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What is a Charitable Lead Trust?

Estate Planners | Monday, January 3rd, 2011

A growing number of people are choosing to take advantage of the charitable lead trust, a trust that is designed to provide income payments to a favorite charity for a fixed number of years, their entire lifetime, or a combination of the two. After a period of time, assets within a charitable lead trust are paid either to the grantor of the trust or to other beneficiaries that are named in the trust documents. The charitable lead trust is also sometimes referred to as a charitable income trust, although the former is more common because the payment of income to the chosen charity precedes (thus, leads) the payment of the remainder of the trust to the donor’s heirs. The charitable lead trust can be thought of in many ways as the inverse of the charitable remainder trust, and the guidelines for establishing and executing a charitable lead trust, including its operation and how it is taxed, different substantially from the guidelines that surround the charitable remainder trust. This trust allows a donor to transfer assets, including cash, artwork, stocks, and so on, to a trust for a specific number of years; payments are made from the trust to the donor’s chosen charity or charities annually. After the term of the trust expires, the remainder is returned to the donor’s heirs or beneficiaries. This type of trust can shelter the assets’ appreciation, protecting the assets from estate tax. The Internal Revenue Service establishes the rate that assets are expected to grow in the charitable lead trust. This is called the hurdle rate. Typically, any gains beyond the hurdle rate can be passed to the donor’s heirs, tax-free. The hurdle rate is locked in for the term of the trust, although the IRS adjusts the rate monthly.

Types of Charitable Lead Trusts

There are two types of charitable lead trusts, the charitable lead annuity trust and the charitable lead uni-trust. The charitable lead annuity trust involves a donor setting a fixed annual gift for the charity or charities in the trust. In the charitable lead uni-trust, the charity or charities will receive a percentage of the value of the trust each year, with fluctuating benefits based on the returns or losses of the trusts’ investments. Because the charitable payments in an annuity type charitable lead trust are fixed, it is more popular than the uni-trust. In the uni-rust, the assets in the trust grow and the percentage that goes to charity uses up more money, leaving less for the heirs at the end of the trust’s term.

Taxes and the Charitable Lead Trust

A donor that established either type of charitable lead trust will get an upfront deduction to their income taxes that are based on the payments that the charity receives from the trust. However, many donors opt to forgo the deduction because taking the deduction will trigger the payment of taxes on the investment gains within the trust.

Before considering a charitable lead trust, be sure to consider that this is an irrevocable trust, so once you have put assets in, you can’t take them back out. If the assets value goes down, the amount for your heirs could be less because the trust must make its payments to the charity regardless of what might be going on in the market. And since the money going to the heirs is a taxable gift, it will also lower your estate tax exemption. Consult your estate planner to find out if a charitable trust is the right trust for you and your family’s future.

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