Think of a Charitable Lead Trust (CLT) as the opposite of a Charitable Remainder Trust. With a CLT, the money stream flows to charity now, while your children or grandchildren wait until later. During the waiting period, the trust invests and (we hope) grows. When the term ends, whatever is left—often more than you started with—moves to your heirs, and much or all of that transfer may escape gift and estate tax.
How a Basic CLT Might Look
- You transfer $3 million of growth stock into the trust.
- The trust pays your chosen charity $150,000 every year for ten years.
- At year 10, the remaining balance—let’s say it has grown to $3.7 million—transfers into a family trust for your children.
The charity enjoys steady funding for a full decade, and your children receive any surplus value with potentially little or no additional transfer tax.
Two Easy CLT Styles
1. Charitable Lead Annuity Trust (CLAT)
A CLAT pays the same dollar amount to charity every year, making it a good option for organizations that rely on predictable funding.
Best for: Donors who want the charity’s payments to remain consistent and predictable.
2. Charitable Lead Unitrust (CLUT)
A CLUT pays a set percentage of the trust’s value, recalculated each year. Payments can rise or fall depending on market performance.
Best for: Donors who are comfortable with flexible payments and hope that investment growth will result in larger charitable gifts.
The “Zero-Out” Move
Some families structure the annual charitable payments so that, using IRS interest-rate assumptions, the calculated value of the remainder passing to heirs is approximately zero for gift tax purposes when the trust is established.
If the trust earns more than the applicable IRS Section 7520 rate during its term, the additional growth may ultimately pass to the family with little or no additional gift or estate tax.
This strategy is essentially a bet on long-term investment performance—and one that can be attractive when the trust’s investments outperform the applicable IRS rate.
Grantor vs. Non-Grantor: Which Fits You?
Grantor CLT
A grantor CLT may provide an upfront income tax deduction, subject to applicable limitations. This can be attractive in a year when you have a significant taxable event, such as selling a business. However, you generally must report the trust’s income on your personal income tax return during the trust’s term.
Non-Grantor CLT
A non-grantor CLT generally does not provide the donor with the same upfront income tax deduction. Instead, the trust files its own income tax return and may claim deductions for qualifying charitable payments, subject to applicable tax rules.
This structure may simplify the donor’s personal income tax reporting while still providing potential estate and gift tax benefits.
Investing Inside the Trust: The Two-Bucket Plan
Many trustees organize the portfolio around two primary objectives:
Bucket 1: Income and liquidity assets
Bonds, dividend-paying stocks, and other income-producing investments can help provide the cash needed to make charitable payments on schedule.
Bucket 2: Growth assets
Broad-market index funds, private equity interests, and other growth-oriented investments may help the trust pursue returns above the applicable IRS hurdle rate, potentially increasing the remainder available to the family.
This two-bucket, or “barbell,” approach seeks to balance the trust’s charitable obligations with the goal of growing the assets that will eventually pass to heirs. Investment decisions must remain consistent with the trustee’s fiduciary duties and applicable prudent-investor standards.
Key Advantages in Everyday Words
Immediate charitable impact: Your favorite cause receives funding now rather than waiting decades for a future gift.
Potential estate and gift tax savings: The value of the future interest transferred to heirs may be discounted for gift tax purposes, potentially allowing additional appreciation to pass to the next generation with reduced transfer taxes.
Family harmony: Children know how long they must wait and what they may eventually receive, helping establish expectations and potentially reducing future disputes.
Common Questions About Charitable Lead Trusts
What if the market tanks?
The trust’s charitable payment obligations generally remain in place even if investments lose value. The family remainder may shrink substantially, and depending on the trust’s terms and investment performance, there may be little or nothing left for heirs.
Can I choose more than one charity?
Yes. The trust document can identify multiple charitable beneficiaries or authorize the trustee to divide the annual payments among different organizations, subject to the trust’s terms.
Do my children pay income tax when they receive the remainder?
The tax treatment depends on the trust’s structure and the assets distributed. Beneficiaries may receive assets with accumulated income or other tax attributes that affect their tax obligations. The amount of income distributed to charity during the trust’s term does not, by itself, guarantee that the remainder will be free of income tax.
The Bottom Line
A well-designed Charitable Lead Trust can help generous families support causes they believe in today while potentially transferring future investment growth to the next generation at a reduced gift and estate tax cost.
If you like the idea of “charity first, family later” and believe your investments may outperform the applicable IRS interest rate, a CLT may be worth serious consideration.
Because the tax consequences depend on the trust’s structure, funding assets, charitable payment terms, and investment performance, consult an experienced estate planning attorney and tax professional to determine whether a Charitable Lead Trust fits your family’s goals. To learn more, contact our office today!