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Sunday, May 5, 2024
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Case Studies |
The Flexible Foundation
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Case:
Jane and Bill Wilson are both 70 and are now retired. Years ago, they each inherited stock from their parents. The entire portfolio is now invested in two stocks. There has been no management of the portfolio for the past 30 years.
Jane and Bill think that it would be good judgement to diversify. However they do not want to pay any capital gains tax. Both of them live fairly modest lives and will soon be required to start taking distributions from their IRAs. Thus, they do not want added income now, but may need more income in the future.
Question:
Is there a way that Jane and Bill can diversify without paying tax? Can they control their income? If they need income, they would like to take income. If not, they would consider making gifts to charity. Can this arrangement be done at very modest cost?
Solution:
The solution for Jane and Bill is the flexible foundation. Their assets are under $1 million and, therefore, they cannot justify the cost of a private foundation. With the private foundation, they would not be able to receive income themselves. They need a solution that allows them to choose whether to keep the income themselves or give it to charity.
Jane and Bill had spoken to a financial advisor about a private foundation. However, there were two problems with the private foundation. First, a PF is fairly expensive to create and operate. Second, once assets are given to a PF, they cannot be returned to the donors.
A better solution for Jane and Bill is the flexible foundation. The flexible foundation is actually a net income plus make up unitrust. In this document, the trustee will allocate capital gain to principal. Each year, the trustee will be able to allocate gains to income and pay the distributions to Jane and Bill.
To minimize costs, Jane and Bill will serve as initial co-trustees, with a corporate successor trustee if they are no longer willing or able to perform trustee duties. They secured the services of a trust administration company and decided to invest 60% into a diversified equities no-load fund and 40% into fixed return securities. The fixed return income will be distributed to them, but the gains on the securities may either be allocated to income or to principal.
At the end of each year, Jane and Bill have the choice of making a transfer of trust principal to charity. Under PLR 9550026, a portion of the trust income and remainder may be allocated to a charity. For example, Jane and Bill could designate a charity irrevocably to receive 10% of the trust and also irrevocably transfer 10% of their income interest to that charity. Since the charity now owns both the income and remainder interest in that 10%, then one-tenth of the trust may be distributed to the charity.
Jane and Bill have also created a "pass through" Donor Advised Fund (DAF) with an area charity. Each year, they can make an addition to the DAF and then use the Donor Advised Fund to make allocations to their favorite charities. This DAF makes the gift process easier to administer. The trust writes one check each year to the DAF and the DAF then makes grants to charities.
This is a very flexible plan. It preserves the option to take income if that should ever be necessary. It also is administered with lower cost than a private foundation. Finally, it enables the charities favored by Jane and Bill to receive maximum benefits.
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