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Charitable Lead Trust

Jack, an ardent Cato supporter, has managed a consulting firm for many years. As he begins to think about the future, he realizes that he wants to leave a meaningful legacy to Cato but also wants to ensure that his niece, Alice, is financially secure. Jack has no children but is close to Alice, a young lawyer just starting out. Jack is also worried about the impact of estate taxes. Fortunately, Jack learns of a trust that could solve his conundrum— a Charitable Lead Trust (CLT). Jack’s adviser explains that CLTs are quite straightforward:

“Your will should direct that a portion of your assets flows into a CLT. The income earned on the CLT assets will pass to charity for a term of years—say for 5, 10, or 20 years. You get to choose how long. After that term has expired, the assets pass to family members—in your case, Alice. And your estate will get an estate tax charitable deduction equal to the value of the income stream going to charity.”

For Jack and Alice, a CLT brings it all together—a legacy for Cato, long-term security for Alice, and an estate tax deduction.

This device is the mirror image of a charitable remainder trust. You fund an irrevocable trust that then pays a certain percentage to the Cato Institute for a specified period of time. After that time, the principal is paid to a remainder beneficiary (typically, children, grandchildren, or other family members).

With a charitable lead trust, you can pass an income-producing and potentially appreciating asset to your heirs while also helping Cato advance civil society. The value of the assets placed in the trust is frozen for gift tax and estate tax purposes on the date of transfer. This means that any future appreciation of the assets is free of gift and estate taxes.

In addition, if the CLT is set up during your life, a charitable gift tax deduction is earned for the actuarial value of income paid to Cato during the term of the trust. The greater the amount paid to Cato, and the longer the term, the greater the charitable gift tax deduction. It is possible to earn a deduction equal to the value of the assets transferred to the trust, making the gift to the trust remainder beneficiaries tax-free.

Bear in mind that it is also possible for your will to set up a CLT, one that will take effect at death. In fact, this option was illustrated in the example. In this case, the CLT may generate an estate tax charitable deduction, assuming your estate is large enough to pay estate taxes.

Note that certain age and minimum donation restrictions apply to this giving device.

Charitable Remainder Trust

Over the past 25 years, Fred and Mimi built a well-known investment boutique. Because they have no children, they are discussing the possibility of selling the firm at some future point but are daunted by the slew of taxes generated by a sale. One of their financial advisers suggests that they consider a uniquely attractive planning structure: namely a Charitable Remainder Trust (CRT). As their adviser explained:

“The basic idea behind a CRT is simple. You transfer low-cost basis assets to the CRT while reserving a flow of income for your lives. You designate a charity to receive what’s left over, the so-called remainder. You get an upfront income tax charitable deduction and, more importantly, when assets are sold within a CRT capital gains taxes are not immediately payable.”

This device allows you to transfer property irrevocably to a trust, which then pays you or your designated beneficiary a set annuity or percentage of the trust assets for life or for a term of years up to 20 years. When the trust terminates, the remaining assets pass to the Cato Institute. There are two ways to structure the remainder trust.

With a unitrust, your annual payment varies each year and is determined by multiplying a fixed percentage (at least 5 percent) set at the establishment of the trust by the fair market value of the trust’s assets in a given year.

With an annuity trust, your annual payment is a fixed percentage (at least 5 percent) of the initial trust principal and, thus, unlike the unitrust, does not vary from year to year with the subsequent actual value of the trust.

The charitable remainder trust allows you to make an irrevocable commitment to contribute a significant sum to assist Cato with its important work while retaining a payment stream for you or your beneficiary for a period of time or for life. You will receive a current federal income tax charitable deduction for the value of Cato’s remainder interest in the trust. You can also defer or possibly avoid capital gains taxes on appreciated securities used to fund the trust, and the assets used to establish the trust reduce the size of your estate. Additionally, the trust is not taxed if it sells appreciated securities, and undistributed capital gains or earnings in the trust accumulate tax-free. This permits a larger asset pool for reinvestment and, thus, larger payments for you or your beneficiary.

Note that certain age and minimum donation restrictions apply to this giving device.