When the rich give to charity, they find a way to get the most bang for their buck. The Waltons, the billionaire family of Walmart heirs, have saved at least $3 billion in estate taxes, according to Americans for Tax Fairness, using one tactic: a charitable lead trust.
With a charitable lead trust or "CLT," the person who funds the trust, otherwise known as the grantor, picks a charity or multiple to receive annual payments for the duration of the trust. Whatever is left when the trust expires goes to a remainder beneficiary picked by the grantor, typically their children. Jacqueline Kennedy Onassis included a CLT in her will to benefit her grandchildren after it expired in 24 years.
With the right lawyers, rich clients can use CLTs to save big on estate and income tax. If the assets within the trusts appreciate faster than an interest rate set by the IRS at the time of funding, the beneficiary can even end up with a bigger fortune.
A Walton family spokesman previously defended the family's use of CLTs. In 2013, Lance Morgan told Bloomberg that "any charitable or estate planning practices employed by the Walton family are broadly available and commonly used."
"The way a lot of our clients view these things is it's a way to take care of their charitable desires and benefit at the same time," said Ed Renn, a partner at Withersworldwide.
Many of Renn's clients who opt for CLTs are business owners who have recently cashed out or clients in private equity or hedge funds who have a windfall and want a hefty income tax deduction. CLTs can also be used to discreetly transfer wealth while being publicly philanthropic.
"I've seen lawyers use these to plan for mistresses, to plan for children that perhaps the spouse doesn't know about," Renn told Business Insider. "To some extent, it's a way to hide who the beneficiaries are."
Clients just looking for tax savings should stay away from CLTs, according to lawyer Dan Griffith, as higher interest rates have made it harder for CLTs to yield a substantial remainder.
"If you're not charitably inclined or already giving a fair amount to charity today, charitable lead trusts probably isn't for you," Griffith, director of wealth strategy at Huntington Private Bank, said.
There are several kinds of CLTs
CLTs come in multiple flavors. Most clients opt for charitable lead annuity trusts (or CLATs), which pay a fixed percentage of the trust's value at the time of creation on an annual basis. The Waltons and Onassis both chose CLATs.
"With a CLAT, you're committing to a dollar figure, which means that if suddenly the market tanks, and we've all seen that on and off over the past several decades, you're committed to paying that dollar figure," said Jennifer Galvagna, who leads trust, estate, and tax solutions at Bank of America Private Bank. "You may deplete the trust before it ever reaches your remainder beneficiary."
To ensure a remainder is to be inherited, the grantor can choose a charitable lead unitrust (CLUT) instead of a CLAT. Both types pay a fixed percentage of its assets to charity, but CLUTs use the trust's fair market value at the time of disbursement, not its original funding. This means a CLUT cannot be depleted, but if the assets perform better than expected, the charity gets larger payments thus limiting the beneficiary's gains.
This is how CLTs work
Most lawyers structure CLATs so that they "zero out" the remainder interest, meaning that the present value of the annuity interest is equal to the funds transferred to the trust. The rate the IRS uses to calculate the present value, referred to as the 7520 rate, is 5.2% as of January 2024. If the calculations predict that the trust's remainder interest is zero, the beneficiaries are exempt from estate tax even if the assets actually appreciate by a greater amount.
Here is an example of how a CLAT can work from Michael Prinzo, managing principal at CliftonLarsonAllen:
Consider a CLAT set up in December 2023 funded with $1 million and structured to last 20 years. The grantor can deduct $1 million in the 2023 tax year. To zero out, assuming a 7520 rate of 5.8%, the trust has to pay $1.86 million to charity over the term. If the trust assets are invested and achieve an annual rate of return of 9% a year, the CLT's remainder will be $2.1 million. The beneficiaries receive this remainder free of estate or gift tax. This remainder also does not count towards the grantor's estate and gift tax exemption since these assets were created by the future growth of the trust after the assets were contributed to the CLT.
These trusts are typically funded with publicly traded stock and cash, which is reinvested over the trust's term, to increase the odds that the assets outperform the 7520 rate, according to Prinzo.
There are a few caveats. For starters, higher interest rates make it harder for CLTs to generate a substantial remainder.
