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How charitable lead trusts work

A senior couple going through their paperwork together at home
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Trusts can be powerful estate management tools. They can provide an effective way to transfer money, property or other assets to beneficiaries efficiently and often in a tax-friendly way.

There are many types of trusts, each with a unique set of benefits and features. For instance, a charitable trust can help you directly support your most cherished causes as well as your loved ones. More specifically, a charitable lead trust allows you to give back to organizations and communities you care deeply about and make a financial difference while you are still alive to see the impact.

This is a way in which you can live and leave a legacy. Here's a look at how charitable lead trusts work and what you need to know before creating one.

How does a charitable lead trust work?

To establish the trust, the donor funds the trust with assets, such as cash, securities or property. You define the time period that the trust will last, such as for your lifetime or a set number of years. The trust then makes regular payments from the assets to one or more charitable beneficiaries for the time period specified in the trust documents.

There are two ways to calculate the dollar value of the regular payments made to a charity:

  • Charitable lead annuity trust. With a CLAT, payments are based on a fixed dollar amount that is established when the trust is formed.
  • Charitable lead unitrust. With a CLUT, payments are not based on fixed dollar amounts. Instead, they are recalculated each year as a fixed percentage of the current value of the trust assets.

Once the designated length of time passes, any assets that remain are then returned to the original donor or distributed to the donor's noncharitable beneficiaries, often their family members or other loved ones.

You may think of it as the opposite of a charitable remainder trust in that you support the charity first and then your loved ones rather than receiving income before supporting the charity.

Advantages of a charitable lead trust

Now that you understand what charitable lead trusts are and how they work, here are some of the benefits that they can provide.

You can make a meaningful impact

One of the greatest benefits of this kind of arrangement is that it allows you, the donor, to experience first-hand the positive impact you create. It enables you to see the benefits of your charitable donation as the organization uses the funds during your lifetime. However, it also allows you to establish a legacy that will last long after you're gone.

Additionally, creating a charitable lead trust can help reduce the final value of your estate and reduce your tax liability, allowing you to pass more wealth to your heirs.

You may experience tax advantages

When you establish a charitable lead trust, you'll designate it as either a grantor or nongrantor trust. This designation affects the tax treatment of both the donated assets and the income the trust generates.

  • Grantor trust. The donor is able to claim an immediate charitable donation income tax deduction for the assets placed within the trust. The value of the deduction is the present value of payments the lead beneficiary is expected to receive for the duration of the trust term, subject to IRS limits. Any income generated by the trust is reported on the donor's personal tax return and taxed at the appropriate rate.
  • Nongrantor trust. No immediate charitable donation income tax deduction is available for the donor when assets are placed within the trust. The grantor also does not incur a personal income tax liability on trust income. Instead, the trust files its own tax return and is liable for any income tax. The trust is able to claim a tax deduction for the value of any payments made, so it's not likely to have an income tax liability as long as it pays out the income earned during the tax year.

Passing on wealth to your heirs

By providing potential tax benefits, charitable lead trusts can be a way for you to pass more wealth to your heirs. The particular structure of your trust will determine specific tax treatment, but you may be able to reduce estate and gift taxes when the assets pass to remainder beneficiaries.

For example, a "zeroed-out" charitable lead annuity trust generally will produce a higher payout to the charities, but the full remainder at the trust termination passes to the beneficiaries both gift and estate tax-free.

If wealth transfer is important to you, your financial advisor can provide options that are appropriate for your situation.

Disadvantages of a charitable lead trust

Various trust structures are right in different situations. It's important that you carefully consider the drawbacks in addition to the benefits of any type of trust as they relate to your unique set of circumstances and your estate strategy. Here are some of the main advantages and disadvantages of a charitable lead trust:

They are irrevocable

You cannot take back assets after they've been transferred to the trust because it's irrevocable. This also means it is inflexible once established. You cannot terminate the trust or change its terms once it is in force.

They are subject to market risk

You can invest the assets held within the trust in an effort to increase their value. However, all investments are subject to risks. You may have reduced remainder interest left to your heirs depending on how well the investments perform and the size of the payouts to lead beneficiaries.

The interest is not tax-exempt

Income earned on assets held by charitable lead trusts is not tax-exempt, which may not be the case with other types of trusts you might opt for. You need to be mindful of the tax implications of income earned by the trust.

Is a charitable lead trust right for you?

You'll want to consider the different types of trusts available to you, factoring in your current financial situation and charitable goals. You may find that this type of trust, which allows you to directly support one of your favorite causes and your beneficiaries, is a good option.

Trusts are complex and need to be structured correctly to provide the desired benefits. Connect with a local financial advisor and your tax advisor for insight into how a charitable lead trust could be part of your future plans and for help setting one up. While Thrivent does not provide specific legal or tax advice, we can partner with you and your tax professional or attorney.