Is There a Silver Lining to the Current Financial Doldrums?

Is There a Silver Lining to the Current Financial Doldrums?
By John A. Gram, Attorney, Whelchel, Dunlap, Jarrard & Walker, LLP
 
In spite of (or perhaps because of) the 2008 stock market collapse, followed by what appears to be, if not a double-dip recession, a prolonged period of unfamiliar financial territory where interest rates are virtually zero for risk-free investments, charities are still in need of financial support and many of us are still interested in estate planning. One seldom-used planning technique that is attractive today because of the continued low interest rate environment is referred to as a "shark-fin CLAT (charitable lead annuity trust)."  A CLAT is the conceptual opposite of a charitable remainder annuity trust ("CRAT").  In a CLAT, a charity receives the income for a term of years and at the end of the term the assets revert to the donor or, in the more typical case, to the donor's children or grandchildren, with the idea being to both assist charity and to pass assets to family members with less gift tax than an outright gift.  A CRAT has diminished attractiveness when the deemed federal interest rate is low, but a CLAT is more attractive at such times.
 
            The interest rate used for calculation of these charitable split interest gifts is referred to as the Section 7520 rate, published monthly, equal to 120% of the federal midterm rate, derived from comparable Treasury obligations.  In funding a CLAT the donor is allowed to use the rate during the month in which the valuation date falls (the date of the transfer to the CLAT) or for either of the two months preceding the month in which the valuation date falls.  This allows you to lock in a rate while setting up the CLAT.
 
            The Section 7520 rate hit a historic low in February 2009 of 2.0%.  It went up somewhat from that, but never anywhere near the historic median rate, which has been a bit over 6%.  The rate for September 2010, when this article was submitted, was back down to 2.4%, the low for the year 2010 and the prospects do not appear too great for a quick and/or extensive increase in this rate.
 
In June 2007, the IRS published model CLAT forms that permit fluctuation in the annuity payments to charity during the term of the CLAT, allowing the planner to back-load the annuity, which makes a CLAT more attractive for an asset that you expect to appreciate but do not know exactly when it will appreciate and/or be sold.  The shark-fin CLAT gets its name by picturing on a graph the abrupt increase in the annuity rate after years of virtually nothing with a balloon at the very tail end.  The higher the charity's annuity and/or the longer the term that the non-charitable beneficiary has to wait to receive the funds, the greater the value of the charitable portion of the donation and the lesser the value of the gift to the family members.  These techniques can often be used to entirely eliminate the gift element.  Once the rate applies to a transaction the rules assume that rate will remain in effect whereas most people recognize that rates go up and down.  A low Section 7520 rate coupled with a greater annuity equals a low or zero gift.  The key is that the trust can out perform the 7520 rate when it is so low.
 
            Think in terms of the fruit versus the tree analogy.  Low yields mean low Section 7520 rates.  With a CRAT the donor gives away the tree and retains the fruit, while with a CLAT the donor gives away the fruit while retaining the tree.  Think of today's investment climate in terms of a strong tree but a low yield or poor fruit.  Giving away the fruit makes more sense than giving away the tree under these assumptions.  Although charities, including the Medical Center Foundation, would prefer to have a steady stream of gifts, economic modeling has shown that the ability to transfer wealth to family members has better odds by using the balloon or shark-fin strategy.

This bulletin provides a general summary of recent legal developments. It is not intended to be and should not be relied upon as legal advice.