|
Sunday, April 28, 2024
 |
Case Studies |
Changing a Lackluster NIMCRUT into a Shiny New Gift Annuity
|
Case:
Megan Moss created a net income plus makeup charitable remainder unitrust (NIMCRUT) about 16 years ago with $1 million of appreciated stocks. Because interest rates were substantially higher at that time, Megan's NIMCRUT was drafted with a 7% payout. Unfortunately for Megan, interest rates have now plummeted to 3%. As a result, her trust distributes about $30,000 a year, which is all taxed as ordinary income. In addition, because her trust is invested almost solely in bonds, Megan's trust is still valued at about $1 million. While Megan would like realized capital gain to be paid out of her trust, the trust provision and strategy were not contemplated at the time of trust formation. Knowing of Megan's disappointment and needing to fund a building project now, the charitable remainder beneficiary of the NIMCRUT has approached Megan about a possible improvement to her plan.
Question:
How can Megan attain a fixed 7% payout for the rest of her life, given her current situation? Can she improve her after-tax income as well? Finally, can charity benefit from such a solution?
Solution:
The charitable remainder beneficiary suggested that Megan transfer her income interest to the charity in exchange for a charitable gift annuity. It is important to note that Megan may transfer only her income interest and not the entire value of the trust for a gift annuity, since the remainder already belongs to the charity.
The value of Megan's income interest is determined by doing a present value calculation (in accordance with Sec. 7520). Because this is a NIMCRUT, the applicable federal rate of 3% for the month of the conversion is used and not higher 7% listed in the unitrust document. Let's assume that Megan's income interest is now valued at $212,200. Based on her age, the American Council on Gift Annuities rate is 6.8%. Therefore, Megan will receive an annuity of $14,429.60 every year with no further fluctuations.
Megan will also receive a charitable income tax deduction for the transfer of her income interest for a gift annuity. The deduction will equal the excess of the value of her unitrust income interest over the value of her gift annuity contract. This deduction is a capital gain-type gift, so it will be limited to 30% of AGI. In addition, Megan's after-tax income will be greater with a gift annuity. With the NIMCRUT, all the income was taxed as ordinary income. However, with a gift annuity, about half of the income will be taxed at much lower capital gain rates.
Finally, the charity will benefit greatly from this solution. After Megan transfers her income interest, the charity will own both the income and remainder interest. Therefore, the trust will merge and the trustee may distribute all the trust assets to the charity. Although the trust's growth was virtually non-existent for the past 16 years, the charity can now reinvest all the assets in a more balanced and diversified portfolio.
Megan is very pleased with this "conversion" solution, which will increase her income and keep it constant for the rest of her lifetime. In addition, an unexpected benefit to Megan was the joy of helping charity fund a current financial need that would not have been possible without her "conversion."
Editor's Note: The Service in PLR 200152018 approved this conversion strategy. While not precedent, a private letter ruling is a potential indicator of the Service's position in a certain area of tax law.
|
|
|
|
