Planned Gift Gone Bad....You Can't Make This Stuff Up

Planned Gift Gone Bad....You Can't Make This Stuff Up

Article posted in Charitable Remainder Trust on 11 August 2014| 10 comments
audience: National Publication, Two Hawks Consulting, LLC | last updated: 11 August 2014
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Summary

In this brief article, we seek your knowledge and advice on a tricky estate mess. Read on and reply.

by Randy A. Fox

Late last week I received a call from a colleague of mine, a planned giving officer at a large hospital in the southwestern part of the United States who presented me with the outline of a mess of a testamentary planned gift he was trying to save. There are number of issues that need to be resolved  and several I’m not sure how to fix but here’s the gist of the gift and if anyone has any ideas, let me know.

Husband and wife, both age 80. A number of years ago they decided they wanted to leave a significant gift to the hospital. There were significant IRA assets at the time, something in excess of $3 million. There were also significant assets in the estate for the surviving spouse but instead of leaving the IRA assets directly to the institution, they named a Charitable Remainder Annuity Trust (CRAT), with the spouse as the income beneficiary and the institution as the remainder beneficiary and trustee.

Here’s where it gets strange(r). The CRAT language calls for a fixed dollar payout ($145,000/yr), not a fixed percentage. Because of the market downturn and the fact that there have been ten years of Required Minimum Distributions, the balance of the IRA has declined dramatically to $1.3 million and the stated payout rate disqualifies the CRAT. Certainly this can be repaired with a reformation and the document apparently provides for that.

However, the glaring oversight is that the IRA to CRAT transfer is not a tax free rollover since the CRAT is not a qualified non-profit. Someone’s going to have to pay income tax, about $400,000 worth depending on the state.  This will leave only $900,000 to fund the CRAT and will probably BE a payment of $45,000-60,000 annually, far from the originally intended amount.

Observations:

  • If you’re going to set up a testamentary CRAT, use a fixed payout percentage because:
    • You don’t know how much money will remain
    • You don’t know how old the income beneficiary will be
    • You don’t know what the §7520 rate will be
  • Never use an IRA for this unless you calculate the income tax and account for it

Too many variables. Too many mistakes.

What a mess. Somewhere between bad communication and malpractice. Better solutions, anyone?

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Comments

Re: Planned Gift Gone Bad....You Can't Make This Stuff Up

Could they just go out and buy a commercial Annuity (I help people buy them for the benefit of Charities)
money is invested and pays income till they pass. Can be for both husband and wife???

Re: Planned Gift Gone Bad....You Can't Make This Stuff Up

I fear that eventually the trust will go to zero regardless; there's probably not enough market potential to recover the lost ground. Would it be possible to terminate the trust and establish a charitable gift annuity?

Re: Planned Gift Gone Bad....You Can't Make This Stuff Up

It should be noted that a CRT termination is an income taxable event.

Re: Planned Gift Gone Bad....You Can't Make This Stuff Up

You are correct that this is a possibility. But, this is more of an issue for the charity and not the CRT beneficiary. If, however, the beneficiary is relying on these CRT payments for their standard of living, and their stopping will have a significant financial impact, then this is a financial planning question for the beneficiary. As for the beneficiary still wanting to give to the charity, this can be fixed with new giving, either from the CRT payments as they are received or otherwise. Can other CRAT term adjustments be made? Maybe, but this is complex and expensive way to go, assuming that it is even a legal possibility. I would make sure expert legal counsel is involved if the parties wish to go with some type of modification.

Re: Planned Gift Gone Bad....You Can't Make This Stuff Up

The way I see it is that all is fine except for the issue of satisfying the 5% minimum annuity requirement, the 10% remainder requirement and the related, but different, exhaustion test. So, the issue is not creating a testamentary CRAT or using an IRA to fund it but how the CRAT annuity amount was worded, basically a set amount instead of a desirable formula that would adjust for the facts existing at that time to ensure CRAT qualification. To me, this is simply a matter of poor legal document drafting, likely done by an attorney or other drafter who did what the client wanted rather than really thinking about how it really needed to be done. The only fix that I am aware of is a qualified reformation (possibly along with a PLR) to correct the terms of the CRAT retroactively. Otherwise, the attorney may want to notify his E&O carrier.

Re: Planned Gift Gone Bad....You Can't Make This Stuff Up

But the issue IS that using an IRA to fund a testamentary CRAT is a horrible idea. Why would you force the entire asset to be taxed at income tax rates prior to establishing the income stream for the survivor? That is just bad planning, plain and simple.

Re: Planned Gift Gone Bad....You Can't Make This Stuff Up

Jason, funding a testamentary CRT (CRAT or CRUT) can be a good idea. Of course,having an IRA beneficiary as a trust of any type for the surviving spouse will speed up the required minimum distribution requirements, but with a CRT, this should not really matter. With a CRT, the taxable income is taxed only as it is distributed with the payments from the CRT. The CRT is a tax deferral device, and not a tax acceleration device. Again, the issue here is not the desire to have the IRA pass to a testamentary CRT, but rather the actual structuring and drafting of the CRT.

Re: Planned Gift Gone Bad....You Can't Make This Stuff Up

It was a good idea but not well thought out nor well executed. Many better ways to do this

Re: Planned Gift Gone Bad....You Can't Make This Stuff Up

This is a great article and example of not very good advice from all advisors to this donor couple. Just to clarify what you are suggesting that the IRA to CRAT transfer.... would be a tax free transfer if the CRAT was qualified would it not? In your example the CRAT would not qualify because it doesn't pass the 10% minimum and also because of the fixed dollar payout. Of course the income beneficiaries would have ordinary income from the payments but we know that to be true of all IRA assets. A qualified CRUT for the donor rather could be a much better outcome...correct?

Re: Planned Gift Gone Bad....You Can't Make This Stuff Up

Perhaps a CRUT would have been better. But the CRAT could have been ok if the document was prepared with more thought

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