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Wednesday, May 8, 2024
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Case Studies |
Marketing Ideas During Soft Markets and Dropping Interest Rates, Part 3 - Two-Layer Charitable Lead Annuity Trust
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Case:
Jack Henry, 50, is ill and is expected to live only about five years longer. As a result, Jack has turned his attention to his family and wrapping up loose ends regarding his finances. His current estate plan already provides that his wife Judy receive the bulk of his estate. However, Jack would like to create an inheritance plan for his son, John, from a previous marriage.
John, 20, is currently in college and not sufficiently financial responsible to manage a large inheritance. Nevertheless, Jack would like to create a plan that would distribute to John $5 million over time. The plan ideally would distribute funds to John when he reaches the ages of 30 and 38. In addition to providing financial responsibility, Jack wants to instill in John a love of philanthropy, which has played an important role in Jack's own life. Finally, Jack does not want to pay any gift or estate taxes on the transfer.
Question:
What planned gift would give John "hands-on" philanthropic involvement? How could this planned gift be structured to provide John with $5 million yet require no gift or estate taxes to be due?
Solution:
After consulting with his attorney, Jack decided that a Charitable Lead Annuity Trust might achieve his objectives. First, the charitable beneficiary of the CLAT will be a Donor Advised Fund created in John's name. Each year the DAF would distribute at least 5% to local charitable organizations based upon John's recommendation. (Ed. The actual distribution decisions are made solely by the charity where the DAF was funded. However, in most cases, the charity will follow the recommendations of the donor and donor's family.) This yearly, active involvement with the DAF and local charities will cultivate new personal relationships and maybe even new values for John.
Second, in order to meet Jack's distribution goals for John, Jack elected to create a two-layered trust plan. Not wanting to give John "too much, too fast," the layering of the lead trusts will provide John with principal at selected times/ages. The layering of distributions hopefully will teach John financial responsibility. Moreover, the layering of distributions will ensure that there will be resources available for John's later years.
Jack therefore created a 10-year and an 18-year CLAT, which will distribute assets to John at ages 30 and 38. Jack decided to fund both trusts with $2 million in assets for two reasons. First, the charitable deduction will completely offset any gift and estate tax liability. Second, John will be older and hopefully more financially responsible to handle the inheritance. Therefore, Jack funded the 18-year CLAT with $2,000,000. Based upon the low 3.2% AFR for May of 2008 and a 7% payout, the taxable gift was only $107,000! With an assumed return of 8%, John could receive over $2.7 million at the termination of the 18-year CLAT.
Jack funded the 10-year CLAT with the remaining $2 million. Based again upon the 3.2% AFR and a 7% payout, the taxable gift was only $820,000. Therefore, the two CLATs trigger total taxable gifts of approximately $927,000, which is easily covered by John's gift exemption. Also, with an assumed return of 8% John could receive almost $2.3 million from the 10-year CLAT.
In both CLAT situations, the additional growth passed on to John will not be subject to further gift or estate taxes. Finally, the DAF will receive $3.9 million from the two CLATs, which John will have a major role in distributing. Overall, Jack's inheritance plan achieves all of his desired goals and places his son John in a very enviable and influential role - a wonderful lasting gift from father to son.
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