A Church Building Fund’s Friend: The Lead Trust

The current poor economy provides a climate for some planned giving techniques to yield greater benefits than any time in recent history. One example is the charitable lead trust.

A lead trust is normally funded with income-producing assets. In one model, the trust pays a stipulated percentage for a certain number of years to a charity. At the end of the designated time frame, the trust assets either revert to the donor or are passed to children or grandchildren.

If you are a church leader, you’ll want to pay special attention because lead trusts are funded with an average of five million dollars.

What could your church do with an income stream of 5-10% on 5 million dollars paid for 5 to 20 years?

 A lead trust can be a solution for people who have specific problems or goals. For example…

• They’ve received a large bonus or just sold a business and need a large current tax deduction.
• They have a stock portfolio that has decreased substantially in value but feel certain that the stocks will rebound in time.
• They have a large estate that will be taxed at 50%+ and they want to pass their estate on with little or no inheritance tax.
• They have a large estate and don’t want to dump significant wealth all at once on children who may not yet be financially responsible.

So why is a lead trust such a good deal now?

One of the components of the formula that computes the income tax deduction a person gets is the Applicable Federal Rate, AFR for short. Due to the decline in interest rates, the AFR has reached record lows. The lower the AFR the higher the tax deduction.

$1,000,000 Lead Trust Paying 5% for 10 Years

 

Charitable lead trusts have many applications and can simultaneously provide a benefit to your church.

Here’s one example…

Tom is the CFO of a software company. He’s 51 and wants to retire at age 60.

Tom’s income has averaged $400,000 for the last few years.

His company just landed a multi-year contract. Since Tom was instrumental in piecing together the financial part of the deal, he will receive a one million dollar bonus this year.

He really doesn’t need the additional million in income and is not too excited at the prospect of $400,000 going to taxes. He would like to sock as much away as he can for his retirement.

Tom is very active in his church and his church has just embarked on building a new addition.

Tom puts his million-dollar bonus into a 9 year lead trust which will pay 5% to his church for 9 years. This produces a charitable income tax deduction of $400,000, saving him $160,000 in taxes.

Since his million dollars will come back to him in 9 years, he is taxed on the $50,000 a year the trust pays to his church. One of Tom’s options is to have the lead trust invest in municipal bonds so there won’t be any tax due.

However, since the stock market is down, Tom feels he can do better by paying some tax with a good prospect of getting more than his million dollars back after nine years.

So he instructs the trustee to invest in high-grade stocks that are projected to grow at 8%.

Tom’s million dollars will grow to $1,375,000 after nine years. So not only did he save $160,000 in taxes in year one, the extra $375,000 comes back to him tax-free as well.

The trade off is to pay taxes on the $50,000 the trust will pay to his church each year for the next nine years.

In addition, Tom’s church receives $450,000 over the nine years to help pay for its church addition.

How Your Church Can Raise 6 Figures In 90 Days

I am a participant in a forum composed of planned giving officers, attorneys, CPAs and other professionals working in the charitable giving field.

Recently there was a question, followed by a series of posts, which asked how best to fund a charitable trust designed to pay out income when the amount was $150,000 or less.

You can learn a lot from just what briefly follows. If you are a church leader, I’m going to show you how you can potentially put 6 figures in your bank account in the next 90 days.

First, the discussion and the problems that surfaced…

The initial post outlined a tentative plan to fund a $100,000 to $150,000 gift using a charitable remainder trust (CRT). These trusts pay out a percentage of the trust assets for the life of an individual, or multiple individuals, and then pass the value of the trust to a charity.

The first response was from a CPA who indicated that the cost to file the myriad of forms required was not warranted unless the trust was funded with at least $100,000.

The second suggested using a single premium immediate annuity (SPIA) to fund a charitable gift annuity. Gift annuities are simple to set up, have low administration costs, and are best suited for elderly donors. The donor gets an immediate tax deduction and a guaranteed life income. Since a high percentage (70%+, depending on age) of the payout is excluded from tax, the effective yield can be twice that of a CD. Like a CRT, the gift annuity passes to the charity at the donor’s death.

The discussion that followed on the forum surrounded using the SPIA to “re-insure” the charity’s obligation. The quirk about gift annuities is that they are regulated by each state. If an organization has been in existence for less than 20 years and has assets of less than 2 million specifically designated to back gift annuity agreements, some states require re-insurance.

All this discussion was interesting and informative. However, I thought everyone was missing the boat. In my experience, the main reason for using a SPIA to fund a charitable gift annuity is to provide the charity immediate access to a portion of the gift.

Important!

I have done what I am going to describe next. However, before you put a plan like this in motion in your church, you need to consult with your attorney, have him or her research the charitable gift annuity regulations and reserve requirements for your state.

Let’s take a 75-year-old woman who wants to give $100,000 to her church in exchange for a life income. When she dies, whatever is left over after funding her income will go to the church.

I won’t go into why she may want to do this or the problems she has that this arrangement will solve. Furthermore, we’ll assume that a charitable gift annuity is the solution of choice.

A “normal” gift annuity that is sponsored by your national church would take the $100,000, set aside the required reserve, invest conservatively and pay out the annual rate suggested for her age by the American Council on Gift Annuities of 6.3%. These rates are actuarially calculated to leave about half of the initial gift to the charity at the life expectancy of the donor.

The church will have to wait until this woman dies to receive any benefit. Plus, I would check and see if the money goes to your national church or to your parish.

How can we provide the same income stream and an immediate benefit to your local church? Here are the numbers…

The cost to buy a SPIA on a 75-year-old female that would pay $6,300 a year as of the date of this post is $64,116. For the analyticals out there, this is a life only, no certain period annuity. That means the church can put $35,884 in the bank or endowment fund and use it in any manner desired.

