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[Revising an earlier article, this issue evaluates the merits of a Charitable Remainder Trust in light of recent estate tax changes. In it, we analyze both the financial and psychological issues involved in evaluating this powerful planning technique.] A New Look at Charitable Remainder Trusts Continuing our review of the effect of recent changes in estate tax law on some of our industry's most powerful marketing strategies, we will examine the use of a Charitable Remainder Trust. Case Study Ted and Ginnie Jones are a retired couple, age 65 and 60 respectively. They have three children. They want $200,000 a year in retirement cash flow (after tax) increasing by 3% a year as an inflation offset. Their current estate totals $8.6 million (Click here for a breakdown of their assets) of which $2.2 million is invested in undeveloped real estate inherited years ago from Ginnie's grandfather. They expect future appreciation of this property to be limited to 3% a year, and their inclination is to sell it and invest the proceeds for a better return. However, their inherited cost basis is only $200,000, and they are reluctant to pay the resulting capital gains tax. This appears to be a perfect circumstance for a Charitable Remainder Trust coupled with a Wealth Replacement Trust. Let's assume their newly formed charitable trust sells the property for $2.2 million and invests the proceeds at 10% (in a normally taxable investment) of which 1% pays for asset management, 3% is retained for growth, and 6% is paid out to Ted and Ginnie for income. To complete the strategy, Ted and Ginnie's Wealth Replacement Trust purchases $2.2 million of participating survivor life insurance with paid-up additions as the selected dividend option. The advantages are threefold: 1) The charity selected as the remainderman of the charitable trust will be beneficiary of a substantial benefit from the transaction, beginning at $2.2 million and rising by a compounded 3% a year; 2) Ted and Ginnie's children will inherit a substantially growing life insurance death benefit free of wealth transfer taxes (it outpaces the value of the land had it been retained as an estate asset); and 3) Even after gifting the Wealth Replacement Trust the $50,000 a year it needs to support the premium for the $2.2 million policy, Ted and Ginnie will have about $36,000 in after tax spendable income (growing by 3%) that wasn't there before. Mathematically, it looks like they should do it -- so why haven't they? Why, months after their advisers have all concurred that the transaction makes sense, are they still thinking about it? One of the potholes inherent in charitable trust presentations is that, compelling as the mathematics may be, many people are not comfortable with a transaction where they lose access to the capital. In other words, they fear running out of money more than they welcome tax efficiency. They might need access to that capital later! When you read about Bill Gates putting $100 million of Microsoft stock into a charitable trust, this is not an issue -- it represents only a tiny fraction of his net worth. While Ted and Ginnie may well appreciate the elegance of the calculations, the land represents over 25% of their net worth, and their instincts tell them "maybe we ought to hang on to it in case we need it later." Unfortunately, the vast majority of your wealthy prospects are far closer to Ted and Ginnie's situation than Bill Gates', and this is why many a well-designed case can turn into a china egg that won't hatch. Let's see if we can establish a comfort zone for Ted and Ginnie that helps them in their decision-making process. First, we do not want to present any wealth preservation strategies until Ted and Ginnie first have a financial checkup to determine if their specific level of retirement cash flow can be met without depleting their current asset base below their comfort zone -- even if they both live until age 100. We prepared revealing "before and after" scenarios using InsGiftâ -- the Wealthy and WiseÔ System. Review the following graphic that compares Ted and Ginnie's net worth comfort zone after deducting their retirement income cash flow requirements. Strategy 1 shows the status quo; Strategy 2 integrates the results of the suggested plan. Clearly, their initial comfort zone is reduced somewhat by the Strategy 2 scenario; however, now that they can see by precisely how much, the key question becomes, is it an acceptable reduction?
Over the long term, Strategy 2 provides the superior net worth comfort zone. This means that the Charitable Remainder Trust technique is so efficient that, long range, it more than replaces Ted and Ginnie's initial loss of net worth. This may come as a very pleasant surprise to many professional advisers -- as well as Ted and Ginnie. Ted and Ginnie's acceptance of Strategy 2 cannot be fully gauged until its impact on their children's inheritance is reviewed in the following graphic illustrating the comparison of wealth transferred to heirs.
As shown in the above graph, the Strategy 2 results are superb from the heirs' point of view. In addition, as you can see below, Ted and Ginnie's favored charitable cause is scheduled to receive substantial funds as remainderman of the charitable trust.
This strategy produces a tolerable short-term reduction in Ted and Ginnie's comfort zone, a significant increase in the wealth passed to their heirs, and a major deferred endowment for their favorite charity. The magic of the analysis allows Ted and Ginnie to make an informed decision about the value of the technique in the context of their overall estate. Without it, they may well respond to a typical presentation as many wealthy folks have, i.e., when in doubt, do nothing. As you can see from the graphs, there is a reason that a Charitable Remainder Trust is often called the last great Congressionally approved tax shelter. Illustration Comments: We used version 6.0 of InsGiftÒ -- the Wealthy and WiseÔ System ("InsGift") for the analysis, and the graphics that appear in this article are from that version. InsGift users can review all reports and related menu inputs for the plan presented by downloading the InsGift Workbook named "MA131.!IG" from this website. Click on Producer's Center; then on Workbook Download. The Workbook can then be imported into InsGift by selecting Client Workbook/Import Workbook. To download the Workbook now, click here. If you are not licensed for InsGift, please contact InsMark at 1-888-InsMark (467-6275) (or click here) for licensing information. Computer Business Card: InsMark has released a new Computer Business Card ("CBC") in a PowerPoint format that presents the logic of Charitable Remainder Trusts, and it follows the general logic of this article. CBC licensees are authorized to make unlimited copies for distribution to clients, advisers, and charities. For CBC licensing information, contact an InsMark Account Executive at 1-888-InsMark (467-6275), or click here. Members of InsMark's Power Producers Marketing Group receive all CBCs on a complimentary basis. We are very proud to be the innovators of this new charitable concept, and there is no source other than InsGift for the analysis. Note: InsGift does not perform CRT calculations, but most charities that participate in CRTs can assist you with the calculations. Firms like Crescendo also offer software that performs CRT calculations. (Complimentary CRT calculations are also available at www.philanthrotec.com.) From the data provided, it is simple to calculate the income tax savings generated by the income tax deduction associated with a CRT as well as the after tax income generated to the donor. InsGift has menu inputs for these items but does not calculate them. |
