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Monday, May 6, 2024
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Case Studies |
Testamentary Lead Trusts in Four Layers
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Case:
Robert White, age 65, is a successful real estate investor. The bulk of his estate, valued at $7 million, consists primarily of real estate. He currently owns two apartment buildings, each valued at $l.5 million, and two strip malls valued at $1 million each. His other estate assets include his personal residence valued at $500,000 and a portfolio of stocks, bonds and mutual funds. The apartment buildings and the strip malls were acquired over the years via a series of like-kind exchanges as allowed under Sec. 1031 of the Internal Revenue Code. Therefore, Robert's tax basis in these properties is extremely low. Also, each of the properties is performing very well, yielding on average a net income of 10%, not including capital growth averaging 2% over the years.
Robert is a widower and has five children, ages 25 to 35. Three of the children are married but currently do not have any children. He is very proud of his children, as they all graduated with honors from his alma mater. They are all doing well in their chosen professions. Robert and his wife, who passed away five years ago, taught their children well in finances and the important role of philanthropy. Ten years ago, Robert and his wife used $500,000 of stock to set up a family donor-advised fund, which has been an important tool in teaching the children about philanthropy.
Recently, Robert met with his attorney regarding his estate plan. He was informed that if he passed away with his current estate size of $7 million and directed his estate entirely to his children, the estate tax would be over $2.5 million. Therefore, some of his real estate holdings would need to be liquidated within nine months of his death to pay the estate taxes. Robert wants to transfer his wealth to his children, but doesn't think they can "handle" it all in one lump sum. Even though they have managed their money well, he feels that if this large sum of wealth can be transferred over time or "stair-stepped," he would be much more comfortable. Also, since he and his children all attended the same university, he would like to make a substantial gift to their alma mater upon his passing.
Question:
Is there an estate planning tool which allows Robert to "stair step" his wealth to his children, reduce estate taxes and not force a quick sale of his property upon his death to pay the estate tax?
Solution:
In a recent meeting with his attorney and the Director of Gift Planning at the university, Robert decided to use a technique termed "four-layer lead trusts." The way this works is that each of the four parcels of real estate would be used to fund a separate testamentary charitable lead trust that would pay income to the university for a different term of years. The income from each trust would be paid to the university for the designated term. At the end of each term, the trust assets would then be distributed to the children. Robert decides to fund the testamentary trusts as follows:
| Term |
Trust Amount |
Payout
Rate |
Annual Distribution to University |
Distribution to Children |
| 5 years |
$1,000,000 |
10% |
$100,000 |
$1,127,057 |
| 10 years |
$1,500,000 |
10% |
$150,000 |
$2,026,462 |
| 15 years |
$1,000,000 |
10% |
$100,000 |
$1,745,594 |
| 20 years |
$1,500,000 |
10% |
$150,000 |
$3,661,573 |
The value in doing this is that the trusts will produce a total charitable estate tax deduction of $3.85 million. No property will have to be sold, as Robert's liquid assets will be used to pay the estate taxes. Foremost in his mind is that the estate will be distributed over a long period of time to his children, thus fulfilling his primary objective. Upon his death, the children would immediately receive some assets after estate taxes and costs have been paid. Based upon total projected returns in the trusts of 12%, the children will receive a total of $8.56 million over the 20-year period. Lastly, $6.5 million will be distributed from the four trusts to his alma mater over the same period.
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