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Tuesday, May 7, 2024
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Case Studies |
A Primary Characteristic of a NIMCRUT... Defer, Defer, Defer
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Case:
Jonathan Goldman, age 72, and his wife, Joanna, age 62, are both retired from successful careers in public relations and advertising. When Jonathan retired five years ago, his company provided him with a nonqualified deferred compensation plan which would pay him income until he was 80 years of age. Therefore, eight years remain on the deferred compensation agreement. After the compensation agreement terminates, Jonathan would like to provide income to his wife for a period of seven years. However, if she passes away before the seven years, the income would be paid to their two children, ages 35 and 40.
Jonathan and Joanna both serve on the board of the local Home for the Aging. They have been active philanthropists and have given gifts to the Home throughout their 40-year marriage. The board members were recently challenged to give a major gift to the endowment campaign of the Home and they would like to consider making a $1 million pledge to the campaign. However, they would like to receive an income stream from the $1 million for a period of time.
Question:
What gift vehicle would be available to Jonathan and Joanna which would allow them to defer income for a period of eight years as desired and then pay income to them for a period of seven years?
Solution:
In meeting with their CPA and the Major Gifts Officer at the Home, it was decided that the vehicle of choice to accomplish their objectives would be a 15-year charitable remainder unitrust with a net income with makeup formula (NIMCRUT). Joanna will be the primary income recipient and if she passes away during the 15-year term, the income from the trust will be paid for the remaining term to their two children. In the trust, Joanna will reserve the right to revoke the children's interest thereby making the gift incomplete for gift tax purposes. However, if she does pass away during the trust term, the fair market value of the trust assets will be included in her estate. Her estate will then receive an offsetting charitable estate tax deduction equal to the present value of the remainder interest of the trust calculated as of the date of death.
Jonathan and Joanna decide to fund the NIMCRUT with $1 million of highly appreciated stock. Before funding the trust, however, Jonathan will transfer his interest in the stock to Joanna to avoid any future inclusion of the trust in his estate. Since the goal of the trust is to defer income for a period of eight years and then pay income to Joanna for the remaining seven years of the trust, the trust is invested initially for growth. To facilitate income deferral, i.e., investing for growth, the trust could be invested in zero coupon bonds, high growth stock or mutual funds, or in one or more tax-deferred variable annuity contracts issued by an insurance company. In order to accommodate the annuity contracts as a trust investment, the trust agreement will be written to define "income" to include "distributions from an annuity contract." Therefore, the trustee will have distributable income from the annuity contract only when a cash withdrawal is made, thereby allowing deferral of income until desired. Also, "realized capital gains" can also be defined as income to accommodate investments in high growth stocks and mutual funds.
The results to Jonathan and Joanna are quite compelling. Based upon a payout rate of 5%, the charitable income tax deduction for setting up the 15-year trust will be $479,439. By funding the trust with appreciated stock, they will bypass all the capital gains taxes on the stock. During the initial 8-year deferral period, the trust will grow to over $1,850,000 (assuming an 8% trust return). In year nine, if the trustee begins to distribute the assumed trust return, Joanna will receive just over $148,000 per year. However, the distribution to Joanna is discretionary. If she needs less income, she can take less. If she needs more, the trust can dip into the trust's makeup account. In the ninth year, the deficit account is projected to be over $450,000 and, therefore, the trustee could withdraw the entire amount and distribute it to Joanna at any time. This is assuming, of course, that income is available to make the distribution. By utilizing variable annuities or high growth stocks with the appropriate trust income provisions, the ability to distribute income when desired is certainly viable.
If Joanna should pass away prior to the termination of the trust, the income from the trust for the remainder of the term will then pass on to the children. Depending on the amount of income distributed to Joanna (and possibly to the children), an amount significantly greater than the original funding amount of $1 million will probably pass to the Home upon the termination of the trust.
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