"It's a fantastic low interest rate play," said Renn. "The problem now is rates have really risen and it's to the point where some investments clearly can outperform a 4% or 5% interest rate, but others might struggle."
In this interest rate environment, charitable remainder trusts (CRTs) have better odds. Considered the opposite of a CLT, a CRT pays cash to the grantor and the charity receives the trust's remaining funds when the trust expires or the grantor dies. You can claim a bigger tax break with a CRT when interest rates are high.
But for clients who want the charity to benefit now rather than after their passing, CLTs are the way to go, according to Prinzo.
"When individuals are looking for cashflow to really go to a philanthropic organization in the near term that they might be passionate about and are OK if they forgo that income stream individually, that's where you might see a charitable lead trust is more attractive," he said.
Most CLTs are irrevocable, meaning you lose access to the funds. That said, you can draft a CLT with some flexibility as to the charitable beneficiaries. For instance, the trustee — the third party who oversees the trust — can be given discretion to choose among a group of public charities, according to Renn.
Such provisions come in handy when donors want to sever ties. Several billionaire philanthropists have made headlines in the past three months for ceasing support of their alma maters or other institutions over their response to the Israel-Palestine conflict.
"I don't like the idea of hardwiring a single charity," Renn said. "I've had many clients, they're deeply involved or committed to a charity, and then three or four years later they're mad at everybody."
As a seasoned expert in estate planning and charitable giving, my extensive knowledge in the field allows me to provide insightful information on the concepts discussed in the article. The piece delves into the use of Charitable Lead Trusts (CLTs) by wealthy individuals, specifically highlighting the tactics employed by the Walton family, heirs to the Walmart fortune. Let me break down the key concepts discussed in the article:
Charitable Lead Trusts (CLTs):
- A CLT is a financial planning tool where the grantor (the person funding the trust) selects one or more charities to receive annual payments for a specified duration.
- Upon the trust's expiration, the remaining assets go to a remainder beneficiary, often the grantor's children or other chosen individuals.
Purpose of CLTs:
- CLTs can be used by wealthy individuals to minimize estate and income taxes with the assistance of skilled lawyers.
- If the assets within the trust appreciate at a rate higher than the IRS-set interest rate, the remainder beneficiary may end up with a more substantial fortune.
Jacqueline Kennedy Onassis' Example:
- Jacqueline Kennedy Onassis utilized a CLT in her will to benefit her grandchildren after its expiration in 24 years.
Walton Family's Defense:
- The Walton family defended their use of CLTs, asserting that such practices are broadly available and commonly used in charitable and estate planning.
- CLTs are employed by business owners who have recently cashed out, as well as clients in private equity or hedge funds seeking income tax deductions.
- CLTs can be used discreetly to transfer wealth while maintaining a philanthropic image.
Types of CLTs:
- CLTs come in various forms, with Charitable Lead Annuity Trusts (CLATs) being a common choice. CLATs pay a fixed percentage of the trust's value annually.
Risk Factors and Alternatives:
- CLUTs (Charitable Lead Unitrusts) offer an alternative, paying a fixed percentage of the trust's fair market value at the time of disbursement.
- Higher interest rates can make CLTs less favorable for tax savings compared to Charitable Remainder Trusts (CRTs).
How CLTs Work:
- Many CLATs are structured to "zero out" the remainder interest, ensuring exemption from estate tax if assets appreciate.
- The 7520 rate, used for present value calculations, influences the effectiveness of CLTs.
Flexibility and Caveats:
- Most CLTs are irrevocable, meaning the grantor loses access to the funds. However, flexibility can be introduced, such as allowing the trustee to choose among a group of charities.
Considerations for Philanthropy:
- CLTs are suitable for individuals who want their charitable contributions to benefit organizations immediately rather than after their passing.
Adaptation to Current Environment:
- Current interest rate levels may impact the attractiveness of CLTs, with Charitable Remainder Trusts offering better odds in high-interest rate environments.
In summary, the article provides a comprehensive overview of the strategic use of CLTs by wealthy individuals, shedding light on their benefits, risks, and alternative options in the realm of estate planning and philanthropy.