Did you know that wealth vulnerability can become wealth opportunity in the form of a charitable lead trust (CLT) that can put your wealth to work as an instrument of change and a permanent part of your legacy?
This is a highly sophisticated approach to UHNWI and HNWI wealth governance that defers tax liability and multiplies philanthropic impact. Let’s learn more.
What Is a Charitable Lead Trust?
A Charitable Lead Trust is a trust that pays income to a charity for a period of time. More specifically, a CLT is an irrevocable trust that supplies financial support to one or more charitable organizations over a defined period. If the trust’s term ends, any assets remaining go to noncharitable beneficiaries (typically, family members).
CLTs have a different structure than charitable remainder trusts and how the money is paid out. While charitable remainder trusts prioritize income for beneficiaries before charities receive the remainder, CLTs do the opposite: After the term, the rest of the assets go to beneficiaries, but the payments go to charities first.
How Does It Work?
At its core, a CLT operates as follows:
Funding the Trust
Assets contributed to the trust are from the grantor. Cash, publicly traded securities, real estate or even private business interests are all examples of these assets.
Payments to Charity
A charitable beneficiary receives regular payments over the trust’s term – either a fixed amount (in the case of a charitable lead annuity trust) or a percentage of the trust’s assets (a charitable lead unitrust). These payments satisfy the “lead interest” of the trust.
Distribution to Beneficiaries
After the trust term, any balance assets belong to the noncharitable beneficiaries such as spouse, heirs or otherwise.
There Are Two Types of Charitable Lead Trusts
The type of CLT is what will determine the tax implications and benefits. The two primary categories are:
Grantor Charitable Lead Trust
A grantor CLT enables the grantor to take an immediate income tax deduction for the present value of the payments designated for the charity. But the grantor is also liable for income tax on the trust’s earnings during its term.
For those who can handle the ongoing tax liability and want a large current-year deduction, this approach works.
Charitable Lead Trust (Non-Grantor)
A non-grantor CLT is taxed on undistributed income, but the trust itself – not the grantor – is responsible for the taxes. Distributions to charitable beneficiaries are deductible by the trust as unlimited income tax charitable deductions.
This structure typically results in superior benefits for estate and gift tax planning, as it requires the grantor to forgo the immediate tax deduction, but typically delivers superior results.
Both types can also be structured as reversionary or non-reversionary trusts. For reversionary arrangements, the remaining assets revert to the grantor. In non-reversionary setups, they go to other beneficiaries, usually heirs.
Charitable Lead Trusts Help You Save Money on Taxes
The effectiveness of a CLT depends on tax planning. Key benefits include:
Estate Tax Reduction
Estate tax charitable deductions for the value of the interest paid to the charity are provided by non-grantor CLTs. It brings about a smaller taxable estate and saves through possible preservation of more wealth for your heirs.
Gift Tax Mitigation
A gift tax charitable deduction may be available for lifetime contributions to a non-grantor CLT. With proper care in structuring the terms of the trust, the remainder interest can be tax-free or tax minimized.
Income Tax Benefits
Upfront income tax deduction is available for grantor CLTs but at the cost of ongoing tax liability on trust income.
When Establishing a Charitable Lead Trust, There Are Several Things to Consider
To set up a CLT, you need to be very careful and think ahead. Things to think about are:
Trust Duration
The trust can be for a fixed number of years, the lifetime of an individual, or both. Longer terms may give you the most tax breaks, but you’ll need to plan carefully to make sure you have enough money to make yearly donations.
Funding Assets
Cash, publicly traded securities, real estate, or private equity are all examples of types of contributions, which may include securities. There is each type of real estate with their respectively unique tax implications and liquidity considerations.
Charitable Beneficiaries
The charitable organizations selected must be tax-exempt under IRS rules. CLTs are often paired with donor-advised funds, which grantors can use to select or change charitable recipients.
