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Wednesday, May 8, 2024
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Case Studies |
A Bridge to the Future – A Unitrust or an Annuity Trust
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Case:
Douglas and Tracy Fletcher, ages 60 and 56 respectively, have been asked to make a lead gift of $1 million to an endowment campaign recently initiated by the local philharmonic symphony. They have accumulated a substantial portfolio of stock over the past 10 years due to the run-up in the worldwide stock markets. They were fortunate to purchase shares via an IPO in an Internet company three years ago and those shares have soared. The shares were purchased for $50,000 and now are worth $1 million. They would like to use these shares to fund the gift to the symphony but would also like to consider receiving an income stream from the stock for a period of time.
Question:
In a recent meeting with the Major Gifts Officer of the symphony's foundation, Douglas and Tracy discussed the possibility of making the lead gift to the campaign utilizing the appreciated stock. They had attended a seminar in which the speaker explained the ins and outs of various planned gifts and they were quite interested in setting up a charitable remainder trust. After a lengthy discussion of charitable trusts with the Major Gifts Officer, Douglas and Tracy narrowed their options to two different charitable trust scenarios.
Solution:
First of all, they could consider creating a 5% unitrust with the stock that would pay income to them for the balance of their lifetimes. Since the securities do not currently pay any dividends, the trust would increase their income by $50,000 per year. Their combined life expectancy is 31.7 years, so this option may not be the symphony's first choice. However, assuming the trust investment return is 8%, the income to Douglas and Tracy would continue to grow over time, the trust would have grown to over $2.4 million upon their passing. Their income tax deduction would be over $280,000.
In the meeting with Douglas and Tracy, the Major Gifts Officer learned that Douglas has a qualified retirement plan, currently valued at $1.2 million, which is growing rapidly. His withdrawals at age 70½ are projected to be about $100,000 per year, based upon the projected fund balance and the chosen withdrawal option. Douglas and Tracy currently have a combined income of $150,000 and they expect that, with the income from their investments and Douglas' retirement plan withdrawals, their income will be significantly higher in their retirement years. Consequently, they have little interest in an increased income stream, at least in their early retirement years.
The other alternative is to consider using the stock to fund a term of years charitable remainder annuity trust. The income from the annuity trust would be payable to Douglas and Tracy for a period of 10 years, until Douglas reaches age 70½. Assuming that they chose an 8% payout, they would enjoy an increased income stream of $80,000 per year and an income tax deduction of over $400,000. Then, they might consider using all (or a portion) of the after-tax income to fund a life insurance trust for the children. A large insurance policy could be purchased on the lives of a couple 60 and 56 years of age with an income stream of $80,000 per year for 10 years.
When the annuity trust terminates, Douglas will begin receiving distributions from his retirement plan. As a result, the income from the retirement plan will more than "replace" what they will lose from the termination of the trust's income stream. Therefore, the charitable trust has, in effect, acted as an income "bridge" for the 10-year period from the creation of the charitable trust at age 60 to Douglas' retirement at age 70.
Douglas and Tracy like the idea of using the term of years annuity trust as a vehicle to enhance their income stream for the next 10 years until Douglas is required to take distributions from his pension plan. As stated, they can use all or a portion of the income stream to establish a life insurance trust for their children. They could also use a portion of the income stream to give to their children, taking advantage of the annual exclusions, or reinvest the income in the markets.
In looking at the ultimate value to the symphony, the term of years annuity trust is more attractive to Douglas and Tracy because the trust will terminate after only 10 years. Therefore, the symphony will receive the benefit of the trust assets much sooner. Assuming they live for at least 10 more years, they will have the opportunity to see their gift "go to work" during their lifetimes, as opposed to what would happen with a trust that would result in a distribution to the charity after they are gone.
Lastly, another gifting option to consider is Douglas' retirement plan. Upon the passing of the survivor of Douglas and Tracy, the plan balance could be transferred to the symphony. The plan is an excellent asset to use as a bequest because of the heavy estate and income tax burden assessed on this type of asset upon transfer to family members.
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