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Flexibility in a CRT

Flexibility in a CRT

Flexibility and Options

The Power of the NIMCRUT

Vaughn W. Henry

 For those considering an IRC § 664 – Charitable Remainder Trust as an estate or retirement planning tool, take a look at the Net Income with Make-up provisions of a CRT (NIMCRUT). While the standard Charitable Remainder Uni-Trust (CRUT) requires 5% as a minimum annual distribution, based on annually revalued assets, it is rigid in its distribution rules. Add a net income feature and you receive the lesser of all the trust income or the original pay-out percentage, whichever is less. If you make income, you have to take it, with no ability to defer it until later. However, if the trust makes no income, the beneficiary receives nothing. Thus, income potential is forever lost in poor performing years. The problem with trusts that may effectively last for several lifetimes is that IRS prototype (pre-approved and standardized) trust documents do not allow for much flexibility in managing complicated distributions. Instead, use a customized NIMCRUT, and it becomes a “spigot trust”. Called spigot, like a water valve, the special trustee directs the trust administrator to turn the income streams on and off as needed by the beneficiary. The traditional NIMCRUT funding approach uses growth mutual funds to prevent unwanted income from spilling out of the trust. When income is needed, the assets inside the trust are generally repositioned into income funds capable of generating the required pay-out. Unfortunately, this does not effectively control ordinary income that forces unwanted distributions out of the trust. This happens when net income is produced from the occasional capital gains or dividends generated by any investment in the CRT. While funds producing 2% ordinary income and 8% growth are not shabby, it becomes more efficient when all 10% of the gain can be deferred and retained inside the trust to compound tax-deferred for future use. The down side occurs when the equity market has a bad year and there is no “distributable net income” (DNI) produced, so the beneficiary cannot access any funds during that year. During the accumulation phase, this is not a problem; but, during the distribution phase it creates a serious management problem when using mutual funds. Briefly, a solution may lie in a proper trust drafting and a series of deferred annuity contracts that have “earned income”, but as long as an independent trustee refuses to accept it, the money can remain undistributed. Unfortunately, few annuity providers offer the administrative support to work within these specially constructed NIMCRUTs. Those that do, have learned how to flex according to the needs of their clients. When the trustee holds several annuity contracts and specifies that one be completely invested in a fixed portfolio, the income beneficiary can be assured that at least some income will always be available for distribution. This is much different from the mutual fund approach, over which the trustee has no discretionary control in distribution. Properly structured, a NIMCRUT can provide a vehicle for managing tax-deferred growth. Regarded as the eighth wonder of the world, tax-deferred compounding investments can fund both college educations and retirement needs from the same CRT account. Best of all, this can be done without the usual age restrictions and penalties on pre 591/2 distributions from tax sheltered savings. For example, the trustee may direct the “spigot” be opened to pay for children’s tuition and then closed until income is needed for retirement, when it is again reopened. By aggregating the undistributed income in a make-up account, the accumulated deficiencies may be made up by paying out excess funds in years that produced extra income. Generally, NIMCRUTs work best for younger trust beneficiaries with hard to value assets that may be difficult to immediately market (e.g. farm land, development property, etc.) and reposition within the trust. Given the capacity to accumulate a little cushion when income is not needed, the NIMCRUT is ideal as a retirement supplement. This ability to store income and grow it efficiently provides for future substantial distributions from the make-up account.

Charitable trusts have the capacity to prevent death from interfering with passing down a value system. Besides obvious philanthropic interests, why use a charitable trust? The CRT allows for:

  • Estate planning options
  • Increased cash flow from more diversified assets
  • Improved asset management and retirement planning
  • Tax-free conversion of individual and corporate appreciated assets
  • Redirected “social capital” (those assets targeted for tax liquidation) by having the family control the ultimate use, not the government
  • Income tax deductions for split-interest gifts

Who else would benefit from such a vehicle? Anyone with or apt to have a fully funded qualified plan with excessive accumulations. With no IRC §415 limitations, the tax deferred accumulations within a “spigot trust” offer the trust beneficiary the similar performance of another retirement plan without the burden of meeting anti-discrimination regulations for employees. After evaluating the numbers on many pensions where years of savings are ultimately lost to estate tax, income tax and excise tax, look at the CRT for viable planning alternatives.

ãVaughn W. Henry,Henry & Associates. 1996, 1998

E-mail [email protected]

Springfield, Illinois 62703-5314

(217)529-1958 or toll-free 1(800)879-2098

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Statistical lifetime trust income for both donors = $4,478,161

Calculated charitable gift of remainder interest = $5,070,433

Current income tax deduction = $250,920 for the $1 million transfer

Example of one scenario in a 5% NIMCRUT earning 10% and deferring payout until year 6, withdrawing assets from the make-up account and then drawing an increasing stream of income for life. The donors (age 56/54)) contribute $1 million in highly appreciated stocks (although cash works too), avoiding the capital gains tax on the appreciation. They receive current tax deductions of $250,920 available over six years and then an income stream for their joint lives, statistically for 35 years. The donors designed the deferred income to be available to buy a vacation home as they enter retirement. By creating a wealth replacement trust for their heirs, they effectively remove a $1 million asset from their taxable estate, while transferring that value to their children tax-free. This trust is primarily designed for younger donors who want to maintain control of their income stream. Hard to value assets like real estate can also work well inside of this trust. There is a new TAM from the IRS on this procedure that addresses the self-dealing concerns by some legal commentators. Properly done, the NIMCRUT works as designed.

Statistical lifetime trust income for both donors = $1,750,000

Calculated charitable gift of remainder interest = $13,740,680

Current income tax deduction = $408,986 for the $1 million transfer

The second scenario is a 5% Charitable Remainder Annuity Trusts (CRAT) earning 10% and paying out a 5% annuity, or $50,000/year for the donors’ joint life expectancies (35 years). The donors (age 56/54)) contribute $1 million in highly appreciated stocks (although cash works too), avoiding the capital gains tax on the appreciation. They receive current tax deductions of $408,986 that reflects the probability of a higher remainder interest being left to the charity. By creating a wealth replacement trust for their heirs, they effectively remove a $1 million asset from their taxable estate, while transferring that value to their children tax-free. This tool is best used for much older donors unconcerned about inflation who want to leave a larger gift to charity. Funded with stocks, cash or other liquid assets, it provides for a straightforward and uncomplicated income stream.

Statistical lifetime trust income for both donors = $4,309,931

Calculated charitable gift of remainder interest = $4,920,774

Current income tax deduction = $250,920 for the $1 million transfer

Example of a third scenario in a 5% Standard Charitable Remainder Uni-Trust (CRUT) earning 10% and paying out 5% annually producing an increasing stream of income for life. The donors (age 56/54)) contribute $1 million in highly appreciated stocks (although cash works too), avoiding the capital gains tax on the appreciation. They receive current tax deductions of $250,920 available over six years and then an income stream for their joint lives. By creating a wealth replacement trust for their heirs, they effectively remove a $1 million asset from their taxable estate, while transferring that value to their children tax-free. This trust is designed for donors concerned about inflation who still wish to leave a significant gift to charity. The standard CRUT does not offer any choice in deferring income generated from the trust, but may offer more tax efficient distributions now that the Taxpayer Relief Act of 1997 has changed capital gains treatment.

Designing charitable trusts to meet the different needs of donor and charity offers great flexibility. Besides manipulating the payout from the CRT, and choosing the type of trust and character of assets held by the trust, the trustee often has the ability to change the remainderman to reflect concerns about use of the family’s social capital.