Application of Charitable Lead Annuity Trusts

January 19th, 2009

Clients that wish to make contributions to charities can take advantage of low interest rates and depressed asset values to create and fund a charitable lead trust. This technique works much the same as a GRAT, but provides a stream of payments to a charity rather than back to the grantor during the initial term of the trust. A charitable lead annuity trust (CLAT) is an irrevocable trust that gives a designated charity (this can be a family foundation or a public charity) the “lead” interest consisting of a stream of payments for a term of years or for an individual’s life and thereafter passes the remainder interest to (can continue as a trust for the benefit of) remainder beneficiaries – usually the donor’s children.There are special rules on the use of CLAT’s for GST tax purposes which make this tool less attractive for estate planning on passing wealth to grandchildren. Because of this drawback it is best that donors designate their children (or trusts for their benefit) as the remainder beneficiaries of any CLAT.

The charitable beneficiary receives an annuity from the trust for the term of the CLAT, after which the remainder flows to the grantor’s children. Similar to a GRAT, the value of the gift to the remainder beneficiaries is established by referencing the 7520 rate. Any return in excess of this assumed interest factor results in a tax-free gift to the remainder beneficiaries.

Another variation and an alternative to a CLAT is establishing a GRAT and then making annual gifts to charity of the amounts received back from the GRAT in the form of an annuity payment. This allows the grantor to retain complete control over amounts given to charity as well as selecting the charitable recipients in each year. It also provides the grantor with an annual income tax deduction for the amount of the contributions.

The techniques we have been discussing is appropriate for people with estates large enough to incur an estate tax imposed at death. The current exemption from federal estate tax is $3.5 million. While this was scheduled to phase out in 2010, it is likely that the Obama administration will continue the exemption at this level. I don’t know how long interest rates will remain at these levels but it represents a great chance to pass on wealth to children at a significantly reduced cost of federal estate tax.

These are unique tools for high wealth individuals to preserve the value of their estates. I hope you enjoyed these series and can benefit from them.