innovative estate planning

Cool but tricky gift annuity ideas

Welcome new subscribers to the Planned Giving Blog – thank  you for joining our 800 subscribers!  This week though I came across some interesting gift annuity issues that I think are important to think about.

Flexible deferred gift annuities are totally OK if you are licensed in NY (to issues CGAs)

That is the good news but there are some serious caveats.  If you were wondering, the flexible CGA is a deferred CGA in which the donor can choose when payments are to start (with at least a one year deferral to start). Each year the donor delays, his/her potential payment jumps to reflect an additional deferral year.  A really cool option for many reasons, besides the fact that it is a great way for a donor to “wait and see” as their right to income increases dramatically each year they don’t activate the CGA.  I have pitched these where the donor is not sure he/she will even need the income or they want some sort of hedge to see if the nonprofit does what it says it will do.  In other words, the donors may choose never to take the payments! Also, the contract itself lays out what the new payment plan would be each year, avoiding potential conflicts with your donors in the future.

Here is what makes them tricky if you are licensed in NY.  The NY guide on CGAs from their Dept. of Insurance states that Flexible Deferred are ok if the contract is for up to 20 years of payment options.   Beyond a 20 year schedule, you need approval from them for your contract.  What a headache and who knows how long they will take and how much nit-picking they will do over the language of your contracts.  NY Dept. of Insurance attorneys are known for ridiculous scrutiny over every punctuation mark and even reject previously approved language.  To make matters worse, NY expects you to only use pre-approved agreements, in general.  Have you gotten your Flexible Deferred CGA agreements approved?  Have you gotten the language of your other contracts approved!

One client of mine ran into some trouble with the NY Dept. of Insurance, apparently ignored their demand letters, and received a cease and desist letter from issuing new CGAs until they dealt with whatever the issue was.  This issue of contract language had become a big problem for them and they had to return a really large amount of money to a recent annuitant to undo their CGA since it happened during the suspension period.  Yikes.  You can guess that a consultant (me) was needed in the absence of the fired planned giving director (lesson for anyone in charge of planned giving programs – don’t ignore those legal letters!).

All of this reminds me how annoyingly complex running national CGA program can be.  Basically, your program better bring in enough CGAs to justify significant staff time overseeing the program’s legal/registration issues or maybe it’s time to think twice about issuing CGAs in every state (particularly NY and CA).

CGA funded with an Estate Note?

This idea come up yesterday with a client.  What is the difference between an irrevocable estate note (irrevocable pledge) and a life estate?  Life estates offers donors a charitable deduction and a charity in theory can accept a life estate for a CGA.  A legally binding pledge/note against your estate doesn’t offer a deduction but who is to say it isn’t any riskier than a life estate in real estate.  Why not allow a donor to sign a legally binding commitment to an amount out of his/her estate and the charity gives him/her a gift annuity for the present value of the committed amount.

Now, you have ask the obvious – why in the world would the nonprofit commit to paying a lifetime annuity when all they have is a pledge agreement?  Yes, there has to be assets at the nonprofit (whether given by this donor or not) which they can park in their CGA pool to replace the present value figure to rely on to cover the payments.  Assume that is the case.  Any other issues with this plan? Am I treading in S. Prestley Bake territory (for the legal nerds out there) – the namesake for my law school (which happens to be considering a change to The Lois Lerner Law Center 🙂

Stay tuned as I work on this one…..


Joe Paterno and Lessons in Estate Planning and Asset Protection

Apparently behind the Penn State scandal there is some speculation about an “estate planning” move made by the 84-year-old Joe Paterno in July this year.

The move: a $1 sale of his $600,000 home to his wife in July.

Here are two articles on the topic:

What struck me about these posts are the comments – many of which reveal that the supposed liability avoidance theory is most patently false.

A house owned jointly by a husband and wife (called Tenancy by the Entirety) is the most  secure asset from creditors/lawsuits you can find – the only creditors that have a shot at it are joint creditors to both spouses.  Unless Mrs. Paterno was a co-coach with Joe at Penn State, the transfer of the house makes no sense from an asset protection perspective.

The most intriguing part of this whole story is the 101 opinions on this topic (all over the map) – and the silly speculation of the initial writers of the news articles.  These stories should give readers pause before accepting the initial conclusions of journalists on tax topics like this – it may be that authors are actually clueless on the topic.

My vote: it was standard estate planning at work, an attempt to divide up the estate assets to take advantage of each spouse’s federal estate tax exemption.  Just bad timing.


Chariable Lead Trust Revolution!

Apparently I missed an unbelievable revolution in the charitable lead trust arena, by about 10 years! (and so did most of the rest of the planning community)

At yesterday’s PPGGNY’s planned giving day, I heard Paul S. Lee, JD, LLM, National Managing Director of Bernstein Global Wealth Management, talk about the so-called Shark-Fin Lead Trusts.

There is no way I can do justice Lee’s presentation.  Myself, a self-proclaimed lead trust guru (having worked heavily on three lead trusts that actually came to fruition), didn’t think there was much new under the sun with these planned giving vehicles – but I was very wrong.  I am going to try and summerize in shortest form the innovations he talked about (at least the ones I grasped) and give you a link to a recent paper Paul wrote on the topic (for the die-hard planners out there).

