Charitable Lead Annuity Trusts, or CLAT trusts, have become a popular method for individuals to minimize their Federal Estate Tax bill. Sometimes referred to as “Jackie O” trusts after the former First Lady Jacqueline Kennedy’s will called for one upon her death in 1994, these trusts have the ability to transfer money tax free to heirs.
Here is how it works. A donor places money into a charitable lead annuity trust, or CLAT trust, for a defined period of time, say 15 or 20 years. The donor defines how much will be distributed each year to charity for the life of the trust and whatever is left over is transferred to the designated beneficiary tax free. The degree by which CLAT trusts save the donor Estate Taxes depends on the prevailing Treasury Interest Rates at the time that the trust is created. Currently US Treasury Rates are at historic lows.
When a donor sets up a CLAT Trust the IRS assesses how much estate tax would be due based on the amount designated to go to the remainder beneficiary or heir. Most CLATs are setup so the heir’s estimated remainder is zero. The amount of money initially placed in the trust is then plugged into an IRS formula. This formula is based on the prevailing US Treasury Interest Rates.
If the trust’s investments outperform the IRS’ benchmark rate then the extra earnings pass to the designated heirs free of any estate tax. For CLATs created this month the IRS benchmark rate is 1.4%. That means that any outperformance of the trusts investments above and beyond a 1.4% return would pass to the donor’s heirs tax free. With a large enough spread between the IRS benchmark rate and actual performance, families can end up transferring more wealth to heirs than they would have been able to even after they have given to charity.
A drawback to CLAT trusts are that they lock up money for years. They are most attractive for people wishing to make gifts to a different generation. One example would be a grandparent wishing to set up a gift for a grandchild to receive once they reached 18 years of age.
The author, Joe Pioletti, is a trust attorney with Pioletti Pioletti & Nichols in Eureka, IL, 309-467-3213.