A Young Millionaire... What to do with All That Money?
Case:
Beatrice McClaren, Executive Vice President of the local bank, made a gift to her daughter, Katrina, under the Uniform Gift to Minors Act. The gift consisted of 1,000 shares of stock in the bank where Beatrice is employed. Initially, the stock was worth only $10 per share, for a total transfer value of $10,000. Since the transfer was only $10,000, Beatrice used the annual gift tax exclusion and therefore no gift taxes were paid on the transfer. One of the main reasons for making the gift to her daughter is that any future appreciation in the stock would be shifted from Beatrice to her daughter, thereby reducing Beatrice's potential estate tax burden. Under the Uniform Gift to Minors Act, Katrina will receive the property from the custodian at age 21. Katrina is now age 18 and therefore the stock will be transferred to her in three years.Since Beatrice gave the stock to her daughter, the bank has done extremely well financially and the value of the stock has skyrocketed to $1,000,000. As a result, Beatrice is very concerned that transferring such a large amount of wealth to a 21-year-old would be detrimental to her daughter. Katrina and her mother are very close and Katrina highly respects her mother's advice and counsel. Beatrice has been very open about the value of the stock and would like to use its value to teach Katrina the value and importance of philanthropy. Since Beatrice has made major gifts and has volunteered extensively throughout her life, she would like to pass on this legacy to her daughter.
Question:
Beatrice has discussed with Katrina the possibility of using these funds to make a charitable gift when she, Katrina, reaches age 21. Also, Beatrice is concerned that a million dollars is an extraordinary sum to be made available to her daughter in one lump sum. She thought it would be wiser to provide Katrina with an income stream instead. What gift vehicles could be utilized by Katrina to fulfill these objectives?Solution:
Because Katrina will only be 21 years of age, she cannot fund a charitable remainder trust for her lifetime. The 10% minimum deduction test for charitable trusts, which became law through the Taxpayer Relief Act of 1997, precludes Katrina from setting up such a trust. However, even though a lifetime trust cannot be utilized, a term of years charitable trust is a viable alternative. A deferred payment gift annuity is also an option for Katrina.In meeting with Beatrice's financial advisors (and with Katrina's consent, of course), they devised the following plan: At age 21, Katrina would fund a 20-year charitable remainder unitrust (CRUT) with $500,000 of the stock. The trust payout would be set at 5% which will allow for substantial growth over the term of the trust. The other $500,000 would be used to fund a deferred gift annuity with a deferral period of 20 years. The deferred annuity payout would be $29,500. Therefore, she would receive payments beginning at $25,000 per year from the CRUT. Based upon an assumed trust return of 8% per year, the payments would eventually increase to about $44,000 in year 20. Then in 20 years, payments from the deferred annuity would begin and continue throughout her lifetime.
Beatrice, in her wisdom, likes this plan. It gives Katrina adequate income when she graduates, enabling her to live comfortably but also giving her incentive to establish a career. She also knows that as Katrina gets married and has children, the income will be available if she chooses not to work. The $29,500 from the deferred annuity will eventually provide a nice stream of income for future financial needs, such as college expenses for Katrina's children.