College Fund Charitable Remainder Trust

College Fund Charitable Remainder Trusts

Š2000 through 2009 by Lorin Castleman, Esq.

The Castleman Law Firm
A Professional Corporation

5870 Stoneridge Mall Road, Suite 207
Pleasanton, CA 94588
(925) 463-2221
Fax: (925) 463-0328

An excellent, but little known, estate planning tool is a short term (no longer than 20 years) Charitable Remainder Trust (CRT) that is used to pay for a child's or a grandchild's college education.

These are the Benefits

The parent or grandparent who creates the trust (the donor) gets an income tax deduction
The assets of the trust are removed from the donor's estate, thereby decreasing estate tax.
If highly appreciated property is contributed to the trust, there is no income tax paid on the gain when the asset is sold.
The child receives payments from the trust that are used to pay for college expenses.
The payments received by the child are taxed at the child's income tax rate, not at the (usually) higher tax rate of the parents.
The college (or any other charity chosen by the donor) receives a significant contribution when the trust ends.
The trust does not provide a disincentive to the child, because there will not be a pot of money waiting for the child when he or she graduates.
The "pot" goes to the charity chosen by the donor.
If the trust is established before the child is ready to go to college, the value of the trust can grow tax free, thus building up a larger fund from which to pay for college expenses.

These are the Disadvantages

The trust is irrevocable. The terms of the trust cannot be changed (although the eventual charitable recipient can be changed by the donor if the donor is not the trustee).
The asset or money contributed to the trust cannot be used or retrieved by the donor.
Unless payments are made to the child beginning with the first year the trust is established, the value of the child's income interest will be subject to gift tax.
The child could use the payments received for something other than college expenses. However, built-in "incentive penalties" can lessen the chance of this happening, or the payments can be made to a different trust managed for the benefit of the child. Alternatively, the donor can terminate the child's income interest, and distribute the principal to the charity early.

Here Are Two Examples of How a CRT for College Expenses Works

Example One: Trust Established in Year Child Begins College

Parent establishes a charitable remainder annuity trust in the beginning of the year when Jill will go to Uphill College. Parent contributes $200,000 of appreciated stock, which is paying no dividends, to the trust. The stock has a basis of $75,000. When the trust sells the stock, and converts it into a balanced portfolio, the trust pays no income tax on the gain.

Although the trust could last for any number of years from one to twenty, parent chooses a four-year term to coincide with a typical four-year college program.

Each year, Jill will receive a $30,000 payment from the trust (assuming a 15% annuity trust pay out). When the trust ends, the college or a charity chosen by parent will receive approximately $113,000 (assuming that the trust has an annual return of 6%). When parent creates the trust, parent gets a charitable income tax deduction of around $84,000. Also, the income tax paid by Jill on the money she receives will be much less than the tax that would have been paid by parent. If parent wants to put some incentives in the trust to encourage Jill to get good grades, attend full time, and stay off of drugs, parent can include a provision that her income interest will terminate early if she fails to meet the standards set out in the trust.

Because parent gives up ownership of the assets that are contributed to the trust, the trust assets are not part of her estate. Thus, her estate taxes are reduced.
In this example, $13,000 of the annual payments from the trust to Jill will qualify for the annual gift tax exclusion, so the gift tax cost is reduced. If the trust is established by husband and wife, $26,000 of the annual payments will qualify for the annual gift exclusion. It is important to note that the gift tax exclusion only works when the payments to the child begin the same year the trust is created.

The example just given is an example of a short-term charitable remainder annuity trust, because the amount paid to Jill each year is a fixed amount. Parent could have created a trust that would have paid out up to $46,600 each year to Jill, but the charitable income tax deduction would have to be lowered to $20,000, and the charity would receive only $20,000. The trick is to find the right combination of the annual payment to the child and the amount of the income tax deduction.

Example Two: Trust Established Several Years Before Child Begins College

Parent establishes a charitable remainder unitrust when Jack is eleven years old. Because parent anticipates that Jack will start college when he is 18 years old, and will graduate when he is 23, parent sets the trust term for 14 years, so that he will receive an extra payment after he graduates. The payments to Jack will be delayed until he begins college.

Parent contributes $200,000 of appreciated stock, which is paying no dividends, to the trust. The stock has a basis of $25,000. When the trust sells the stock, and converts it into a balanced portfolio, the trust pays no income tax on the gain. During the first seven years of the trust, it invests solely in growth stock that pays no dividends. In the eighth year, the trustee sells the growth stock, and invests in a balanced portfolio.

The trust is designed so that it will pay little or nothing to Jack during the first seven years. Beginning in the eighth year, and continuing until the trust terminates, he will receive an amount equal to 15% of the value of the trust assets, determined annually. In this example, those payments will total about $219,000. (The payments for each year, beginning with the first year they start, would be about: $45,000; $39,000; $34,500; $30,000; $26,500; $23,000; and $20,000. (They decrease each year, because the value of the trust is decreasing, since some of the principal is being used to make the payments to Jack.)

When the trust ends, the college or charity chosen by parent will receive about $118,500 (assuming that the trust has an average annual return of 6% until distribution starts, and 3% after distribution begins). When parent creates the trust, parent gets a charitable income tax deduction of about $20,500. As is the case with Jill, the income tax paid by Jack on the money he receives will be much less than the tax that would have been paid by parent. Parent can put the same incentives in the trust as parent did for Jill.

Parent gets the same estate tax benefit as in Jill's case, but the annual gift tax exclusion is not available, because Jack does not start receiving immediate payments.

The example just given is an example of a short-term charitable remainder unitrust. Notice that there will be a significant difference in the amount of the charitable income tax deduction, depending on the type of trust used and the size of the distribution to the child.

Conclusion

The above two examples are obviously hypothetical cases. Each case must be planned carefully, and each case will be different. Short-term charitable remainder trusts should be compared to state supported "section 529 plans." in some cases, the use of the CRT will produce a better result for the family than a section 529 plan. A CRT for education is an excellent way to obtain an income tax deduction, reduce estate tax, provide for a child's education, and make a significant contribution to society.

Š 2000 through 2009 by Lorin Castleman, Attorney-at-Law. All rights reserved.

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