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Including one or more charitable trusts as part of a testamentary estate plan is a creative and powerful way for clients to achieve multiple goals in one estate planning vehicle. Such goals may include donating assets to charity, tax-efficiently transferring wealth to children, and reducing (or even eliminating) estate tax liability.
Two types of charitable trusts that may be included in an estate plan are a charitable remainder trust (CRT) and a charitable lead trust (CLT). There are variations of each type of charitable trust but for simplicity’s sake, the function of a CRT is to distribute a percentage of trust assets to a noncharitable beneficiary(ies) (i.e., the grantor’s children) annually for a defined period of time (e.g., 10 years). The annual payments to the noncharitable beneficiary(ies) must be greater than 5% but no more than 50% of the fair market value of the trust assets, with the assets being revalued annually. The remaining trust assets at the end of the trust’s term are then distributed in a lump sum to a charitable beneficiary, which could be one or more charities, a family foundation or a donor-advised fund (DAF). A CRT does not eliminate all estate tax, but it may produce a significant charitable deduction.
A CLT is essentially the opposite of a CRT. With a CLT, trust assets are distributed annually to a charitable beneficiary for a defined period of time. After such time period expires, the remaining trust assets are distributed in a lump sum to the noncharitable beneficiary(ies). The CLT comes with a benefit that the CRT does not: The amount transferred to a CLT could receive a 100% charitable deduction depending on how the CLT is structured. Although this article describes using such trusts as part of a testamentary estate plan, either or both types of trusts may also be created during a grantor’s life, and instead of existing for a defined period of time, could exist until the death of the grantor.
A recent client example is informative and illustrative of the power of this type of planning. The client was charitably inclined and also wanted to increase the amount that would be distributed to her children upon her passing. Upon the client’s death, the client’s revocable trust provided that 50% of her assets would be distributed to a 10-year CRT, with the remainder, after accounting for any estate tax, being distributed to a 10-year CLT. As a result of this planning, the client’s four children would receive annual payments from the CRT for the first 10 years and then would also receive a lump sum consisting of a share of the balance of trust assets held in the CLT. The charitable beneficiary would receive the opposite: annual payments from the CLT for the first 10 years and then a lump sum from the CRT in year 10. The following tables illustrate the amounts that are projected to be distributed to the grantor’s children, the charitable beneficiary (a DAF) and the amount of estate tax1:
The above example illustrates the “best of both worlds” nature of this type of planning. With this planning, the grantor accomplishes the following: (1) leaves a significant charitable bequest; (2) leaves sizable assets to the grantor’s children; and (3) dramatically lowers the grantor’s tax bill2, in particular as it compares to the potential tax bill if the grantor simply passed assets on to her children.
Each client has different personal values and goals embedded in their estate planning. It is important to be thoughtful with the planning strategies implemented. It does not always have to be as simple as “leave X amount to the next generation and donate Y amount to charity.” Instead, the use of one or more charitable trusts in a testamentary estate plan may better achieve the client’s goals and leave a greater legacy to both charity and family.
Adam, Jeffrey and Jonathan work together in the Chicago office of Katten’s Private Wealth Group, which is among the largest in the country. Adam is a member of AEF’s Council of Advisors and is an ACTEC fellow. They advise UHNW business owners, multi-generational families and family offices to provide flexible estate planning solutions that preserve and protect their clients’ wealth in a tax-efficient manner.
This article was originally published by the American Endowment Foundation, and is republished here with permission.
1 The following assumptions are made as a part of these tables: (a) grantor had a $100,000,000 taxable estate (having either used up all gift tax exemption with lifetime gifts and/or allocating the unused estate tax exemption to children at death); (b) the applicable 7520 rate is 5% (September 2023 rate); © the unitrust payment to the non-charitable beneficiaries is 5%; (d) all trust assets grow at a rate of 8% annually; and (e) all beneficiaries do not spend any of the trust assets and the trust assets are invested and continue to grow at 8% annually.
2 If the same client instead left $100 million directly to her children (and $0 to charity), the estate tax bill could be approximately $40-$50 million depending on whether the marginal estate tax rate was 40% (federal) or closer to 50% (federal and state combined) (and assuming all gift/estate exemption was utilized in other transfers).
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