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Malpractice V – Henry & Associates

Malpractice Coverage – V

Don’t Leave Home Without It

(fifth in a series on design and implementation issues)


image“In this world nothing can be said to be certain, except death and taxes” – Benjamin Franklin

 in a November 15, 1789 letter to a friend


Sometimes the tax tail wags the dog and poorly trained sales producers, especially in the insurance and financial services area, try to pitch charitable planning as a tax avoidance scheme.  Not that the use of a charitable lead or remainder trust, gift annuity or pooled income fund won’t have tax benefits.  They all do, but estate tax savings usually aren’t the prime motivator for planning with these complicated tools.  According to a recent NCPG Survey of Donors, 77% of CRT creators felt a desire to reduce taxes and 76% had long-range estate or financial planning reasons to create a CRT.  However, 91% had a desire to support a charity in its mission.  There’s more to marketing these things than as capital gains avoidance trusts.


Attending a one-day workshop on tax planning doesn’t make someone an expert on charitable trust design, and sometimes a remainder trust is exactly the wrong thing to offer a client.  A §664 CRT practically guaranteed to make clients unhappy would use Mrs. J. D. Baker’s plan as a prime example of what not to do.  Mrs. Baker, a 90 year-old widow, had a highly appreciated, but low-income earning, commercial building that she plans to leave her church as a bequest in furtherance of its youth programs.  Her estate (taxable in 2001) is slightly over $1 million in value, but the majority of it is in the $600,000 structure.  In her case, a simple bequest to charity will reduce her estate far below that which will trigger any federal estate tax.  Should she live into 2002 or beyond, the rising exclusions will further shelter her estate from federal estate tax liabilities. 


Sometimes simple is better than complicated, especially when dealing with unsophisticated clients.  


Where this planning first went wrong is that the broker persuaded Mrs. Baker to contribute her property to a NIMCRUT by telling her that she’d be receiving 15% of the sales proceeds when the building sold, and then an added 15% every year until she passed away.  What wasn’t conveyed to Mrs. Baker was that this “net income” trust pays out the LESSER of net income earned after trust expenses (interest, rents, royalties and dividends less accounting, brokerage and trust fees) or the UNITRUST amount.  Most empty buildings have a limited ability to generate large cash rental returns and in today’s low interest environment, the probability that Mrs. Baker would receive 15% of  $600,000 annually is pretty slim.  Unfortunately, she was counting on it, and not meeting client expectations is a sure way to create problems for all of the advisors involved.


Wait, it gets worse.


Convinced by the broker that Mrs. Baker had a large estate tax liability, she was sold a life insurance policy with a $90,000 annual premium.  In addition, she funded her ILIT (irrevocable life insurance trust) with premium payments without being told that she was making taxable gifts to her heirs.  Where did she expect to generate the money with which to pay the premium?  She was told that her NIMCRUT would produce the required distributions.  Unfortunately (again), the CRT was designed so it was practically impossible that the required after-tax income could be distributed to meet her needs.  More unmanaged client expectations occur when the planner creates expenses that can’t be realistically met by using a fixed annuity earning 6% in a 15% NIMCRUT.


Since Mrs. Baker lived mostly on her modest social security and investment income, she might have otherwise been an excellent prospect for a CRT.  Too bad she won’t be able to fully use her income tax deduction.   Nevertheless, the local insurance agent who proposed her estate plan seemed to have more “commission needs analysis” than client needs analysis in mind in his proposal.  A responsible planner would not put the bulk of a 90 year old woman’s estate into an irrevocable trust, making it unavailable for nursing home or medical expenses.  In essence, she could have met her initial planning goals of living comfortably, paying no death tax and passing the building to her church without using a CRT.  Should a CRT turn out to be an effective planning tool, then a much harder to manage NIMCRUT should not be used if the client absolutely needs to have reliable, steady income.  A FLIP-CRUT, or even a standard CRUT if there is an expectation that the asset could be readily sold, would be a more prudent tool than the more restrictive NIMCRUT.  Either of those variations of CRUT would have been more satisfactory for an aged donor who absolutely depended on the trust to maintain her financial independence.


In any case, by overselling the fear of paying tax, when the client isn’t likely to pay federal tax (given her stated goals), the commercial advisors took advantage of a vulnerable client purely to sell product, rather than to provide solutions.  Too bad the products made the problems worse.  A good advisor should be able to suggest tools to help a donor preserve personal financial security and still fulfill any client’s charitable goals.


Henry & Associates