A charitable lead trust is a form of charitable trust that first distributes assets to the named charities. Once the assets have been distributed to the charities as specified in the trust, the named beneficiaries receive the remainder of the trust’s assets. Here’s how it works. Consider working with a financial advisor as you incorporate charitable giving into your estate plan.
What Is a Charitable Lead Trust?
A charitable lead trust is a form of irrevocable trust. This means that once you establish the trust and make contributions to it, you cannot take those assets back.
With a charitable lead trust you establish a set term for charitable giving. This can be defined by either an amount of time or a condition. The trust then makes charitable donations during this period. For example, the trust might make charitable donations for five years or until some named individual dies. This period is known as the “term of the trust.”
Once the term of the trust ends a charitable lead trust gives the remainder of its assets to named beneficiaries. Beneficiaries can be you, friends and family, or anyone else you choose. The same as how you choose charities, when you establish a charitable lead trust you choose its beneficiaries and how they will receive the trust’s assets.
When you create a charitable lead trust you can define how it distributes its assets. This means that you name the charities that the trust gives to, as well as how much money it gives to those organizations. You can do this through a wide variety of mechanisms, such as nominating a percent of assets or a defined amount of money that a charity will receive.
For example, you might set up a charitable lead trust with the following structure:
- Initial contribution of $100,000
- Designate a board of trustees to manage its investments
- A term of trust of 10 years
- All investment proceeds split annually between the charities ABC and XYZ
- Your two children as the named beneficiaries
In this case, the trust would take its initial $100,000 contribution and invest that money. Once per year, it would take any profits made from those investments and split that money evenly between the charities XYZ and ABC. The trust would do this for 10 years (the term of the trust). At the end of the term, the trust would dissolve and split any remaining money evenly between your two children. Ideally this means that your children would each receive $50,000, but that would depend on whether the trust’s investments lost money at any point.
A charitable lead trust is the inverse of a charitable remainder trust, which distributes assets to its beneficiaries and then gives any money remaining in the trust to charity.
Why Use a Charitable Lead Trust?
There are several reasons to use a charitable lead trust. Here are some of the most important ones.
Structured Giving
A charitable lead trust allows you to structure your donations to charity over time. You can give specific instructions, define which charities will receive money, establish the time frame over which they will receive money and more. Named charities must receive at least one payment per year, but otherwise there are few restrictions on how much or how often a charity needs to receive money. This allows you to create a long-term scheme for charitable giving, as well as one which you don’t necessarily have to carefully monitor.
Investments
Trusts can put money into investment securities and manage such assets over time, and they can make their donations based on how these investments perform. It is common for a charitable lead trust to invest its principal, then make donations with the profits from those investments. At the end of the charitable term the trust will then distribute its principal to named beneficiaries.
Tax Benefits
There are several ways in which using a charitable lead trust can help your taxes. For particularly wealthy households, passing assets to your heirs through a trust can help avoid incurring estate taxes. In other cases, you can significantly reduce or even eliminate capital gains taxes depending on specific circumstances.
However, most of the tax benefits of a charitable lead trust come from the tax deductions you get for the trust’s charitable giving. You can do this in two ways. If you structure your trust as a grantor charitable lead trust, then the IRS allows you to take an up-front deduction for the future donations that the trust will make. However, you also will pay taxes on the trust’s investment income during the term of the trust. With a non-grantor trust you can only take a tax deduction based on the assets which you directly transfer into the trust, however you also are not taxed on the trust’s investment income.
Trusts mainly provide financial benefits to third-party beneficiaries. While you can set up a charitable lead trust which names you as one of its beneficiaries (this is called a reversionary trust), in most cases you will get about the same tax benefits as if you had simply made the charitable donations directly. The main exception to this is that in some cases you can pay lower capital gains taxes by receiving your assets back through a trust.
However, most of the benefits will accrue to other beneficiaries who receive their money through this trust. Depending on the nature of the trust they can receive this money with reduced capital gains, estate and gift taxes compared to if you had simply given them the assets directly. This is why most financial planners use charitable trusts as a form of estate planning.
The Bottom Line
A charitable lead trust is a form of charitable trust designed to give assets to charity, and then return any remaining funds to named beneficiaries. When you establish one you determine who will receive these funds and for how long the trust will operate. Once this term expires, the trust gives any remaining funds to beneficiaries that you have decided on.
Tips on Estate Planning
- To fully understand the tax implications of a charitable lead trust you must understand the concept of a grantor trust and a non-grantor trust.
- Can a charitable lead trust help you with your taxes? The only way to really know the answer is by asking an expert, such as a financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Trusts can be one of the most versatile forms of long-term financial planning, and they come in a wide variety of types. Perhaps the most basic division among trusts is the split between simple and complex.
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