Remainder Beneficiaries
Decide who will get the trust’s other assets once a term ends. Most often, this decision is in line with a broader set of estate planning goals; namely, transferring wealth to children or grandchildren.
Legal and Administrative Costs
Legal setup and ongoing maintenance are needed for CLTs. Get the benefit of advisors experienced in the complex administration of trusts to be in compliance with IRS regulations and be as effective as possible.
Charitable Lead Annuity Trusts vs. Charitable Lead Unitrusts
The payment structure of a CLT significantly impacts its operation and tax treatment:
Charitable Lead Annuity Trust (CLAT)
The charity gets a fixed annual payment that does not change with the performance of the trust. CLATs give some predictability and are maybe useful in low interest rate environments.
Charitable Lead Unitrust (CLUT)
The charity is paid a percentage of the value of the trust, which is revalued annually. Greater flexibility is provided by CLUTs, but variability in annual distributions is introduced.
The grantor must choose among these structures based on the grantor’s goals, the assets to fund the trust, and the market.
Advanced Strategies: CLTs and Donor-Advised Funds
Some grantors want flexibility in charitable giving, and combining a CLT with a donor-advised fund can be a powerful vehicle to accomplish this mission. Here’s how it works:
- The CLT is the charitable beneficiary of the donor-advised fund.
- The donor-advised fund receives payments from the trust, and the grantor can recommend grants to particular charities from the donor-advised fund.
- The flexibility of this arrangement allows the trust to adapt giving strategies without changing the structure of the trust.
Knowing all that, does a charitable lead trust work for you? It’s a powerful tool, but not for everyone. Its suitability depends on a number of key factors that must fit with your broader financial and philanthropic goals. UHNWIs and HNWIs need to understand these factors to determine if a CLT is part of your overall wealth strategy.
The Size and Composition of Your Estate
Whether a CLT is right for you depends on the size and nature of your estate. Individuals with the most to lose should consider this type of trust – it’s best for people with sizable assets that are producing income or are appreciable over time. Cash, securities or real estate can be great funding sources, but more complex assets may need more planning.
Your Charitable Inclinations
Do you have passion for certain causes or efforts? Creating a lasting philanthropic legacy is a CLT. But the trust is only as good as the commitment to charitable giving, as payments to the charity are central to the arrangement.
Transfer Tax Savings Versus Income Tax Deductions
The decision will also be influenced by your priorities in tax planning. A grantor CLT may be beneficial if you want to receive immediate income tax benefits. If, however, minimizing estate and gift taxes to your heirs is more important, a non‐grantor CLT may be the way to go.
Willingness or Readiness to Relinquish Control
To establish a CLT, you must give up control over the assets that you contribute to the trust. This irrevocable transfer can be a tough decision if you want to keep direct access to those assets during your lifetime.
Working with Experts
CLTs are complicated and you should work with experienced advisors. Your estate planners, tax attorney, and even your financial professional can help you analyze your objectives and develop a customized approach.
They may also consider other vehicles, such as charitable remainder trusts or private foundations, to make sure that the approach you select fits perfectly with your goals.
A CLT is not a solution that will work for everyone, but for the right person it provides unparalleled opportunities to combine philanthropy with effective wealth preservation.
Dominion’s Charitable Lead Trust Expertise
Our experts at Dominion know all about the complex world of wealth governance. We take a precise, adaptable, and legacy-preserving approach to establishing CLTs. Moreover, we work with a global network of trusted legal and financial advisors to ensure that every trust is tailor-made to your specific objectives and circumstances.
But we know a charitable lead trust means more than giving. It shows what a vision you have; it ensures that your wealth is well preserved while at the same time supporting a cause that you believe in.
By following our guidance, you can use this sophisticated strategy to attain unbelievable financial peace of mind. If you are interested in a charitable lead trust, contact the team at Dominion to discuss whether it is right for you. We’ll build a plan together that is uncompromising in protection.
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