Stanley - Charitable remainder unitrusts

Wednesday, December 15, 2004

'Tis more blessed to give than receive. Especially when charitable remainder unitrusts are involved.

Properly set up and administered, a charitable unitrust makes benefactors the beneficiaries - of reduced tax bills, periodic income, and perhaps even improved cash flow - while still allowing them to leave a legacy of at least 10 percent to the charities of their choice.

Under the most common unitrust scenario, donors irrevocably transfer assets out of their estates and into a trust created by an attorney. In doing so, they stipulate that what's left in the trust at a specified time in the future becomes the property of designated charitable organizations. Prior to that, however, the donors can arrange to have the trust make periodic payments (at least annually) to themselves or other named beneficiaries.

Consider the example of a married couple who decides to contribute a growth stock they've owned for many years, but which pays little in dividends, to a unitrust ultimately earmarked for their respective colleges. The trust then sells the stock and reinvests it into greater income producing vehicles, which in turn provide periodic payments to the couple, who have been designated as beneficiaries of the trust, until the death of the surviving spouse.

In doing so, the couple is able to take advantage of the flexibility offered by charitable remainder unitrusts:

· They can name whomever they want as trustee, including themselves.

· They can select annual, semiannual or quarterly distribution payments from the trust subject to a minimum of 5 percent and a maximum of 50 percent of the trust value.

· They can add funds to the unitrust at any time and invest the funds in whatever manner they wish, if they are the trustee.

· The income can continue for their lifetimes, or for a fixed term of not more than 20 years, or a combination of the two.

Here are some of the benefits that accrue to the donors from their philanthropy:

An immediate income tax deduction

Although their charity may not receive anything for many years, the government allows the couple to take an immediate income tax deduction for the charitable gift. The amount of the deduction, which may be taken against ordinary income up to 30 percent of their adjusted gross income (for capital gain property), depends on three factors: the size of the gift, the ages of the couple, and the unitrust distribution percentage.

The IRS has published a table for calculating the "present value" of this future gift. Deductions may be further reduced if the donors adjusted gross income exceeds certain thresholds. They won't get a 100 percent tax deduction for the amount the charity will receive, but they will get something each time they contribute to the trust.

Bypass of capital gains tax

Charitable trusts are tax-exempt; therefore, the trustee avoided capital gains taxes on the appreciated value of the stock when it was sold. The trust retains all proceeds of the sales, which help generate greater distribution amounts for the designated beneficiaries, namely the couple themselves.

Increased income

Investments held for a long period of time, such as land or low dividend growth stocks, can generate large amounts of capital gains when they're sold, but rarely spin off a lot of annual income. The capital gains tax-free reinvestment through the unitrust allows the couple to dispose of, without tax, an asset earning a relatively small yield and the trustee can reinvest the proceeds in a higher yielding instrument, boosting their current income. Further, over a period of years, the trust can reinvest this extra cash.

Generating increasing cash flow

Selecting the right percentage distribution can make the unitrust an excellent cash flow generator. The trust assets will be revalued annually, and the couple's income will be a percentage of that total value. If they ask for 7 percent of the trust value as an annual distribution, and the trust earns 10 percent in a year, then roughly 3 percent will remain as a growth factor inside the trust.

The following year's 7 percent distribution will be larger because the amount in the trust is larger. It may be to their advantage to choose a relatively low payout percentage that, in turn, will allow the unitrust's yearly payments to grow.

A legacy of philanthropy

The couple knows that ultimately their generosity will benefit the institutions of their choice. However, if they had been torn between leaving assets to charity or family, they may have been able to solve their dilemma with life insurance.

Proceeds from a second-to-die policy purchased with part of the income distribution from the trust and payable to their heirs could make up for the value of the stock they placed in the unitrust. And, if properly administered, the death benefit could be passed on free of federal estate tax.

You can also arrange for a different type of unitrust to pay less than the distribution rate you select, and be owed the distribution rate in later years. That feature, and the advantages it can have toward building a retirement income, will be the subject of a subsequent article.

Sharon Stanley is a representative of The Prudential Insurance Co. of America in Cape Girardeau. (334-2603 )

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