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Monday, April 29, 2024
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Case Studies |
FLIP Unitrust v. NIMCRUT - And the Winner is ...
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Case:
Samantha and Kevin Donaldson, both 55, have been married for over thirty years. They are professional musicians and have been members of the city orchestra for twenty years now. Not surprisingly, Samantha and Kevin are passionate supporters of music. They hold workshops to teach young people musical instruments, and can be frequently found passing out flyers to encourage attendance at the city orchestra's performances.
In a recent visit with the orchestra's gift planner, Jamie Evans, the Donaldsons indicated their desire to leave a gift to the orchestra upon their death. The Donaldsons estate was valued at $3 million, and they envisioned a bequest of $200,000. Jamie then described the benefits of a Charitable Remainder Trust (i.e. tax deduction now, bypass of gain, increase income) and suggested it as an option. The Donaldsons loved the idea they could receive an income tax deduction now for a gift they planned to make in the future. Furthermore, they had a large block of appreciated assets that would be well suited for the CRT. The only reservation the Donaldsons had was the increased income. They were currently in their highest income earning years, and did not need to boost their taxable income. Preferably, the Donaldsons would like to defer the income until they retire. Therefore, they asked Jamie if there was a way to structure the CRT to act like a retirement vehicle. Jamie recalled a session she attended that discussed the use of FLIP Unitrusts and NIMCRUTs as retirement vehicles, however, she was unsure which CRT was more appropriate in the Donaldsons situation.
Question:
Which CRT should the Donaldsons utilize for their situation,a FLIP Unitrust or a NIMCRUT?
Solution:
A FLIP Unitrust and NIMCRUT both offer the ability to defer income - and thus grow principal more rapidly - because they both at inception are net income trusts. As a net income trust, the CRT is not required to make an income payment if the trust does not generate any trust income. Hence, trustees can invest trust assets to produce little, if any, trust income.
The primary difference, however, between the two trusts occurs in the future when one trust 'flips' and becomes a straight trust, or Type I trust. At that point, the FLIP Unitrust has the advantage of making payments from income or principal, thus assuring beneficiaries a trust payment equal to the trust payout percent. Also, a straight unitrust is less concerned with investing for income or capital gains because it can pay from principal if need be. The disadvantage of the FLIP Unitrust, however, is that any accrued deficit will be lost (i.e. no make up will be made) when the trust becomes a straight trust.
Consequently, many decisions regarding the use of a FLIP or a NIMCRUT revolve around the amount of the deficit account. For example, if the Donaldsons decide they want to start receiving income at age 60, or five years from now, the deficit account is almost $60,000 with a 5% payout CRT. If instead they choose income to begin at age 65, or ten years from now, the deficit account balloons up to almost $145,000. In either case, a FLIP Unitrust will not likely make up this deficit before it "flips." Thus, the Donaldsons need to weigh the importance of the deficit versus the advantage a straight unitrust has with respect to payout and trust investments.
After consideration of the two plans, the Donaldsons realize that if they decide to retire at age 60, they would prefer the FLIP Unitrust because of its benefits and the relatively small deficit account. However, if they decide to retire at 65, the NIMCRUT is their choice because the deficit account is too large to lose. Taking into account their health and likelihood of continuing employment, the Donaldsons opt for the FLIP Unitrust, which will flip in five years. They are very pleased with this choice. The Donaldsons are able to generate a $48,000 deduction, and ensure a $600,000+ bequest to the city orchestra - a plan which brought sweet music to their ears!
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