Bob Waldman and Sarah Kahl published "Taking Advantage of Low Interest Rates with a Charitable Lead Annuity Trust" in the Spring 2011 edition of The BCF Edge, newsletter of the Baltimore Community Foundation.
Interest rates have begun to rise, but they remain relatively low. That makes this a good time to take advantage of an estate planning tool known as a charitable lead annuity trust (CLAT)—a technique that enables donors to benefit both charity and family members.
The mechanics of a CLAT require an upfront transfer of assets to a trust, and from that trust, a fixed amount is paid to charity each year for a period of years. The amount distributed to charity is determined by an interest rate table set by the IRS. At the end of the term, whatever amount is left in the CLAT passes to the donor’s beneficiaries—the donor’s children, for example.
Depending on the structure of the CLAT, the donor may receive an income tax deduction, and significantly, the children would receive the remainder interest with little or no gift tax cost to the donor.
A CLAT is an excellent tool for building an endowment and may be used to build an endowed fund at the Baltimore Community Foundation to benefit a particular organization or cause, a scholarship program, or a donor-advised fund to carry out personal or family giving.
Here’s an example: A mother with a $15 million stock portfolio is interested in setting up a trust fund for her adult children. She is also interested in benefiting charity; she typically donates about $100,000 each year. The mother could transfer $1 million of her stock to a CLAT that (based on current rates) would pay her fund at BCF $113,670 each year for 10 years. The transfer of the remaining assets to her children at the end of the term would be treated for gift tax purposes as only a nominal gift, because IRS calculations anticipate there will be little left in the CLAT given the low interest rate.
From the perspective of a donor, a CLAT is more attractive when interest rates are low. If the mother had made the transfer in February 2007 when interest rates were high, the annual distributions to charity would have been $133,310—and 5% growth would have left nothing for her children.
Donors establishing a CLAT may choose to use the interest rate for the current month or either of the two preceding months. Today’s rates remain low, but are rising rapidly. In December 2010, the relevant interest rate was 1.8%. The same rate for March 2011 is 3.0%.
Donors interested in creating a charitable lead annuity trust should act quickly.
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Robert L. Waldman, a tax partner, chairs the Business Division of Venable, LLP. He practices extensively in the areas of philanthropic and estate planning, employee benefits and taxation.
Sarah Kahl is an associate in Venable’s Tax and Wealth Planning Group. She focuses on advanced gifting techniques and other tax-saving strategies.