charitable lead

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.

As mentioned in my previous post (and other ones on lead trusts – see http://theplannedgivingblog.wordpress.com/category/charitable-lead-trusts/) 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.