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The Charitable Lead Trust: A Vehicle Worth Considering in a Low Interest Rate Environment
Published Date : January 25, 2016
Many families hold philanthropy as an important family value and strive to find ways to give efficiently, perhaps accomplishing additional objectives in the process. Investors, having lived with low interest rates for many years, are starting to see signs that rates may gradually rise. That begs a question: are there unique financial planning opportunities worth considering before rates rise? After taking advantage of basic opportunities, such as refinancing mortgages and student loans, people who are charitably inclined might be wise to explore whether a Charitable Lead Trust (CLT) would enhance their giving.
Think of Charitable Lead Trusts (CLTs) as the reverse of better-known Charitable Remainder Trusts (CRTs). CRTs provide grantors income for their lifetime, while CLTs provide that income to designated charities. Also, CRTs pay the remaining corpus of the trust to charity at the death of the Grantor while, in the case of CLTs, the corpus either goes back to the original owner or to designated beneficiaries.
CLTs come in two forms: a revocable Grantor Trust (the corpus goes back to the original owner) and irrevocable Non-Grantor Trust (the corpus goes to beneficiaries). A charitable intent is essential to the rationale to pursue either type of strategy. Capital goes into the CLT and, for a fixed term of years, payments are made to charity. But when grantors decide where the remaining corpus will go, he/she either optimizes for the charitable gift deduction or the gift tax impact of transferring assets to heirs.
For all CLTs at inception, the value of the charitable gift is calculated by summing the present value of all future charitable payments using a discount rate that is set monthly and linked to interest rates on mid-term US Treasury debt (under IRS Code Section 7520). Mathematically, this inverse relationship between interest rates and the charitable gift value results in a larger, more favorable charitable tax deduction when interest rates are low. In a Grantor Trust, because the assets will be returned to the estate of the grantor, the goal of maximizing the grantor’s charitable deduction is more easily achieved in the current interest rate environment.
Non-Grantor CLTs, irrevocable trusts that pay annual charitable contributions and distribute remaining assets to named beneficiary (ies), do not provide a frontloaded charitable tax deduction to the grantor. Instead, the focus is to minimize gift tax impacts on assets destined for beneficiaries. The value of the gift is determined at inception by subtracting the present value of the charitable payments, same as above, from the value of assets put into the trust. An added benefit is realized if, over the life of the trust, the assets contributed to the CLT appreciate on an average annual basis greater than the rate set by IRS Code 7520 (currently 2.2%) providing beneficiaries a gift worth more than the grantor claimed for gift tax purposes at the trust’s inception.
Charitable lead trusts are complex. There are many important factors that could not be addressed in this brief article. However, in this period of historically low interest rates, CLTs in either form are worth exploring for those with charitable intentions.
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