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When Jacqueline Kennedy Onassis died, she left the bulk of her estate in a charitable lead trust, reportedly saving millions of dollars in estate taxes and allowing both her heirs and the selected charities to receive a significantly larger portion of her estate. The benefits of a charitable trust are not limited, however, to the extremely wealthy (or famous). Charitable trusts can be important components of any estate planning program. They permit an individual to make substantial gifts to a favorite charitable organization without giving up all rights over the property either currently or at a later time. Therefore, they are unique exceptions to the general rule that a person cannot claim a current tax deduction by making a limited or postponed gift. Through a charitable trust, an individual can make an irrevocable future gift to a charity and still claim a current income tax deduction for the gift.
Two types of trusts
Charitable trusts may take either of two alternative forms: a charitable lead trust or a charitable remainder trust. A charitable lead trust provides a stream of income for a stated period of years to the designated charity; when the period ends, the property held in trust returns to the donor or to the donor's designated beneficiary. A charitable remainder trust provides for the retention of a stream of income to the donor, either for a period of years or for life, followed by a gift of the property to the charity when the period ends.
Charitable lead trusts
Under a charitable lead trust, the donor receives an immediate federal income tax deduction when he makes the gift, equal to the present value of the future income stream. The donor is taxed each year, however, on the value of the income interest that is payable to the charity. The donor may establish a charitable lead trust during his lifetime, or may establish it at his death under his will, with the property returning years later to his designated heirs. If the donor establishes the trust at death, the estate claims an estate tax deduction instead of an income tax deduction.
Charitable remainder trusts
A charitable remainder trust may take either of two forms depending on whether the income payments are determined based on the trust's initial value or the value of the trust property determined on an annual basis. Under a charitable remainder annuity trust, the payments must be at least five percent of the trust's initial value. A charitable remainder unitrust, on the other hand, must provide for payments equal to at least five percent of the annual value of the trust's property. Therefore, the payments under a charitable remainder annuity trust remain the same for the period of the trust, while the payments under a charitable remainder unitrust vary depending on the trust's investment return.
If the income from the trust property under a charitable remainder trust is insufficient to make the stipulated payment, the trustee of a charitable remainder annuity trust must sell enough property (invade principal) to make the payment. Invasion of the trust principal is permissible, but not required by the tax laws for a charitable unitrust; therefore, many charitable remainder unitrusts provide for the payment of the lesser of the trust income or five percent of the current value of the trust.
Charitable trusts can be established as any one of four types - a charitable lead annuity trust, a charitable lead unitrust, a charitable remainder annuity trust, or a charitable remainder unitrust - each of which serves a different objective. Depending on your personal objectives and current financial situation, one or more of these types of trusts may be appropriate components of a comprehensive financial plan. Your tax, legal, or financial advisor can assist you in determining which of these alternatives is most appropriate for your unique situation.
Updated: January 1, 2013
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.