by Gene Christian and Lon P. Dufek
March 1996
Volume VII, Number 3

With the combined effect of state and federal income, property, sales, capital gains, excise, use and estate taxation arguably at an all-time high, people (and their professional advisors) have become keenly aware of the need to do income, retirement and estate planning with tax considerations at the forefront.

We hear rumblings in Washington that our tax system may be changing–maybe even dramatically–during the next few years. Proponents of flat tax, national sales tax, value added tax and other plans are sending up “trial balloons” to get a sense for the public’s willingness/tolerance to support these various positions. However, very little discussion appears to involve estate and gift tax rates–the most onerous in the code. It may be that the amount of the estate allowed to pass tax-free is increased, but estate and gift tax rates will likely remain unaffected.

Since most Americans dislike paying taxes even more than standing in line, clearly there is a window of opportunity to help the charity’s closest and wealthiest friends (and the professionals who advise them) understand their charitable estate planning options. When high net worth individuals learn they can support their favorite charitable causes–in lieu of estate tax to the government–with a relatively modest interruption of what otherwise goes to the heirs, powerful partnerships can be formed.

One such partnership involves “tandem trust” estate planning, i.e., a charitable remainder trust (CRT) and a charitable lead trust (CLT) created on a testamentary basis as the centerpiece of the overall estate design. When the wealthy individual passes away, the remaining estate can be divided between a CRT and CLT. The idea is to provide income streams to the family and charity and then lump sums to each, respectively, when the terms of the trusts expire.

In the following example, we’ve assumed a single person or surviving spouse with a $10,000,000 estate. In utilizing what we term the “tandem trust” plan, we assumed a section 7520 rate of 7.0 percent (sometimes referred to as the applicable federal rate or “Rate of the Month”), a 10 percent charitable lead annuity trust and a 6.25 percent charitable remainder unitrust each at $4,000,000 for 10 years with each trust return assumed to be 10 percent. Estate settlement charges will further reduce the taxable estate, although we have not factored them in for this illustration.

If the heirs inherit the estate outright, the estate tax on $10,000,000 will be $4,958,000. Thus, after taxes, the heirs will inherit only $5,052,000. Note: Charitable organizations receive “zippo” in this estate plan.

If, however, the estate plan is written so that $4,000,000 is transferred at death to a 10 percent charitable lead annuity trust for a period of 15 years and another $4,000,000 is transferred to a 6.25 percent charitable remainder unitrust with income to the family for the same period, the estate tax burden is slashed to $2,000,000 as depicted in Table A.

The tandem trust plan, as you will note, is really quite powerful. This kind of estate plan can resonate with wealthy individuals because it controls and helps to protect the inheritance for loved ones. Many wealthy people are concerned about their heirs receiving too much inheritance too soon. In fact, based on the numbers above, the family’s inheritance is decreased minimally because of the substantial reduction in estate taxes. At the same time, the results for charity are enormous. It is also straightforward. Beyond the settlement costs typically associated with an estate, two trusts are created on a testamentary basis. Trust administration duties must be performed in addition to annual accounting, both of which have costs associated with them. However, this is a small price to pay relative to the estate tax which would otherwise be due.

And it is simple. As people think about ways to minimize estate taxes, there are a precious few options to consider. One option would be to create a private foundation or establish a donor-advised fund within a public foundation. However, some people would rather not create their own organizations complete with staff/advisors, budgets, annual tax filings, reporting and so forth simply as a way to avoid estate tax.

A second option would be to create a very long, very large, testamentary lead trust similar to what Jackie Onassis did in her estate plan. The obvious objection to this type of plan is that the heirs must wait until the term of years expires before they receive any inheritance.

A third option would be to create a charitable remainder trust, either on a current or testamentary basis, while in addition creating a wealth replacement or life insurance trust for their heirs. This is a common planning approach, but it is sometimes criticized because the vast majority of an estate must be “tied up” in the CRT and unusually large sums of life insurance purchased in the process. Certainly, the life insurance trust planning technique could be combined with the tandem trust plan to produce very favorable results—even possibly resulting in the elimination of estate tax.
Finally, then, the tandem trust estate plan may have the least “downside” overall. It allows the high net worth individual to avoid creating his or her own organization…or postpone an inheritance to heirs for many years…or currently tie up large portions of his or her estate…or purchase large amounts of life insurance (although a more modest amount may be desirable). And, the term of years and payout rates for each trust can vary depending on the unique circumstances/needs each particular individual has. For instance, a client may consider creating two CRTs, one for 10 years and one for 15 years, and then two lead trusts for the same time periods (a “layered trust” approach), to achieve their objectives.

Note: Certainly these options are not mutually exclusive from one another and can be used in combination to achieve the client’s objectives.

Regardless, this type of planning is a relatively simple way to protect and control an inheritance for loved ones, all the while creating a tremendous reservoir of support to the charitable cause(s) for which the donor has a heartfelt desire to support…mostly at the expense of sending dollars to Washington.

Gene Christian is charitable estate and tax advisor for St. Vincent Medical Center in Portland, Oregon. He is an executive member of the Northwest Planned Giving Roundtable and the 1996 program chair for its annual conference.

Lon P. Dufek is vice president of Comdel Inc. in Camarillo, California. From 1976-89, he held various positions with the Baptist Foundation of Arizona. He is a CPA and CFP.