Commercial annuity as investment option for a Charitable Remainder Trust?

I worked on the issue of a commerical annuity in a CRT last year – the aftermath of a CRT investing its principal in a commercial annuity and the disaster that followed.

Now, thanks to the planned giving design center and an IRS letter ruling, use of a commercial annuity in a CRT might become more prevalent.  Click through to see the short letter ruling:

The question though is why would a trustee want to do this?

Let’s start with why not.  The story I worked on was a classic example of why not.  Unwitting donors created a CRT with a few hundred thousand dollars of hard earned money, to create an income steam for themselves and a remainder for great charitable works.

Sadly for them, everyone involved with the process of creating this CRT were absolutely clueless – from the drafting attorney to the third party planned giving specialty company to the investment manager.  The investment adviser saw that this trust needed to produce an annuity for the donors for their lives.  So, the investment adviser suggested to put the entire principal in a commercial annuity paying exactly what they are supposed to receive yearly. 

Problem: the principal was not guaranteed.  Second problem: the annuity wasn’t guaranteed either.  Third problem: stock market crashes and eats up the value of the principal.

This was an incredibly poor piece of advice given to these CRT donors. 

I actually devised a bailout plan for this disaster which entailed the donors relinquishing their interest in the CRT in favor of a charity, and that charity issuing a CGA on their lives.  The new income stream would have been about half of what the CRAT was paying but it would have at least salvaged a remainder and guaranteed a fixed income for life.

What they really should have done is sue all of the offending advisers involved – they were all sitting ducks for their so-called professional advice.

In the end, they decided to let the CRT languish.  Having been burned very badly once, I don’t think they were up for any more complexities and just hoped for the best.  Maybe the annuity recovered.  Maybe not.

There was a serious legal issue in that case that is not addressed in the letter ruling that just came out.  The question is whether a trustee should make such an investment, especially if it is not in the best interests of the remainder charities.  Prior rulings, I recall, required an independent trustee to help make this risky decision.

Bottom line, and why I wrote this piece, is that regardless of this new letter ruling, CRT trustees should be very cautious before ever investing in a commercial annuity.  It has to make sense for both income and remainder beneficiaries or the trustee deserves to be sued.

I did promise a discussion of why it would make sense for a CRT to invest in a commercial annuity.  Well, if it can guarantee a remainder, then it might make sense.  Something like reinsurance within a CRT.  The key is guaranteed principal for the charities while guaranteeing the income stream.  In the end, you might be giving up half or more of the principal to accomplish this but that isn’t so bad considering the cases where there is nothing left for the charity.

I have discussed before that I actually believe that reinsurance in the CGA arena is very useful and sometimes a better long term option for a charity.  Could work similarly here for CRTs.

The main thing is to have advisors who knows CRTs and who know commercial annuities – real knowledge, not just faking it.

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