A married couple, each 73, without children are planning to retire at 75. Because of the limitation on deductible state and local taxes, they could use an additional charitable deduction now while they have earned income. They have investments worth approximately $250,000 from which they do not want any income until they are 75. They would, however, like to do their estate plan now, which includes charitable gifts upon their death.
One estate plan which fits their need is a Net Income with Make-up provisions Charitable Remainder Unitrust (“NIMCRUT”) with a “spigot” and a “flip” provision to a standard Charitable Remainder Trust (“CRUT”) after two years. To understand how a NIMCRUT works in order to do what is required, descriptions of terms are necessary.
A standard CRUT is a tax-exempt entity which annually pays non-charitable beneficiaries a percentage of the market value of the trust. This percentage is paid first from net income, i.e. dividends and interest, and then from principal. The distributions to a non-charitable beneficiary are taxable annually as ordinary income to the extent there is net income to the CRUT. The remainder of the distribution is taxable as capital gain to the extent there is accumulated short and long-term capital gain to the CRUT calculated using the carryover tax basis of the donor. If the distributions to the beneficiary are larger than the net income and accumulated capital gain of the CRUT, the difference is not taxable to the beneficiary.
The advantages of a standard CRUT to a donor/non-charitable beneficiary over a sale of assets and investment by the donor are:
- avoidance of principal disappearance due to payment of large capital gains taxes on the sale of assets because of the CRUT’s tax exempt status,
- more available cash from distributions than would be the case with dividends and interest,
- reinvestment without tax consequences because of the CRUT’s tax exempt status allowing for growth of principal and resulting distributions from investment pursuant to a long-term growth strategy, and
- favorable tax treatment of the distributions to the non-charitable beneficiary when dividends and interest are minimized by the growth strategy.
A NIMCRUT differs from a standard CRUT in that it limits distributions to the non-charitable beneficiary to the lesser of all the NIMCRUT net income for the year, i.e. dividends and interest, or the original stated pay-out percentage. In the calculations we provided, the CRUT’s annual return is separated into a growth rate and an income rate. The annual distribution from a NIMCRUT would be approximately the income rate times the principal amount less administrative fees. A distribution to a non-charitable beneficiary from a NIMCRUT is taxed in the same way as a distribution from a CRUT. Because the distribution, would normally be dividends and interest less administrative fees, it would normally be taxable as ordinary income to the non-charitable beneficiary.
The advantage of a NIMCRUT over a CRUT is that by distributing only net income the growth of principal is accelerated. If more income is needed, the investments can be changed to produce more dividends and interest. Then, using the make-up provision, additional amounts can be distributed. Most NIMCRUT’s now contain a “spigot” provision among the powers of the Trustee. If an insurance product such as a variable annuity is purchased, even more principal growth acceleration can be realized if the non-charitable beneficiary does not need any distributions from the NIMCRUT. With such a provision, the Trustee can control the amount of income received by the NIMCRUT, taking just enough to pay administrative fees.
A CRUT with a flip provision is another option to consider. This type of CRUT begins as a NIMCRUT, however, following a specific triggering event or date, the NIMCRUT changes, or flips, to a standard CRUT. The triggering event can be the sale of an unmarketable trust asset, a calendar date, or a specific date such as a birth date or date of death. The triggering event or date must be specified in the trust document, must be objective, and must not be subject to the discretion of the donor, trustee, or any other person.
The advantage of a Flip CRUT over a standard CRUT and a NIMCRUT is its flexibility when distribution needs can be anticipated, or the contribution contemplated does not lend itself to annual distributions. For instance, if a donor, as non-charitable beneficiary, does not need to receive distributions now, but a successor non-charitable beneficiary will need large distributions later, a Flip CRUT may be the right vehicle.
To accomplish what the couple wants, the couple would contribute the $250,000 to a trust now. If a principal growth rate of 8.10% is used, the charitable deduction for the donors would be $114,022.50. The 8.10% growth rate is the average investment growth rate of funds of The Foundation for Enhancing Communities, a central Pennsylvania community foundation, since the inception of its use of a passive investment strategy in the 1980s.
The trust would be first a NIMCRUT for two years with income for distribution being 5% of the principal or interest and dividends, whichever is less. The assets would initially be invested in a variable annuity insurance product. The Trustee would use the spigot provision to only distribute enough income to cover Trustee fees. There would, therefore, be no income to distribute for the first two years. The variable annuity would absorb the rest of any annuity payments as additions to principal.
On the triggering date, December 31, 2021, the Trust would become a standard CRUT with distributions at 5% of principal on the valuation date, the first being January 1, 2022. Annual distributions would begin in the third year of the Trust at $14,170.89. This distribution would increase to $26,067.66 over the projected lifespan of the two donors. The remainder interest, distributable to a designated charity and calculated as if the Trust were a standard CRUT at the end of the 16 years would be $546,383,55.
For people with charitable intent wanting to have a steady source of income with some growth potential, but also some risk, a CRUT is a good vehicle for an estate plan. A NIMCRUT is an even better one, if a charitable deduction is wanted immediately along with a delay in distributions. For people who want to leave something to their heirs, of course, the above may not be the vehicle. Even for people in that situation, however, an estate plan involving a NIMCRUT for part of their assets may be of interest.