Establishing this type of trust could make sense if you’re interested in using your assets to fund good causes during your lifetime while ensuring a smooth transfer of wealth to your heirs after you’re gone. There are some pros and cons involved, and it’s important to understand what it means to be a beneficiary of a charitable lead trust.
Definition and Example of Charitable Lead Trust
A charitable lead trust is a type of trust in which assets produce income for one or more named charities and then the assets are passed on to the trust beneficiaries once the grantor dies. In simpler terms, a charitable lead trust allows you to use income from your assets to fund charitable causes, then leave those assets to your beneficiaries later on. Charitable lead trusts can hold different types of assets, including:
Publicly traded securities Real estate Business interests Private company stock Cash
Say that one of your favorite charities is the National Gallery of Art. You could set up a charitable lead trust to hold part of your estate. The National Gallery of Art would receive income from the trust for a set number of years and, after that, the assets in the trust would be distributed to the beneficiaries.
How a Charitable Lead Trust Works
The process for establishing a charitable lead trust is similar to establishing any other type of trust. The basic steps include:
Creating the trust on paper (usually with the help of a financial advisor or estate planning attorney) Naming a trustee, who acts as a fiduciary in managing trust assets Determining which assets should be held in the trust Transferring ownership of those assets to the trustee Specifying the terms of the trust, including how much income is to be paid out and to which charities Naming one or more beneficiaries
The trust has a set expiration date that’s determined by the trust grantor or maker. During the initial part of the trust term, income generated by the trust is paid out to one or more named charities. Once the trust expires, the assets—and the income they produce—would then be passed on to trust beneficiaries. Here’s a more detailed example. Say that your estate is valued at $10 million. You want to earmark $2 million in assets for a charitable lead trust to support the National Gallery of Art. With the help of your attorney, you create the trust, specifying that the Gallery will be the beneficiary for a period of 10 years, receiving a payment equal to 10% of the trust’s assets each year. At the end of the 10 years, the assets in the trust are to be divided equally between your two adult children.
Pros and Cons of a Charitable Lead Trust
Charitable lead trusts can offer both advantages and disadvantages for their creators and beneficiaries. Before investing time and effort into creating one, it’s important to understand what they can (and can’t) do for you.
Pros Explained
Support charitable causes that are important to you: A charitable lead trust allows you to fund causes that you support and believe in during your lifetime and beyond. Preserve a legacy of wealth for future generations: This type of trust also makes it possible to pass on assets to your children, grandchildren, or other heirs in a time frame that you feel comfortable with. Minimize estate taxes for your heirs: Charitable lead trusts can yield tax benefits, including an income tax deduction for charitable donations and reduced estate and/or inheritance taxes for beneficiaries.
Cons Explained
Transfer of assets is irrevocable: Once you transfer assets to a charitable lead trust, you can’t reverse that decision, so it’s important to be sure that this type of trust is right for your situation. Establishing and maintaining the trust can be costly: Creating a charitable lead trust can be a complex and time-consuming process, which may require the help of one or more attorneys. The trustee is also entitled to a fee for their services. Assets for beneficiaries may be diminished over time: Allocating too many trust assets or too much of its income to charitable causes could shrink the value of the estate passed on to your beneficiaries later.
Do I Need a Charitable Lead Trust?
A charitable lead trust could make sense for your estate plan if you want to donate money to charity while still being able to pass assets on to your beneficiaries in a tax-advantaged way later. Generally speaking, the larger your estate, the greater the tax benefit could be, depending on how long the trust pays your designated charity or charities and the amount that’s paid.
Once your heirs receive assets from the trust on the date specified by the trust terms, they would not be responsible for paying tax on that income. Assuming the assets in the trust perform well, this could help to increase the value of the estate passed on, even as income is being paid out to various charities. That’s a win-win scenario if you happen to be the beneficiary of this type of trust. If you have a smaller estate, on the other hand, then you may not get as much value from a charitable lead trust, in terms of tax benefits. Comparing the cost and time involved in setting up and maintaining this type of trust against the potential tax savings can help you decide if it makes sense for you.
