How a Charitable Lead Trust Works

What if you could open a trust that would benefit your estate planning, tax planning, and investment management all at once? It’s also altruistic, enabling you to make a difference in important causes you care about.

I’m talking about a Charitable Lead Trust—or CLT.

If you’re in the highest income tax bracket, have highly appreciated assets, and could use an income deduction for the current year, a CLT is a strategy you may not have considered.

There are many different types of trusts. But this is an irrevocable trust that makes payments out of the trust to your charity of choice for a set term. After the term ends, the assets in the trust resort back to you or a beneficiary you designate.

Who is Eligible?

CLTs are not for everyone. This strategy is designed for you if you meet any or all of these criteria:

• You’re charitably minded. A CLT is one option for those who are incorporating charitable giving as part of their estate plan or will. If you want to keep all your assets in the family, then this wouldn’t be a good fit for you.
• You want to give consistently over time. If you want to donate to your chosen nonprofit, but you don’t want to make a large lump sum payment, then a CLT can help. This type of trust allows you to contribute generously but spread it out over a designated term.
• You want to reduce future estate taxes. A CLT can reduce estate taxes that your beneficiaries may face. It also allows you to experience additional tax benefits in the here and now.

How it Works

A Charitable Lead Trust is established by creating an irrevocable trust. You create the trust, decide on your charity or nonprofit, and fix the term for how long you want the charity (or multiple charities) to receive payments.

How do the payments work? You have two options:

1. Making fixed payments. This provides security, as both you and the charity know exactly what you’re giving. The downside is that you’re committed to the amount even if the investment is doing poorly.
2. Giving a fixed percentage. In this case, the income stream to the charity fluctuates based on how the investment is doing year to year.

Once you’ve identified the charity and the payment method, it’s time to fund the trust with one or more of the following assets: cash, publicly traded securities, stock, or real estate.[1] You’ll need to contribute enough so the trust has adequate resources to make the required payments. Then the trust disperses annual payments during the set term to the designated charity.

After those payments have been met, the remaining assets are distributed to the beneficiaries of the trust. That can be you, family members, or a family foundation.

CLT Tax Benefits

A CLT can reduce your tax liability at the get go since you typically receive one large tax deduction for initially funding the trust.[2] If the trust assets are transferred to your heirs at the end of the term, they may be eligible for an estate tax or gift tax charitable deduction as well.[3]

Because of the tax benefits that come with this type of trust, it’s going to be the best fit for those with highly appreciated assets who have substantial annual income at the highest tax bracket.

For example, let’s say my client Jerry had highly appreciated assets worth $2 million. Since his income was already at $763,000, he’s at the highest tax bracket already without this major windfall. In this client’s case, we structured a 15-year CLT to give the set amount of $100,000 per year to his local church.

Utilizing IRS Tables and current interest rates for this example, the present value of the 15 $100,000 payments is $1.2 million dollars. Jerry is now eligible for a $1.2 million-dollar tax deduction of his income. He lowered his overall estate value and now has eliminated capital gains taxes on this highly appreciated $2 million dollars. The beauty of this strategy is that he was able to deduct a large percentage of his income to charity in the first year and carry this gift up to five years in the future.

After the 15 years, the remainder of the trust will go to his beneficiaries: himself and his family.

Limitations of a CLT

Here are a few pitfalls you will want to avoid when setting up a CLT:

• Length of the trust: Too long makes the trust not worth it because it reduces the tax benefit to you. Too short means you may not be able retain as much control over your assets which would defeat the purpose.
• Tax-exempt recipient: The recipient needs to be a 501c(3) organization to qualify you for the tax benefits.
• Fees: The charity or nonprofit won’t incur the administrative fees, setup fees, and additional tax preparation and fees. Ask your financial advisor for a detailed breakdown of all the additional fees it will cost your financial plan.
• Diversification: Invest in diversified asset classes with a focus on income generation to avoid having to liquidate—especially for a loss—to fund the required payments.
• Irreversible: The CLT is an irrevocable gift, so it’s important to understand all the implications before moving forward.

Summary

A Charitable Lead Trust might be right for you if you’re charitably minded but would like to retain some control of your assets in order to leave them to your heirs. If you’re interested in a CLT, I strongly recommend that you harmonize your CPA, investment manager, and tax attorney to discuss. Then if you want to pursue this avenue, make sure to get them all on the same page when designing and structuring your CLT.

Another option you might want to consider is a Charitable Remainder Trust[RW1] , which is the inverse of a CLT. Instead of the payments going to charity, the payments provide an income stream for the beneficiaries, typically you or your family. Then the remaining assets go to charity at the end of the set term.

Making charitable giving part of your estate and your legacy is biblical. Jesus said in Luke 6.38, “give, and it will be given to you. Good measure, pressed down, shaken together, running over, will be put into your lap.” Everything you have comes from the Lord. It honors him when you give a portion back to him, however you choose to do that.

[1] https://www.investopedia.com/terms/c/charitableleadtrust.asp

[2] https://www.investopedia.com/terms/c/charitableleadtrust.asp

[3] https://www.fidelitycharitable.org/guidance/philanthropy/charitable-lead-trusts.html

 [RW1]Link to Charitable Remainder Trust blog here when the blog is active