finding the right donors is also like finding a needle in a haystack? Yes, you need to find a donor where all of the bells and whistles hit on target. Facing significant estate taxes (with an estate well in excess of the federal $5.23 million per person exemption)? Otherwise, there is no reason to even consider them. They need to be seriously charitable. Like I said above, there are other similar, non-charitable options that work. And, then you need the right asset/investment and a payout/term that makes sense to your donor. Would be nice, too, if your donor understood what a lead trust really is.
- Too many easier giving/planning options that make more sense to your donors. When a donor or client gives me that blank stare (as lead trust discussions often cause), I know I’m not in good territory. How about a CRAT? How about a GRAT? Yea, that sounds good. I get the message and quietly slink my lead trust pages away. Donors and clients tend to stick with what they know and have done before.
Trust me, I would love to be working on lead trusts. I’m not a naysayer by nature. All I am saying is learn what they are really about and see if you can ever sell one. I wish you luck and offer to discuss any real lead trust scenario with you for free! Send me an email if you think you have a live one (jonathan@plannedgivingadvisors.com) and I’ll give my advice, for whatever it’s worth.