Rich parents want to give to charity and leave more money to their kids. Here's how billionaire families do it. (2024)

With the right lawyers, rich clients can use CLTs to save big on estate and income tax. If the assets within the trusts appreciate faster than an interest rate set by the IRS at the time of funding, the beneficiary can even end up with a bigger fortune.

A Walton family spokesman previously defended the family's use of CLTs. In 2013, Lance Morgan told Bloomberg that "any charitable or estate planning practices employed by the Walton family are broadly available and commonly used."

"The way a lot of our clients view these things is it's a way to take care of their charitable desires and benefit at the same time," said Ed Renn, a partner at Withersworldwide.

Many of Renn's clients who opt for CLTs are business owners who have recently cashed out or clients in private equity or hedge funds who have a windfall and want a hefty income tax deduction. CLTs can also be used to discreetly transfer wealth while being publicly philanthropic.

"I've seen lawyers use these to plan for mistresses, to plan for children that perhaps the spouse doesn't know about," Renn told Business Insider. "To some extent, it's a way to hide who the beneficiaries are."

Clients just looking for tax savings should stay away from CLTs, according to lawyer Dan Griffith, as higher interest rates have made it harder for CLTs to yield a substantial remainder.

"If you're not charitably inclined or already giving a fair amount to charity today, charitable lead trusts probably isn't for you," Griffith, director of wealth strategy at Huntington Private Bank, said.

There are several kinds of CLTs

CLTs come in multiple flavors. Most clients opt for charitable lead annuity trusts (or CLATs), which pay a fixed percentage of the trust's value at the time of creation on an annual basis. The Waltons and Onassis both chose CLATs.

"With a CLAT, you're committing to a dollar figure, which means that if suddenly the market tanks, and we've all seen that on and off over the past several decades, you're committed to paying that dollar figure," said Jennifer Galvagna, who leads trust, estate, and tax solutions at Bank of America Private Bank. "You may deplete the trust before it ever reaches your remainder beneficiary."

To ensure a remainder is to be inherited, the grantor can choose a charitable lead unitrust (CLUT) instead of a CLAT. Both types pay a fixed percentage of its assets to charity, but CLUTs use the trust's fair market value at the time of disbursem*nt, not its original funding. This means a CLUT cannot be depleted, but if the assets perform better than expected, the charity gets larger payments thus limiting the beneficiary's gains.

This is how CLTs work

Most lawyers structure CLATs so that they "zero out" the remainder interest, meaning that the present value of the annuity interest is equal to the funds transferred to the trust. The rate the IRS uses to calculate the present value, referred to as the 7520 rate, is 5.2% as of January 2024. If the calculations predict that the trust's remainder interest is zero, the beneficiaries are exempt from estate tax even if the assets actually appreciate by a greater amount.

Here is an example of how a CLAT can work from Michael Prinzo, managing principal at CliftonLarsonAllen:

Consider a CLAT set up in December 2023 funded with $1 million and structured to last 20 years. The grantor can deduct $1 million in the 2023 tax year. To zero out, assuming a 7520 rate of 5.8%, the trust has to pay $1.86 million to charity over the term.

If the trust assets are invested and achieve an annual rate of return of 9% a year, the CLT's remainder will be $2.1 million. The beneficiaries receive this remainder free of estate or gift tax. This remainder also does not count towards the grantor's estate and gift tax exemption since these assets were created by the future growth of the trust after the assets were contributed to the CLT.

These trusts are typically funded with publicly traded stock and cash, which is reinvested over the trust's term, to increase the odds that the assets outperform the 7520 rate, according to Prinzo.

Buyer beware

There are a few caveats. For starters, higher interest rates make it harder for CLTs to generate a substantial remainder.

"It's a fantastic low interest rate play," said Renn. "The problem now is rates have really risen and it's to the point where some investments clearly can outperform a 4% or 5% interest rate, but others might struggle."

In this interest rate environment, charitable remainder trusts (CRTs) have better odds. Considered the opposite of a CLT, a CRT pays cash to the grantor and the charity receives the trust's remaining funds when the trust expires or the grantor dies. You can claim a bigger tax break with a CRT when interest rates are high.

But for clients who want the charity to benefit now rather than after their passing, CLTs are the way to go, according to Prinzo.

"When individuals are looking for cashflow to really go to a philanthropic organization in the near term that they might be passionate about and are OK if they forgo that income stream individually, that's where you might see a charitable lead trust is more attractive," he said.

Most CLTs are irrevocable, meaning you lose access to the funds. That said, you can draft a CLT with some flexibility as to the charitable beneficiaries. For instance, the trustee — the third party who oversees the trust — can be given discretion to choose among a group of public charities, according to Renn.

Such provisions come in handy when donors want to sever ties. Several billionaire philanthropists have made headlines in the past three months for ceasing support of their alma maters or other institutions over their response to the Israel-Palestine conflict.

"I don't like the idea of hardwiring a single charity," Renn said. "I've had many clients, they're deeply involved or committed to a charity, and then three or four years later they're mad at everybody."