Firstly, if you are not sure about lead trusts in general, read this piece:  Understanding Charitable Lead Trusts (this is my own primer on the topic).  If you don’t have patience for my comments, here is Paul Lee’s article on the so-called Shark-Fin Lead Trust:  BNA_TM_SharkFinClats_1210  Here is another more recent outline:  PSL CLAT Outline (Jun 2011)

So, what did I learn new?

Number 1:  It is totally fine and standard to create a lead trust with laddered payments to charity.  In other words, you can create a lead trust in which payments start at $100K in the first year, jump to $120K in year 2, and keep jumping (any pattern should work even though using 20% incremental jumps has a greater history and is a bit more “standard” than more extreme patterns – as you will see).

Why is this important?  Paul showed us a very important chart regarding lead trust investments.  Guys like me always make projections with flat returns during the term of a trust (I know it is unrealistic but it is the simplest way for me to see generally what might happen with a trust).  In truth, investments in the stock market fluxuate (and yes, over time, you will get that nice average 9% return so says every decent investment presenter I have seen). With lead trusts, typical market fluxations could help or destroy your lead trust. If you start off your lead annuity trust with one or more of the bad investment years (that do happen), your trust might lose too much principal in its early years to catch up during the good investment years (which also happen but maybe too late).  Laddering payments to charity (smaller payments in early years) gives the lead trust much greater chances to succeed by giving your lead trust investments time to catch good investment years in the early years of the trust, which then can carry the trust through good and bad years until the end.

Paul used an amazing example of how this concept works.  He took the last 10 years of returns from the S & P 500 and used them as the investment results of an imaginary lead trust.  The average return over the time period was over 9% – great for lead trust success, right?  Not necessarily.   One column used the S & P 500 returns as they actually occurred and the result was good – money to charity and left overs for children.  The next column, he inverted the annual returns using the most recent years as the early years of the lead trust and guess what?  The trust failed – exhausted its assets.

And, this technique is not bad for charities.  Even if the charity gets less upfront, the present valuing of the income stream of a laddered lead trust requires more money to actually to go to the charity (albeit delayed).

Number 2: Paul humorously recounted how he ignored an email in 2007 announcing that the IRS had issued template Charitable Lead Trust forms.  I also ignored that piece of news – why would an attorney use the IRS’s typical not so great forms.  Well, contained within that 2007 lead trust Rev. Proc. (Revenue Procedure announcement) was a clear statement from the IRS that the income stream to charities under lead trusts needed only to be ascertainable.  In other words, lawyers had been using the GRAT model of 20% increases in annuity payments – not even 100% sure the GRAT rules applied to lead trusts.  Now, this Rev. Proc. says that there is no maximum annual increases like GRATs, rather, just as long as you can calculate the present value of the income stream to charity.  In other words, the Shark-Fin Lead Trust.

The Shark-Fin – I have no idea why that silly name.  How about naming it the Push-The-Envelope Lead Trust.  What is it?  Example: $1,000 a year for 19 years to charity and a balloon payment of $20 million in the last year.

Ok, Paul described some wild reasons why this might work.  But, also described why it didn’t work.  I wish I could write for hours on the whys – I just don’t have the time and Paul himself wrote the article if you want details.  Here is the link again:  BNA_TM_SharkFinClats_1210

Third big piece of news:  under Paul’s illustrations, he made a very strong argument that a lead trust is actually a better estate planning vehicle (especially the charitably minded but not necessarily) today than the other standards (GRATs, etc..).  A very bold statement since I always start with the premise that you will be better off, dollar for dollar (if your goal is strictly money in your hands and that of your heirs), with non-charitable vehicles.  He had a point and that makes his article worth reading if you are a non-charitable planner.

Last thing I learned (or at least confirmed):  Harldly anyone does these things (but for some super wealthy who trust guys like Paul).  Why?  Other options can be done without losing, just try it, and failure only means you start again.  Failure with a lead trust means that the trust ran out of money, charity doesn’t get everything promised, family gets nothing, and donor may have used up some of his precious lifetime giving exemption on a technique that failed to pass anything to the kids.

This leads to the one point I would have raised with Paul had I not glazed over in the last part of his presentation about insurance schemes built into lead trusts and stuff about private equity (no clue where he was going on that):

Paul noted that lead trusts were considered a risky wealth transfer option since no one wanted to do it with a reportable gift against their lifetime exemptions (therefore the investment rates needed for success are very high to offset a “gift” – called the zero’ed out lead trusts).  I wanted to ask him about this year and next being great years for individuals to max out their lifetime giving of $5 million each spouse.

Why not create a lower payout lead trust? That would require the filing of a gift against your lifetime exemption but would be much easier to guarantee good results for both the charity and the family.  Instead of a 7% payout to charity, make it a 3% payout to charity and report a gift to children of up to $5 million.  Then pick a conservative enough investment so that everyone can sleep well at night.

One last word.  Based on this speech, I might say that an attorney or financial advisor that is already guiding clients towards lead trusts, better offer some sort of laddered payment option or he or she might be guilty of malpractice (or at least giving poor advice).