Charitable Remainder Trusts
Charitable Remainder Trusts may be established as annuity trusts, unitrusts, or FLIP unitrusts. Unlike charitable gift annuities, charitable remainder trusts are separate legal entities. At Luther Seminary, trusts naming the LS Foundation as trustee are individually invested and managed. Unlike charitable gift annuities, trust payments are not backed by a pool of dollars or other seminary or foundation assets. A minimum gift amount of $100,000 is suggested. The term of the trust may be (a) for the life of the donor, (b) for the lives of the donor and another named individual, (c) for a term of years not exceeding twenty years, or (d) for a combination of lives and years. The required minimum payment percentage is 5% and payments must be made at least annually. Upon the death of the last income beneficiary, the trust terminates and the principal is distributed to the Luther Seminary Foundation and used for the purposes set forth in the trust agreement. The donor receives a charitable deduction for the value of the future gift at the time the trust is funded. If appreciated assets are used to fund the trust, capital gains taxes are either avoided or deferred many years.
Charitable Remainder Annuity Trusts
Charitable Remainder Annuity Trusts distribute a fixed dollar amount to the income beneficiary (usually the donor) at least annually. The payment must be equal to at least 5% of the fair market value for the assets transferred to the trust on the date of gift. The trust payment amount is established at the time the trust is created and never varies.
Robert and Betty, ages 67 and 65, are now fully retired and would like to (1) increase retirement income, (2) make a significant deferred gift to benefit Luther Seminary, and (3) use the charitable deduction to save income taxes.
They transfer stock valued at $100,000, (basis of $80,000) to a charitable remainder annuity trust having a negotiated 5.0% payout percentage. Payments will be made quarterly. Luther Seminary Foundation is named as trustee. The trust sells the stock and the proceeds are re-invested. The reinvested assets earn 6% annually (2% ordinary income and 4% growth). The charitable tax deduction Robert and Betty can claim in the year of the gift is $31,103. They receive $5,000 annually for as long as either of them lives. Initially, payments are received 60% as ordinary income, and 40% as capital gain. Over time, a percentage of the payment may become tax-free income. (Also, if the trust had been funded with tax-exempt bonds, the income returned to Robert and Betty would have retained its tax-exempt character.) Upon their deaths, the foundation uses the principal remaining in the trust for the purposes specified in the trust agreement.
Charitable Remainder Unitrusts
Charitable Remainder Unitrusts are similar to annuity trusts, except that the amount paid out to the income recipient(s) varies over the years. Payments must be at least 5% of the trust’s fair market value as re-determined annually. Unitrusts provide three payment options: (1) a fixed percentage – regardless of actual net income; (2) net income – pays the net income, after trust expenses, up to the percentage stated in the trust agreement; (3) net income, plus makeup amounts – pays net income, plus income shortfalls from prior years, to the extent of current year net income.
Fred and Nancy, ages 60 and 62, will be retiring within the next three years. They would like to increase their retirement income by selling some low-yield, appreciated stock, but they do not want to pay significant capital gains tax at the time of sale. They would like to make a significant gift to benefit Luther Seminary, and would benefit from a current year charitable deduction. If possible, they would like to have their income-returning gift to the seminary keep pace with inflation.
Fred and Nancy gift appreciated stock valued at $100,000, having a cost basis of $50,000, to a charitable remainder unitrust. Upon its sale they defer capital gains tax on the $50,000 gain. They receive a charitable deduction of $29,884, which helps reduce taxable income in the year of the gift. They agree to a 5% payout percentage with payments named quarterly. The Luther Seminary Foundation is named as trustee. The gifted stock currently pays dividends of 3%. The Luther Seminary Foundation sells the stock and reinvests the proceeds. The reinvested proceeds earn 6%. After 5% is paid to Nancy and Fred, the remaining 1% is added to trust principal. Since the trust is re-valued annually, future payments (5% of the assets’ value, determined annually) will vary as the value of the trust’s assets rises and falls. If the trust continues to earn more than it pays out, their income stream and principal should increase, resulting in a larger eventual gift to the Luther Seminary Foundation. The proceeds will be used as designated in the trust.
Flip Charitable Remainder Unitrusts
Flip Charitable Remainder Unitrusts have a special feature that makes them attractive to donors contributing hard-to-value assets or assets producing little current income. The payout is usually defined to be the lesser of a stated percentage or actual net income until the assets are sold or until a specified triggering date. After the sale of the assets or other triggering event or date, the payout method flips to a fixed percentage payment method.
Assume Fred and Nancy contribute a lake cabin valued at $100,000, instead of the appreciated stock used in the earlier example. They decide on a flip unitrust, rather than a regular unitrust. The triggering event is the date of sale of the lake cabin.
The lake cabin is transferred to the flip trust and is immediately advertised for sale. The charitable deduction remains the same as that in the previous example: $29,884. Until sold, Fred and Nancy will receive the lesser of the 5% payout, or net income. Unless the property is rented out, the trust produces no income while the property is held for sale. Once sold, the net proceeds are reinvested and the payout method flips to the 5% fixed percentage payout rate stated in the trust agreement. The trust’s value is re-determined annually and their payments vary accordingly: Fred and Nancy then receive 5% of the re-determined value each year.
IRS discount rate of 4.2% used for all trust calculations
Charitable Remainder Trusts may be established during lifetime (inter vivos) or through provisions in a will or living trust (testamentary). Charitable remainder trusts are primarily used to provide additional income to the donor and/or other beneficiaries. Frequently, they are also established to provide a secure source of income for a spendthrift child during his or her lifetime or until he/she reaches a pre-determined age.
Retained Life Estate
The Retained Life Estate is a charitable giving option whereby a donor transfers the remainder interest in a personal residence or farm to Luther Seminary but retains the right to use the property during his/her lifetime. The right to use the property includes the right to occupy or rent the property. The donor must keep the property insured and pay all taxes and assessments as they come due. The term “personal residence” includes a donor’s principal residence, a second home, or vacation home and is not limited to the donor’s homestead. Upon the donor’s death, the life estate is extinguished and title is solely in the seminary’s name.
A gift of this type generates an income tax deduction for the present value of the seminary’s future interest. The donor needs to secure a qualified appraisal to establish the property value. The donor may, at a later date, gift the reserved life estate, thereby generating another charitable deduction. If this is done, the seminary now has complete ownership and is responsible for the property; the seminary may also sell the property.
Mary, age 75, would like to be sure that her home is not consumed by unexpected medical expenses and eventually becomes the property of Luther Seminary. However, she would like to continue to live in the home as long as she is able.
Mary deeds the remainder interest in her home to the seminary, but reserves a life estate for herself. She receives a current year charitable deduction which offsets taxable income. She continues to pay the real estate taxes (as homestead property), to insure the property, and to live there. If she later moves to a nursing home, she will be entitled to rent the property and collect the rent. Upon her death, the life estate is extinguished and the seminary has complete title.