One astute forum participant pointed out that some insurance companies will medically underwrite annuities. If the person has health problems and their assumed life expectancy is reduced as a result, the cost of the annuity is less.

I had a case several years ago where we were trying to fund a $3,000 a month life income on a woman age 88. The best bid for a traditional SPIA was $215,000. However, this lady had health problems. When I went to a carrier that medically underwrote the case, the bid dropped to $130,000, 40% less!

Every situation will be different. If I apply this 40% discount to my original example, the cost to the church to fund $6,300 a year for life via a SPIA drops to $38,470 and allows $61,530 to available for  immediate use.

Now let’s set up a plan at your church to put 6 figures in your bank account in the next 90 days.

First, check with your attorney to make sure this will work in your state.

Next, publicize the project. I would suggest having a specific goal in mind that has an emotional appeal to the congregation.

Let’s assume that this idea only applies to 2% of your membership. After all, it works best for donors over age 70. If you have a 500 member church, that’s just 10 people.

Using the non-medically reviewed SPIA example and cutting the donation in half to $50,000, each charitable gift annuity/SPIA transaction would raise about $18,000.

Ten donors times $18,000 is $180,000. And, hey, all you are looking for is 10 folks with a $50,000 CD with a crummy (and taxable) interest rate that would be interested in doubling their income and helping the church.

I realize this is all very sketchy, but there’s your 6 figures. Moreover, this all can be done in 90 days. I devote an entire lesson to this topic in The Smart Giver.

Christian Money Management: The Silver Lining In The Current Bad Economy

Every cloud has a silver lining. There are two sides to every coin. The knife cuts both ways.

The dire state of the economy has given rise to some of the best opportunities to make a gift to your church seen in decades.

Many gifts in the planned giving arena use the IRS’s current “Section 7520″ rate, commonly referred to as the AFR, in the calculation of the income tax deduction you receive as a result of your gift.

Just to give you some historical perspective, a couple of years ago, in March  2007, the AFR was 5.8%. A year later, in March of 2008, it had dropped to 3.6%. In February, 2009, it hit the lowest it has ever been since Sec. 7520 was put into effect in 1989: 2.0%. As I write this, March 2009, it is 2.4%.

What does this have to do with me you say? Let me give you a couple of examples.

Let’s say you are age 75 and have a $50,000 CD down at the bank paying 4%. This only spins off $2,000 a year in interest and the interest is taxable. If you are in the 15% tax bracket, that leaves you with $1,700 to take to the store and buy groceries.

You need more income. Hey, have you noticed the price of bread and milk today? You would not be opposed to increasing your income and helping your church at the same time. In meeting with your financial planner, she suggests you look at a charitable gift annuity. CGAs are pretty plain vanilla—they have been around for over 100 years.

Here is a quick summary of the benefits of using a CGA.

1. Your income will increase from $2,000 a year to $3,150.
2. The rules say you can use the February AFR of 2.0 even though you make your gift in March of 2009. This means that 78.7% of the $3,150 is not subject to tax. Bottom line: More money for groceries.
3. When you die, your church receives $50,000.

Let’s change the assumptions a little. Let’s say you were age 75 in March of 2000 and set up the same CGA when the Sec. 7520 rate was 8.0%. The amount excluded from tax would have been only 53.7%. 

Translation: With today’s low AFR, you pay less income tax and have more money for groceries.

 Another example on the other end of the spectrum. Let’s say you are a multimillionaire and are looking for ways to pass your estate on to your children with the least tax impact possible.

One option may be to use a charitable lead trust. The way this works is:

1. You contribute (generally income-producing) property to a charitable lead trust that your attorney drafts for you.
2. Your church (or another qualified charity) receives income from the trust for your life or a certain number of years.
3. When you die, or when the number of years has expired, the property is distributed to your children.

In a nutshell, given the current AFR, the payout percentage chosen and the number of years the payout will last allows the property to pass to the children at a lower tax transfer cost or even no cost at all.

There’s a lot more to it than that, but for our discussion let’s see how the current low Sec. 7520 rate makes the charitable lead trust more attractive than ever before.

Assume you funded the lead trust with $1,000,000 and set it up to pay 7% ($70,000) a year to your church for 15 years at which time the trust would end and the property dispersed to your kids.

If the AFR was 8% (as it was in Feb. 2000), after doing the math the taxable gift resulting in transferring $1,000,00 to the next generation is $295,040. That is a substantial savings.

However, if the AFR was 2%, the taxable gift would only be $100,549!

In fairness, I should point out that other planned giving vehicles, a lower AFR produces worse results.

I hope the take-a-way from this is that if you are a person who is interested in increasing your income, reducing your taxes, preserving your estate from undo taxation while simultaneously helping your church, it would be prudent to examine the various planning giving techniques which may apply to your situation.

If you represent a church and are interested in raising more money for your ministries and/or building an endowment fund so that eventually your church can finance its operations from the interest on the investments in your endowment fund instead of primarily relying on pledges, it would be wise to communicate and publicize the planned giving techniques that currently have high value due to the low AFR.

This is no small potato. During a planned giving seminar I attended in June of 2008, the attorney from the software company that I use to crunch the numbers indicated that the average lead trust that they consulted on in 2008 was $5,000,000.

If you are a church, I’ll leave you with this thought: A $5,000,000 lead trust that paid out 6% for 15 years would generate an annual income to your church of $300,000. Over the 15 years, it would add up to $4,500,000. If the $300,000 were put in your endowment fund and earned 6% for 15 years, it would grow to $7,400,000 (and change). $7,400,000 at 6% would spin off $444,000 a year forever.

What ministries do you have that could benefit?