The
Charitable Lead Trust
Editor’s note: Gregory A. Jacobs, senior vice president and regional managing director of financial planning at Wachovia Wealth Management in Atlanta, extensively contributed to the information in this article.
One of the most significant problems facing people with large estates is the huge tax burden of divesting large balances in individual retirement accounts or other qualified retirement plans.
Currently, when an IRA is left to a non-spouse or non-charitable beneficiary (for instance, children or grandchildren), the combined income and estate tax liability can exceed 70 percent. Further exacerbating the problem is the generation-skipping transfer tax if an IRA is left to grandchildren. Without proper planning, the Internal Revenue Service will become the primary beneficiary of a wealthy individual’s IRA.
Many strategies address either the income or transfer tax, but very few address both. The charitable lead trust has become more popular in light of low, albeit rising, interest rates. In a low interest rate environment, charitable lead trusts can yield additional assets for families rather than the IRS.
This strategy benefits people over age 59 and a half (the age when you can begin withdrawing from an IRA without penalty) who have significant IRA balances that they don’t anticipate needing for retirement. They should also have a net worth that places them in a taxable estate position, which is currently $1.5 million for a single individual and $3 million for a married couple.
This strategy requires contributing all IRA assets to a charitable lead trust. The trust will pay an annuity to a charitable organization during the specified term, and the family of the IRA owner will be the remainder beneficiaries. The trust will make annual or more frequent payments to charitable beneficiaries throughout the annuity term as calculated based on the prevailing IRS interest rate or the two immediately preceding months (4.2 percent is the best rate available as of February 2005). At the end of the annuity term, all remaining assets held inside the trust that have not been used to fund the annuity payments will pass to the IRA owner’s family tax-free.
If structured properly, a full charitable deduction will be available for income and gift tax purposes in the year of contribution to the trust. Depending on the IRA owner’s overall income tax situation, the deduction generated by the trust contribution may enable him to recapture the entire income tax cost of the lump sum distribution over the five-year carry-forward period allowed for charitable contributions. The full charitable gift tax deduction will result in a zero taxable gift upon formation of the trust, despite the likelihood that assets will eventually pass to family members.
If the trust investment portfolio generates returns in excess of the IRA interest rate in effect when the trust is created, the excess will be available to pass to the IRA owner’s family at the end of the annuity term. Today’s historically low interest rates provide an excellent opportunity for wealthy individuals to pass additional wealth to their heirs with minimal tax implications.
For more information, contact Tony Duva, director of planned giving, at 800-869-1113 or aduva@mcg.edu.
Information in this article is not intended as legal advice. For legal advice,
please consult an attorney.
Tax laws are subject to change.