In the current economic environment, many professional advisors are recommending charitable lead annuity trusts (“CLATs”) to their clients. With a lead trust, a client gives to charity the fruit of the tree – the apples – and keeps the tree for herself or her family. This is different from most types of gifts where the donor gives away the asset itself. Also, lead trusts are very flexible and can be drafted to meet a variety of charitable and personal goals. Further, by naming a fund at a community foundation like The Chicago Community Trust as the beneficiary, families can truly make the charitable impact they seek.
Now is the best time to create a CLAT from an economic benefits perspective. The math behind CLATs uses an IRS assumed rate of return – often called the “§ 7520 rate” – and that rate is currently at 0.4%. Given that the rate is below 1%, many professional advisors are recommending that clients create a CLAT now.
The types of CLATs most advisors recommend are either (1) a non-grantor CLAT to benefit charity, then children; or (2) a grantor CLAT to benefit charity, then whatever is left in the trust goes back to the client.
Clients who create a non-grantor CLAT typically are seeking to reduce their estate taxes and transfer assets to their children tax free. Also, they usually already give to charity. The trust is drafted so that the client is not treated as the owner for federal income tax purposes. Clients fund the trust with low basis assets and hope that the assets will continue to increase in value during the trust’s term. They also hope the CLAT will be invested in a way that it outperforms the total of the IRS’s assumed rate of return; the annuity payment to charity; and the administration costs. When that all happens, the difference is transferred to the children tax free. Because the assumed rate of return now is 0.4%, there is a higher probability of a tax-free transfer.
Below is a visual representation of this type of gift.
Clients who create a grantor CLAT typically are seeking a current income tax deduction and to get money back at a later date. Also, they usually are already giving to charity. For federal income tax purposes, the client is treated as the owner of the trust’s assets.
This type of CLAT is perfect for a client who no longer itemizes due to tax law changes, wishes to make a multi-year pledge, do retirement planning or defer income taxes because of a liquidity event. When the assumed rate of return is low, like it is now, then the client is eligible for a higher income tax charitable deduction. As rates rise, the deduction gets reduced.
Below is a visual representation of this type of gift.
CLATs require input from the entire professional advisory team – lawyer, financial advisor, and accountant – to ensure the client’s goals of benefitting themselves or their families are met. Advisors and clients might also consider talking to the team at The Chicago Community Trust (“the Trust”) to determine which type of fund could help clients achieve their charitable goals.
Which Fund at The Chicago Community Trust Works Best When?
Donor Advised Funds
For clients who struggle with choosing which charity or charities receive the annuity payments, advisors often recommend designating a donor advised fund (“DAF”). The client – or children or grandchildren – serves as the advisor of the DAF and recommends which charities to support, when to support them, and what amounts they receive. Clients may choose to support one group of charities one year and a different group the following year. In other words, DAFs allow for flexibility.
By choosing a DAF at the Trust, clients receive added benefits. First, clients are paired with a person – a philanthropic advisor – who helps them achieve the charitable impact they wish to make, whether in Chicago or elsewhere. This service is included in the DAF’s administrative fee and all DAF holders receive this service regardless of the fund’s value.
Second, clients gain access to the Trust’s team of experts. Unlike other DAF sponsors, we have an endowment from which we distribute funds – “grants” – in support of our commitment to strengthening the Chicago region. These grants are awarded after thorough review by our Community Impact Team, who know which organizations are making a measurable difference throughout the Chicago region. They also have relationships with staff at community foundations in other regions with whom they share ideas and best practices. Thus, clients who create a DAF at the Trust get access to our subject matter experts, their knowledge and their networks.
Finally, for DAFs with a value of at least $1 million, clients may recommend their preferred financial advisor as the investment manager for their DAF.
Other Types of Funds
For clients with other charitable goals, the Trust offers several solutions.
Designated Funds – An Endowment Option
For clients seeking to create an endowment for one or more charities – whether in Chicago or elsewhere – the CLAT could make the annuity payments to a designated fund. It’s called a “designated fund” because the client designates the specific charities. This fund type works well for clients who would like to support:
- multiple charities and not worry about meeting minimums for endowed funds at each charity or keeping track of multiple funds;
- a single charity and keep the funds out of the board’s reach; or
- a single charity that does not yet have an endowment fund.
Field of Interest Funds – Support for Favorite Interest Areas
For clients who have a specific area or areas of interest they wish to support – like the arts, children, food and shelter – but would rather not select the specific charities, the CLAT could make the annuity payments to a field of interest fund. This is the type of fund where the donor tells the Trust the areas he or she wishes to support and our staff selects as the recipients those charities providing “best in class” services. In a sense, the Trust acts as the client’s philanthropic fiduciary.
Unrestricted Funds – Support the Chicago Region
For clients with strong ties to our region and the Trust’s work, the CLAT could make the annuity payments to an unrestricted fund. The Chicago Community Trust’s board in their fiduciary capacity ensure that the funds are used for our region’s most pressing needs.
Best Fund Type for Meeting Client’s Goals
|Client’s Goal||Fund Type||Benefit to Client|
|Flexibility to choose charities; engage next generation||Donor Advised Fund||Chooses which charities to support, when to support them, and how much|
|Create an endowment for a single charity or several charities||Designated Fund||One-stop shopping: one place, one fund minimum; outside fiduciary|
|Restrict gifts to the causes they care about most (e.g., food, shelter, children) rather than specific charities||Field of Interest Fund||The Trust’s staff select charities providing “best in class” services only in client’s interest area or areas|
|Ensure that the Chicago region remains a thriving, equitable place for all||Unrestricted Fund||Give locally; fiduciary oversight of a more than 100 year-old institution|
Whether a non-grantor CLAT or a grantor CLAT best fits the clients’ goals, the best time to create one is now. Current, low § 7520 rates allow your clients to:
- maximize the likelihood of tax-free transfers of assets to children; or
- maximize eligibility for an income tax charitable deduction.
Like any gift, clients ought to assemble their team of professional advisors – lawyer, financial advisor, and accountant – to ensure their tax goals are met. Similarly, advisors and clients could also talk to the team at The Chicago Community Trust about which fund type could ensure the client’s charitable goals are also met.
If you have any questions about charitable lead trusts or would like to learn more about our trustee services, please contact Don Gottesman, Director of Gift Planning, at firstname.lastname@example.org or at 312-616-6141 or Tim Bresnahan, Sr. Director of Gift Planning, at email@example.com or at 312-565-2832. We would also be happy to provide you or your client with an illustration.
To learn more about why now is the best time to create a CLAT, see our recent white paper here.