Friday April 19, 2024
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8.2.4 Trust Investments
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Trust Investments
Introduction: One of the major decision points when creating a charitable remainder trust (CRT) is developing an investment strategy.
Permissible Investments: The laws governing trust investments are state specific, but more than 40 states and the District of Columbia follow the Uniform Prudent Investor Act (UPIA).
Portfolio Allocations: Should the trustee choose to invest in a diversified portfolio, the trustee will need to determine the percentage of the portfolio allocated to stocks and the percentage allocated to bonds.
Costs and Net Returns: The costs of managing a trust vary greatly, depending upon the selection of trustee and the investment manager.
Importance of Cost Reduction: It is essential to review costs.
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Introduction
One of the major decision points when creating a charitable remainder trust (CRT) is developing an investment strategy. Under the four-tier accounting rules, the type of income paid out of the trust is determined by the assets held inside the trust.
Federal law does not usually govern the investment of assets by public charities, but private foundations are prohibited by the federal government from making jeopardizing investments. Accordingly, the brunt of the regulation falls to the individual state in which the trust is organized.
Permissible Investments
The laws governing trust investments are state specific, but more than 40 states and the District of Columbia follow the Uniform Prudent Investor Act (UPIA).
The UPIA states that a trustee must invest using the prudent investor standard. In other words, the trustee must exercise reasonable care, skill and caution when investing trust assets. The trustee should consider the overall risk and return before making investment decisions. Although no particular type of investment is prohibited, diversification is considered essential.
Therefore, the trustee typically should invest in a diversified portfolio consisting of stocks and bonds. Alternatively, other less typical investments may be used as long as the trustee fulfills his or her fiduciary duty and meets the prudent investor standard.
Although the Tax Code does not address whether a CRT may hold an insurance policy, such an investment has been approved in Revenue Rulings and PLRs (the latter of which cannot be used as precedent). Specifically, Rev. Rul. 84-179 discusses the permissibility of a CRT owning a life insurance policy. In addition, PLRs 7928014 and 8745013 discuss the same issue. PLR 7928014 permitted an insurance policy as a unitrust investment. Since the taxpayer retained no rights except the right to change charity, the payments were deductible. PLR 8745013 also permitted an insurance policy as a unitrust investment and discusses the possibility of jeopardizing the charitable remainder. Lastly, although it does not focus on the issue, PLR 200017051 mentions a unitrust holding an insurance policy.
Portfolio Allocations
Should the trustee choose to invest in a diversified portfolio, the trustee will need to determine the percentage of the portfolio allocated to stocks and the percentage allocated to bonds. A "conservative" portfolio may have 50% stocks and 50% bonds. The standard trust portfolio typically holds 60% stocks and 40% bonds. However, during the 1990s, many institutions with endowments transitioned to a 70% stocks and 30% bonds portfolio.
| Potential Portfolio Returns |
| Portfolio | 50% St. - 50% B. | 60% St. - 40% B. | 70% St. - 30% B. |
| Returns | 4.0% 2.25% | 4.8% 1.8% | 5.6% 1.35% |
| Total Return | 6.25% | 6.6% | 6.95% |
Costs and Net Returns
The costs of managing a trust vary greatly, depending upon the selection of trustee and the investment manager. Trustee costs may range from zero to 1.2% or 120 basis points (100 basis points equals 1%).
Similarly, investment management fees may be significant. The cost for investment management ranges from 18 basis points for a large S&P 500 Index fund to 100 basis points for many large mutual funds, to 200 basis points for some international funds.
| Option | ||||
| | Trustee Fee Inv. | Fee | Total |
| Option I | Trustee Private or Charity | 20 Basis Points | 30 Basis Points | 50 Basis Points |
| Option II | Private with Advisor | 25 Basis Points | 75 Basis Points | 100 Basis Points |
| Option III | Corporate | 100 Basis Points | 60 Basis Points | 160 Basis Points |
If the trust holds a portfolio of 70% stock and 30% bonds and earns 6.95%, then the net return of the trust will be that amount less the fees. For Option I, the net return is 6.95% minus 0.5%, or 6.45%. Option II produces a net of 5.95% and Option III produces a net of 5.35%.
