Penn State

• Provides money to your favorite charity each year for a certain number of years?
• After the period of years, gives what's left to your chosen loved ones?
• Shelters the potential growth in the assets from additional taxes?
  

This technique, called a family charitable lead trust, helps affluent families remove wealth from their estates and give it to chosen loved ones in future years. Although what's left in the trust is a taxable gift to the donor's designated heirs, this strategy allows you to pass assets to your heirs with no-to-low gift taxes.

How It Works
The lead trust is ideal if you're charitably inclined and willing to forgo access to part of your wealth now, but you don't want to deprive your chosen loved ones of that wealth later on. With this strategy, you give assets to a trust, and the trust makes payments to one or more of your favorite charities for a number of years, which you choose. The longer the length of time, the better the gift tax savings for you.

Fixed or Variable Charitable Payments?
A charitable lead trust can make payments in one of two ways: a charitable lead annuity trust pays a fixed amount each year to the charities, whereas a charitable lead unitrust (the less common type) pays a variable amount each year based on the value of the assets in the trust. With the unitrust, if the trust's assets go up in value, the payments to charities go up as well. On the other hand, if the assets decrease in value, so do the charities' payments.

When the Trust Term Ends
After the period of years, the assets inside the trust generally pass to your chosen loved ones. If you place depressed assets inside the trust at the beginning, they can grow in value over time and avoid gift tax on their appreciation. In other words, you pay gift tax on the lower value today, and, ideally, your designated heirs get the assets at a much higher value years later without incurring additional gift taxes.

The Time Is Now
Due to the downturn in the economy, the charitable midterm federal rate, the interest rate used in calculating the amount of the gift subject to tax, is at a historic low. Compared to the highest it has been, 11.6 percent in 1989, the current low rates mean a higher tax savings for funding a charitable lead trust. The best gift tax breaks combined with assets that may be depressed in value temporarily create the perfect opportunity to consider a lead trust.

The tax savings is in the form of gift-estate taxes, not income taxes.¹ So, this strategy may be right for you if you are in a situation where your wealth would most likely be subject to estate taxes at your death. In 2012, estates worth more than $5.12 million are subject to an estate tax of 35 percent on the amount over $5.12 million.² In other words, for every $1 million over the threshold you want to leave to your heirs, estate taxes will consume $350,000.

An Example
Jerry has $1 million in securities that create dividends he doesn't need to support his lifestyle. With his other assets, his estate is worth $7 million. His ultimate goal is to have his two children inherit his wealth, but he does enjoy supporting his favorite charity. In fact, Jerry would like to make a $1 million or more pledge over the next 20 years to help provide the charity with financial support.

The Solution: Jerry established a charitable lead annuity trust and funded it with $1 million in securities. When Jerry created the trust with his attorney, he was able to choose which charity or charities he wants to support and which family members he wants to receive the assets in 20 years. Plus, he decided how much he wanted his charity to receive each year—the higher the payment to charity, the lower his taxable gift. He chose to have the trust to pay $40,000, 4 percent, annually for the next 20 years.

Because of the low interest rate, Jerry's $1 million gift to the trust generates a taxable gift in the amount of only $319,980.³

The Benefits: If Jerry has instead left the children $1 million in securities, all $1 million would have been subject to estate taxes at a marginal rate of 35 percent (in 2012) and the children would have inherited only $650,000 after tax; the tradeoff to the kids with the lead trust is they have to wait 20 years to get the full $1 million. Therefore, by implementing a charitable lead trust:

• The children will receive what's left in the trust (whatever the $1 million grows, or declines, in value to in 20 years).
• Only $319,980 of the $1 million in securities is subject to gift tax.
• All the growth the securities earn over the next 20 years escapes gift tax, too. Therefore, if the assets grow to $5.12 million in 20 years, the children would receive the full $5.12 million (in 2012) without paying a penny in additional taxes.
• When Jerry dies, the value of the lead trust is not in his estate and therefore is not subject to estate taxes.
• Jerry is able to control the timing of when his children receive the assets—in this case 20 years.
• His favorite charity will receive $40,000 for 20 years, or $1.8 million overall, in support of its mission.