What Are Charitable Lead Trusts?
Are you looking for a smart way to support the causes you care about while maximizing your family’s long-term wealth? If you’re a high-net-worth individual aged 45 or older, you’ve likely explored different philanthropic strategies- from direct cash donations to donor-advised funds. However, an often under-utilized but highly effective tool exists that can help you realize both charitable and financial objectives: the charitable lead trust (CLT).
In this article, we’ll discuss the key features and benefits of planning with charitable lead trusts. We’ll also outline the differences between grantor and nongrantor CLTs, describe how low interest rates and asset selection impact your strategy, and explain how Falcon Wealth Planning can support your charitable giving goals.
What Is a Charitable Lead Trust?
A charitable lead trust is a specialized trust arrangement that splits benefits between a charitable organization and a noncharitable beneficiary (often the donor or the donor’s family). In a CLT, the charity receives payments—either an annuity or a percentage of the trust’s value—over a set term, and once that term ends, any remaining assets pass to the noncharitable beneficiary.
Two Main Types of CLTs
Charitable Lead Annuity Trust (CLAT):
The charity receives a fixed annual payment, regardless of how the trust assets perform.Charitable Lead Unitrust (CLUT):
The charity receives a set percentage of the trust’s value each year, which can vary depending on investment performance.
Either way, the trust must be created to ensure the charity receives “the lead” payments over the trust term, and your beneficiaries receive whatever is left at the end.
Why Consider Planning With Charitable Lead Trusts?
For high-net-worth individuals, CLTs offer a unique way to achieve multiple goals:
Charitable Giving
You can support your favorite nonprofits or foundations over several years, allowing these organizations to rely on a steady stream of funding.Tax Efficiency
Depending on how the CLT is structured, you can potentially secure significant income or estate tax benefits.Wealth Transfer
Any remaining assets in the trust after the charitable term ends can pass to your loved ones at a reduced—or sometimes even zeroed-out—tax cost, thanks to the way these trusts are valued.
Grantor vs. Nongrantor Charitable Lead Trusts
From a tax perspective, there are two ways to structure a charitable lead trust: as a grantor trust or as a nongrantor trust. Each approach offers its advantages and drawbacks, which we’ll break down below.
Grantor CLT
How It Works: You, as the donor, retain the trust’s tax liability.
Key Benefit: You receive a sizable income tax deduction up front, equal to the present value of the income stream designated for the charity.
Ongoing Responsibility: You pay taxes on the trust’s income each year—even though those earnings go to the charity.
Risk to Consider: If you die before the trust’s term ends, there is a “recapture” rule. Part of the initial deduction can be added back to your final taxable income, which may reduce some of the early tax advantages.
A grantor CLT can be ideal if you have especially high taxable income in the year you set up the trust and anticipate being in a lower tax bracket in subsequent years.
Nongrantor CLT
How It Works: The trust itself is a separate taxpayer, and you do not claim the initial charitable deduction.
Key Benefit: The trust can claim an unlimited charitable deduction for the amounts paid to charity. That means little or no taxable income remains within the trust if the payments match the trust’s income level.
Wealth Transfer Advantage: Assets inside the trust are generally removed from your estate, potentially saving a large amount on estate taxes over time.
Nongrantor CLTs are often favored by donors who do not need a personal charitable income tax deduction but want to shield future trust income from personal tax liability.
Taking Advantage of Low Interest Rates
One of the biggest benefits of planning with charitable lead trusts arises when interest rates are low. A lower IRS “hurdle rate” (often referred to as the Sec. 7520 rate) makes it easier for investments inside the trust to outperform the assumptions used to calculate the value of the trust’s remainder. If the trust’s assets grow faster than that hurdle rate, any excess growth effectively transfers to your beneficiaries free of additional gift or estate tax.
For Example…
Imagine you contribute $10 million to a 10-year charitable lead annuity trust. The trust promises $1 million a year to your favorite charity. If the interest rate is very low—for example, 1%—the present value of those charitable payments is very high, lowering the taxable value of what your family eventually receives. If the trust’s investments grow beyond 1%, that “extra” growth can go to your heirs with minimal additional tax.
Choosing the Right Assets for Your CLT
Selecting which assets to fund your CLT with can be just as important as choosing the trust type. The best assets often have:
High Appreciation Potential: Stocks or real estate that you believe will significantly increase in value over time.
Steady Cash Flow: Making fixed annuity payments requires cash flow or liquidity—especially important in a CLAT. If you rely on in-kind distributions to satisfy payments, you could trigger capital gains inside the trust.
By transferring assets you anticipate will rebound from depressed values or are primed for strong growth, you amplify the tax-saving and wealth-transfer benefits of the trust.
Strategies to Prevent Early Exhaustion of Assets
With a CLAT, the annuity payment is fixed each year. If the trust’s assets underperform, you may risk depleting the trust before the term is over. One strategy is to structure the payments so they increase over time. Smaller payments in the early years help preserve capital, giving the trust more time to build value through investments.
“Shark Fin” CLAT: A more aggressive option, where the largest payment occurs toward the end of the trust term. This front-loads investment growth potential but can be more complex, and the IRS has not fully endorsed such steeply back-loaded payments.
Testamentary Charitable Lead Trusts
You can also arrange a charitable lead trust to begin at death. This is known as a testamentary charitable lead trust, often created through your will or living trust. If your estate exceeds the federal estate tax exemption, a testamentary CLT can help you reduce or eliminate estate tax.
Essentially, any portion of your estate above the exclusion amount can go into a zeroed-out charitable lead trust, receiving a dollar-for-dollar estate tax charitable deduction. At the end of the charitable term, your heirs would receive the remainder of the trust. This approach works particularly well for individuals with larger estates who still want to benefit both charitable causes and family members.
The GST Tax Twist
For grandparents wishing to leave assets to grandchildren (or other skip persons), the generation-skipping transfer (GST) tax adds another layer of complexity. If GST tax savings is a priority, a charitable lead unitrust (CLUT) often works better than a charitable lead annuity trust (CLAT). The rules for applying GST exemption in a CLAT can prevent you from fully leveraging your GST exemption until the end of the trust’s term, sometimes resulting in an unexpected tax bill or unused exemption.
How Falcon Wealth Planning Can Help
Falcon Wealth Planning specializes in helping high-net-worth individuals and families integrate advanced estate and tax planning strategies into their overall financial plans. Our advisors understand that planning with charitable lead trusts is a deeply personal decision, one that requires balancing your philanthropic values with your desire to provide for your loved ones.
Our Process
Discovery and Goal Setting: We begin by learning about your charitable interests, family dynamics, and long-term financial goals.
Customized Strategy: We then evaluate which type of CLT—grantor or nongrantor—best suits your tax situation and philanthropic objectives.
Asset Selection and Funding: We work with you to identify which assets have the best potential for growth and liquidity in a CLT.
Ongoing Monitoring: We remain actively involved, coordinating with your attorneys, CPAs, and estate planners to ensure your trust operates as intended.
Ready to learn more about how Falcon Wealth Planning can optimize your charitable giving and wealth transfer? Contact us today to schedule a no-obligation consultation and begin your journey toward a more impactful legacy.
*The content in this blog is for general informational purposes only and does not constitute personalized financial, investment, tax, or legal advice. Falcon Wealth Planning, Inc., a fee-only, true fiduciary, registered investment advisor, provides this information to give a broad understanding of financial concepts and strategies.