These fees are not unusual. Some trust accounts have fees in excess of 200 basis points and some financial planning firms have proposed "wrap accounts" with fees of 300 basis points.
Importance of Cost Reduction
It is essential to review costs. Charities, private trustees and corporate trustees must all carefully review their cost structure. With lower return rates, it is essential to minimize cost burdens.
There are valid reasons for all three trustee choices. Many charities serve effectively as trustee with very low costs. A private trustee enables the donor to have control over the managing process and may operate less expensively. For large trusts, the costs of a corporate trustee are more moderate in proportion to trust size. In addition, the objective nature of the corporate trustee may be essential for large estates where there are relatives.
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Related Topics on Trust Investments
3.10.10
Investments of Unitrust Corpus:
One of the major decision points when creating a charitable remainder trust (CRT) is developing an investment strategy. Under the four-tier accounting rules, the type of income paid out of the trust is determined by the trust investments.
4.10.4
Sale and Unitrust:
A sole proprietor is typically interested in one principal goal. First, he or she may need or desire cash liquidity. Many business owners have placed most of their assets into the business. Upon retirement, a portion of the business assets will be sold for cash.
4.13.4
Testamentary CRT:
IRD, or income in respect of a decedent, is generally the result of assets owned by the decedent that has untaxed ordinary income or capital gain at the time of the decedent's death. However, unlike other assets, IRD assets do not receive a step up in basis at death. In fact, when a beneficiary receives an IRD asset, the beneficiary is subject to taxation on the asset, just as the original owner would have been subject to such taxation. See Sec. 691.
4.14.3
Sub S Unitrust:
While a charity is a permissible S Corporation shareholder, a split-interest trust like a charitable remainder trust ("CRT") is not. Sec. 1361(e); PLR 8922014. If a CRT receives S Corporation stock from a donor or purchases S corporation stock, the S corporation will be disqualified and reclassified as a C corporation. Such reclassification will likely be upsetting to the corporation's other shareholders and will cause the corporation's income to be taxed twice (as is the case with all C corporations), once at the corporate level and once at the shareholder level.
4.2.4
Assets to Charity or CRT:
As an owner approaches retirement, significant liquid assets may remain in a C corporation. For example, the owner may have been in the construction or sales business and have accumulated significant liquid assets in the C corporation. However, when he or she retires, there is no longer active income, but the cash and liquid assets remain.
4.2.5
Charitable Unitrust Bailout:
The majority of family businesses are sold when the founders retire. However, perhaps one third of the time, children or other heirs will be capable of taking over the business. Normally, one or more children will show the aptitude and skills necessary to acquire and operate the business successfully.
4.3.3
Tangible Personal Property Unitrust:
There are a number of assets that constitute ordinary income potential and are tangible personal property. Works of art created by an artist, farm products raised by a farmer and most cattle owned by a rancher would generate ordinary income upon sale. In addition, equipment, vehicles, aircraft and other items that are subject to depreciation would generate gain recaptured as ordinary income upon sale. All of these assets may be appropriate candidates for a tangible personal property unitrust.
4.5.4
The Inventory Unitrust:
Inventory may be transferred to a charitable remainder unitrust. However, there are two important differences to be aware of when transferring inventory into a charitable remainder trust. The two differences affect the charitable deduction.
4.6.5
IRA to Unitrust for Children:
There are two basic methods for transferring an IRA to a unitrust for children. One option is to transfer the IRA to a term of years trust for the children. The second option is to transfer the IRA to a trust that will pay the children for their lives.
4.7.5
Charitable Remainder Trusts:
A charitable remainder unitrust (CRUT) is an excellent option for donors with appreciated real estate. A CRUT provides a charitable income tax deduction, an income stream and a tax-free sale of the real estate.
4.8.4
Sale and Unitrust:
Another option for selling limited liability company (LLC) assets or LLC units is a combination sale and unitrust. The sale and unitrust allows an LLC owner to sell a portion of his or her interest in the LLC and offset some or all of the capital gain on the sale with a gift to a unitrust.
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