Charitable giving is an integral part of life for many people. Whether donating your time, treasures, or talent, helping others demonstrates your values and sets expectations for future generations.
Charitable Lead Annuity Trusts (CLATs) are tax-efficient estate planning tools that allow donors to make yearly contributions to the charity of their choice while reducing their transfer tax liability for the benefit of their heirs.
How does a CLAT work?
A CLAT is an irrevocable trust. A grantor funds the trust with assets (property, cash, publicly traded stocks, securities, real estate, or other assets) that the trustee manages. The trust makes a series of donations, called an annuity, to a charity over a specified period. The length of the trust is typically a set number of years or the grantor’s lifetime. At the end of the trust, the remaining principal will either revert to the grantor or pass to the grantor’s beneficiaries.
The annuity is based on the initial value of the trust’s assets and is, therefore, determined when the trust is created. A CLAT provides a guaranteed income for the charity without requiring the benefactor to make regular payments.
Grantor vs. non-grantor trusts
If a grantor wishes to remain the owner of the funds in the trust, they can establish a trust that makes regular payments to a public charity or a private foundation. The grantor can take an immediate tax deduction for all future payments to the charity, based on the fair market value of the deduction at the time it is made.
While the charitable deductions are tax deductible when using a grantor trust, the trust’s investment earnings are not. Talk with your estate planning attorney to determine whether this type of trust meets your estate planning and financial goals.
With a non-grantor trust, the grantor funds the trust with the assets and no longer owns them. The grantor does not receive an immediate tax deduction, and the trust must pay taxes on the investment income.
When the funds are distributed to the charitable beneficiaries, the non-grantor trust receives a tax deduction. Since this deduction is not limited, non-grantor trusts are used to reduce transfer taxes.
What is a CLUT?
A CLAT is structured to pay a fixed amount to a charitable organization annually. The donated amount (annuity) is a percentage of the trust’s initial value. The payment remains the same regardless of how well the trust investments perform.
A charitable lead unitrust (CLUT) pays annual payments to the charitable organization, but unlike with a CLAT, these payments are variable and based on a percentage of the trust’s principal, calculated yearly.
What are the potential benefits of a CLAT?
CLATs are helpful in reducing transfer taxes, such as gift and estate taxes. Depending on how they are structured, the grantor may also get a tax deduction when they initially fund the trust.
Potential benefits of a CLAT include:
- Provide regular income to a charitable organization over a predetermined length of time.
- Provide a vehicle to transfer wealth to beneficiaries while still supporting a charitable cause.
- Allow grantors to choose how they will fund the trust, its length, and the annuity payment amounts made to the charitable organization.
- CLATs can be structured to fit a grantor’s financial and estate-planning goals.
- If the trust investments grow faster than the Internal Revenue Service (IRS) Section 7520 rate, the excess growth passes to the beneficiaries tax-free.
What are the potential drawbacks of a CLAT?
CLATs are not for everyone. They are a complex estate planning instrument that requires careful planning and professional expertise. It is essential to verify whether the legal, tax, and administrative costs will exceed the potential financial benefits.
Potential drawbacks of a CLAT include:
- Noncharitable beneficiaries do not receive any assets until the trust term ends.
- If the trust investments grow slower than the IRS Section 7520 rate, the assets remaining at the end of the trust term will be of less value than expected.
- In a non-grantor CLAT, the grantor does not receive an immediate tax deduction when funding the trust.
- The annuity payments are fixed and, therefore, may not meet the charitable organization’s yearly needs.
- Once the grantor funds the trust, since it is an irrevocable trust, they lose control over the assets.
- Careful planning is necessary to ensure that the trust has sufficient funds to make the yearly annuity payments.
A CLAT enables grantors to financially support charitable organizations while receiving transfer tax advantages. However, establishing a CLAT can be complex and, therefore, costly. Potential grantors must also consider the irrevocability of their decisions when funding the trust and the potential volatility of the trust’s investment performance.
Establishing a trust that meets you and your loved one’s needs can be an essential part of creating a comprehensive estate plan. Keep in mind, though, that trusts can be complex and costly. Your Katzner Law Group estate planning attorney can help you consider all your options and develop a plan that meets your needs. They have a long and successful history of administering trusts.
Give us a call today at 866-395-1786 or contact us online to schedule a meeting and discuss your unique financial needs. Let us be your trusted partner on the path to financial success.