Remainder Trust and Lead Trust
A very creative and powerful planning strategy is to combine a charitable remainder trust with a charitable lead trust. Such tandem trusts can be funded through a will or living trust when the individual passes away. The testamentary unitrust may be funded with an IRA, pension plan, stock options, commercial annuity or other IRD asset. Normally, the lead trust will be funded with stocks or real property.
The unitrust provides income for the selected term of years to heirs and the lead trust then provides them with a deferred distribution of principal. The plan is very nicely balanced and has the advantage of diversifying the inheritance. In most situations, some of the heirs are perhaps not as skilled at financial management as others. By diversifying the inheritance, the donor gives all beneficiaries greater opportunity to learn good investment management skills over a period of time.
Example 3.6.4A Tandem Trusts
Mary Wilson has an estate of $12 million. Approximately $3 million is in an IRA and the balance is in stocks and real estate. She is a surviving spouse, with four children.
Mary would like to diversify the inheritance. She would like to pass some principal when she dies, provide income for a period of time and then have a deferred distribution of principal. In addition, she would like to minimize estate taxation. If possible, she would like to save the income tax on the $3 million IRA and avoid any estate taxation on her $12 million estate.
Her advisor suggests tandem trusts. When she dies, the IRA will pass to a 5% remainder unitrust for a term of 8 years. This trust will not have to pay the ordinary income tax on the IRA and will also produce a substantial charitable deduction of $2,000,559. Over the 8 years, the unitrust will pay approximately $1.2 million in income to family members.
Approximately $8 million of the estate is transferred into a family limited partnership. When she passes away, the limited partnership units will be distributed to a charitable lead annuity trust for a term of 8 years. The lead trust will pay 5% on the underlying assets, or 8.33% on the assets after a 40% FLP discount. The lead trust payout over 8 years will be $3,198,720 to charity. At the end of the 8 years, the lead trust value of $5,276,029 will be distributed to the children. However, the underlying assets at that point are now valued at $8,793,381.
This plan provides the children with a substantial inheritance when Mary passes away. During the 8-year term they receive over $1 million in income from the remainder trust. At the expiration of the 8 years, the assets from the lead trust, valued at more than $8.7 million, will be distributed to the children. Each of the four children will receive a total inheritance in excess of $2 million.
Mary's advisor shows Mary how the plan can reduce her estate tax to zero, save income tax on the entire IRA, move approximately $2 million to each child through an inheritance and provide a very substantial distribution to her favorite charities.