Malpractice XVII – NIMCRUT Errors

Over-Selling the Concept

Abusing good planning tools injures clients.

A charitable remainder trust is often a great planning tool for clients with philanthropic interests and an interest in selling an appreciated asset that is not producing income commensurate with its value.  For some clients a CRT is a blessing; unfortunately, for others it is a curse.  Why might the CRT planning be cursed  Too often, advisors approach financial and estate planning as an opportunity to sell a product, and a CRT should neither be sold as a product (it is part of an integrated process); nor should product sales drive the planning decisions.

John and Pat Knopf, married for 39 years and parents of two married daughters who are themselves already well set in their respective careers, have amassed significant stock through John’s employer.  With a five million dollar estate, their assets tripped the trigger for federal estate tax liabilities, which should have posed several planning scenarios for the Knopf’s advisors.  Since almost all of their wealth was either in John’s 401(k) or a stock portfolio that held nothing but his employer’s stock, their assets were not properly diversified  John’s reluctance to reallocate his stock holdings hinged on the unrealized gain in the low basis stock, as he simply did not want to incur a capital gains tax to put the investment account into balance as he approached retirement. 

Into this mix stepped a financial advisor, introduced as an estate planning expert, but his recommendations had more to do with selling product, and inappropriate product at that, than solving problems.  The Knopfs were persuaded to transfer all of the publicly traded stock into a two-life NIMCRUT and to purchase a large “second to die” life insurance policy with the premiums paid from the charitable trust’s income distributions.  What was not properly disclosed in this transaction were the following issues:

1.)    a CRT is an irrevocable trust appropriate for clients with real philanthropic interests, this is not a tax avoidance scam; you can not make money by giving it away

2.)    while a CRT will reduce the size of a client’s taxable estate, there are other non-charitable planning techniques that may also be utilized as a part of a coordinated strategy to ensure that the client’s financial independence and family legacy are properly addressed

3.)    contributing highly appreciated, publicly traded securities to a NIMCRUT as a client approaches retirement with a need for reliable income is not a tactically prudent move when a CRAT, Standard CRUT, or FLIP-CRUT would better serve a client’s need for income without regard for what the trust produces as net income

4.)    a NIMCRUT is better used when funding it  with illiquid and hard-to-value assets, e.g., real estate or closely-held stock

5.)    contributing every bit of a client’s liquid assets to a charitable remainder trust ties up all of the donor’s income producing capacity and may produce a larger income tax deduction than the client can utilize, it would be better to transfer a smaller amount of stock and see how the trust operates, and then make additional transfers into a flexibly designed CRUT once the client is satisfied with the process instead of locking up everything the client has inside a restrictive trust

6.)    contributing all of the client’s appreciated stock means intra-family family gifting is going to be restricted, and to replace the gift requires significant premium payments to maintain the larger than necessary life insurance policy

7.)    using a deferred annuity inside a NIMCRUT may be appropriate for a young income beneficiary who is willing to delay income distributions for seven to ten years, but for an older client who is depending on consistent revenue to maintain lifestyle or to pay large life insurance premiums, a NIMCRUT using typical annuity products may not be able to make distributions when the market declines

8.)    the trustee has a fiduciary obligation to manage the investment portfolio for both the income and the charitable beneficiaries; in some states, the attorney general will step in and require prudent investment policies be followed

9.)    a CRT is no place for creative investment products or day-trading, prudent and well-diversified investments tat are tax efficiently managed would be the preferred vehicle

Any client or advisor considering the use of a NIMCRUT would be well-advised to look at all of the options to ensure maximum flexibility, and understand the use of the various investment tools inside the trust  to ensure it performs as expected.  With so few experienced CRT advisors, a trust maker should spend time and research the experience and management philosophy of any advisor who will be working with the proposed charitable trust.

© Henry & Associates 2006