Perfect Storm for Lead Trusts, Part 2

As mentioned in my previous post (and other ones on lead trusts – see lead trusts are an amazing opportunity for both donors and nonprofits – albeit one that hasn’t really caught on in the planning world.

Let me share something with you from my estate planning background dealing with a few high net wealth private clients – especially ones that were already charitable.  Several times I was very excited to bring up the idea of a lead trust with the client and it never flew.  Partly, as an attorney I can recommend or suggest ideas but ultimately, my job is do what the client asks me to do.  But, there is something else that the promoters of lead trusts won’t tell you.

Here is the secret problem with lead trusts (and read to the end of this post to hear why the problem is less of an issue right now): For wealth transfer purposes, lead trusts are not necessarily the best option even for the charitably inclined. In fact, when you start wondering about what kind of asset will produce enough investment returns to make the lead trust work well (generally 8% or greater annual returns), you have to wonder  if it makes sense at all if you don’t have a guaranteed high rate of income/growth for the potential lead trust assets.

In fact, a GRAT (Grantor Retained Annuity Trust – the non-charitable version of a lead trust) actually presents less risk for wealth transfer reasons.   Why?  A GRAT pays its “annuity” back to the grantor (not to charity like lead trusts) and the remainder goes to children (hopefully at zero gift/estate tax).  GRATs, unlike lead trusts, need to be done in relatively short periods because should the client pass away during the term of the GRAT, all assets in the GRAT get hit with estate taxes (one point where lead trusts are clearly better than GRATs).  Clients typically do 3 to 5-year “rolling” GRATs – basically gambling that one of these will work out for the kids.  If they don’t work out (i.e. the GRATs income/growth are not high enough to produce a gift for the heirs at its termination), all assets end up back in the hands of the client and he starts again.  The point is this: the only real risks for GRATs are dying during the term (never a good thing) and the legal fees for setting them up (not as much as I would like!).

What is the risk with lead trusts for clients considering GRATs, too, for wealth transfer purposes?  If the lead trust fails (i.e. all assets of lead trust are distributed to charity and none or very little for heirs), your client has made some nice gifts to charity, yes.  But, he did not get a charitable income tax deduction for that giving (generally speaking).  And, if he used any of his lifetime gifting exemption, that exemption is lost (as far as I know – an interesting question).

In other words, it may be that a standard multi-year pledge combined with non-charitable estate planning gets the best result for the client from a total tax perspective.

So, what is different today and why am I still touting lead trusts?  Firstly, right now more than any time in recent years, estate planners should be encouraging their clients to use (or potentially lose) their lifetime giving exemptions – today!   All of the lead trust vs. GRAT discussion up until now was with the understanding that these trusts would be designed as zero gifts (on paper, of course) to heirs.  That makes us use very high annuity payments and lessens the chances of success for the trusts.

Part of the perfect storm today for lead trusts has to do with this opportunity.  If your donors are willing to use some of their lifetime exemption on creating a lead trust, then they can choose more a reasonable annuity payout to charity (for example, instead of 7% over 15 years, go with 3% over 10 years).  Now, instead of needing an 8% or better return for the lead trust to have any wealth transfer effectiveness, your lead trust can succeed on much more conservative assumptions.  And, because GRATs still have the risk of estate taxes in case of death of the grantor and therefore still need to use short payment periods, lead trusts finally jump ahead of GRATS because of their new found flexibility.

Lastly, with the advent of “Shark-Fin” lead trust strategies using laddered payments to charity or balloon payments at the end of the  lead trust, a lot of investment risk can be lessened.  Combined with using more conservative payment rates to charity by using some of the donor’s lifetime exemption, I would feel much more comfortable with a client intending invest their lead trust assets in equities.



  1. Points clearly made. Pledges in lieu of more complex CLT planning are the “simple” solution for some donors but, as in the case of a GRAT, if the donor dies before the pledge is paid, the donor’s charitable gift goal (e.g. scholarship endowment) may never be fulfilled. Granted, the donor can make a legally binding pledge or backstop the pledge with a provision in a will, trust or other testamentary gift plan but this gets into the “complex” planning that some donors glaze over when discussing. As the author has noted, CLTs are attractive these days and CLATs allow the donor to lock in a “deal” that may be gone in the not too distant future. The many variations of the Shark Fin CLAT and so called Variable Appreciating CLAT (see PLR 201216045) offer appealing opportunities (but note that there is little IRS guidance on these plans). For risk adverse donors who want to keep it simple, standard CLATs offer the best charitable gift / wealth transfer opportunity in their relatively short history. For example, using the August IRS discount rate of 1%, a CLAT can “zero out” any applicable gift or estate tax with annual payouts of (and “yes” I also show donors a range of lower payouts and allocation of some of the donor’s estate and gift tax exemption available in 2012):

    15-Year CLAT — 7.2124% (5% shelters 69%)
    20-Year CLAT — 5.5416% (4% shelters 72%)
    25-Year CLAT — 4.5407% (3% shelters 66%)
    30-Year CLAT — 3.8748% (2% shelters 51%)

    But this perfect storm appears to be passing… along with the end of hurricane season 2012.

    1. I am honored that someone from Duke commented on the blog! Duke didn’t make my Big Ten of Planned Giving list but I am sure you are pretty close.

      Very interesting and I might re-post your comment as a separate blog post.

      Thank you!

  2. I did not know this Part 2 post was up until just now, therefore, I am posting the comment I just made on the Part 1 blog. 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. And no, I am not speaking of the “shark fin” or “laddered” CLATs, which I am perfectly comfortable with and would love to argue in favor of their validity before the Tax Court (for free). I’ve done 7 large CLATs so far this year (none of which are “zeroed out” nor are the “shark fins”), 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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