Perfect Storm for Lead Trusts – IRS rate drops again, Estate Taxes about to soar

The IRS discount rate for August for valuing charitable gifts (referred to as the AFR or midterm rate) was just announced at 1%.  (This very low rate is actually negative for life income gifts like gift annuities or charitable remainder trusts because it reduces the income tax deduction but for lead trusts, it increases the amount of gift tax deduction – see for an in-depth look at lead trusts)

The estate tax, as mentioned often on this blog, is scheduled to jump to the 2001 rates of 55% top bracket and only a $1 million lifetime exemption on 1/1/13.

If there was ever a time to think about a lead trust – for the charitably inclined who are also concerned about estate taxes – it is now!

Ok, let’s be real, how many of these trusts are really going to happen?  And, if not many, why should we (the fundraisers and other nonprofit leaders) care about them?

In 2001, there were 4,571 lead trust tax returns filed. In 2010, there were 6,609 such returns.  Not that many considering that these trusts last often for 15 to 20 years.  Looking at charitable remainder trusts, we see over 100,000 of them in existence as of 2010.  Probably in the millions for gift annuities.

There have been plenty of favorable times for lead trusts yet they haven’t “taken off” in the planning world.

Well, I actually don’t believe we will see very many lead trusts created now, regardless of the “perfect storm” environment.  Lot’s of reasons. Primarily, they are still too complex not only for donors but also for their advisors.  And, in any case, if you understand them well, you will understand why they don’t work that often.

Here is an example that I just ran today, under the new all time low 1% AFR:  a 15-year $1 million funded lead annuity trust with a maxed-out gift tax deduction (i.e. give me an illustration that shows a $0 gift to the kids).  The payout rate: approx. 7.3%.  That means for this trust to really work well for everyone involved (charity and kids), it better earn at least 8% a year, with no risk of big investment losses (especially in the early years) for 15 years.  In other words, unless someone has an asset that is going to produce that 8% or better return in a guaranteed way for 15 years, your donor might be better offer making annual gifts than to use a lead trust.

That actually takes us to why lead trusts are important for fundraisers.  You see, if you enter into lead trust discussions with a donor, you know a few things about the donor’s situation:

  1. They are wealthy enough to be concerned about estate taxes.
  2. They are charitable enough to be looking for a way to benefit your organization through their estate plans.
  3. They are willing to entertain the best possible tax ways to help your organization, as long as they meet some other planning goals.
  4. Actually, to me, it shows that they really like the idea of helping your organization in a big way.

Think about it.  If you are knowledgeable enough on this topic to spot a potential lead trust donor and feel comfortable enough starting the conversation (with at least an attorney or consultant to help out when it gets beyond your knowledge), the end result may be a wonderful gift.

It just might not be a lead trust – it may end up being a straight multi-year pledge! You may also end up with a bequest commitment. Could be a very one, considering the donor attributes mentioned above.

So, it is worth it for fundraisers to get up to speed on this option. You never know!


  1. I’m curious about your 8% figure. By my calculations, 8% would leave a residual of over $1M to leave to the family (which is the amount of the original gift) BUT – since estate tax might eliminate half of that million – wouldn’t any return that left more than $500,000 in the residual be an improvement over regual annual giving?

  2. You are correct. A little over $1 million is result for kids. A gift/estate tax saving of approx. $500,000. Not a bad deal for the family and great for the non-profit. Still worth doing, for sure, at that rate of return.

    But, if the return is only 5%, the residuum for family drops to $500,000.

    or, only 3% return, residuum to family is down to around $200,000.

    You have to start wondering if this makes sense since the donor is basically giving up income tax deductions and capital gains avoidance by using a lead trust. And, there are still others ways to pass assets to children at reduced gift/estate tax.

    The point is that as you flesh out these options, the lead trust gets more difficult and its benefits get less clear.

    Thank you for commenting!

  3. I couldn’t agree more with the “perfect storm” analogy. However, when you consider all the elements of the current planning environment in the income tax world. wealth transfer tax world, economic climate and ever-changing face of philanthropy, I would call it the “Perfect Storm of Perfect Storms for Charitable Lead Trusts”, plain and simple. In fact, I often describe it as such just to attempt to adequately describe the priority that Major Gift/PG/Development officers should give this incredibly under-utilized tool in the PG toolbox.

    1. Thanks! I love lead trusts! Keep plugging away (educating yourself, identifying the right prospects and talking about them) and you never know.

  4. Jonathan,
    I agree that we won’t see 100s of zeroed out CLATs the rest of 2013 for various reasons, some of which you mentioned in your blog. The biggest of which is the ignorance/discomfort of the donor’s atty/accountant/financial advisor, plain and simple. However, as you know, there are dozens of incredible variations using the CLAT chassis that have nothing, absolutely nothing, to do, with zeroing out the gift component of the remainder interest. I’ve done 7 large CLATs so far this year, and quite of few more in the pipeline. The 1.0% 7520 rate and pending political/tax uncertainly (particularly on the income tax side, not the estate tax side) is driving the bus hard right now. Very fun planning tools for all the players (donor, charity, consultant (me) and advisors.)

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