Despite the recession, the wealthy did not close their purse strings last year. Charitable giving topped $300 billion for the second year in a row in 2008, down just 2% from 2007, the first decline since 1987, according to the Giving USA Foundation, a Glenview, Ill., group that tracks this data. "The big misperception is that charity falls off a cliff in a recession," says Sean Stannard-Stockton, CEO of Tactical Philanthropy Advisors in Burlingame, Calif. He suspects the numbers will be down for 2009, too, but not by much.

Philanthropists, then are still eager to give. And because interest rates are historically low, this also happens to be a good time for wealthy clients to make tax-free gifts to heirs via charitable lead trusts (CLATs). That's because the percentage of principal the IRS requires the CLAT to give to charity each year is based on Federal interest rates (the 7520 Rate to be exact, which is 120% of the federal mid-term rate). Any appreciation, which doesn't go to charity, is passed to heirs tax-free. "When interest rates are low, the less you have to give to charity," Stannard-Stockton says. "Recent rates are the most attractive they've been in a generation."

So long as the principal is actuarily expected to be totally depleted-or zeroed out-by the end of the trust's life, any remaining principal goes to heirs free of estate and gift tax. "The goal is to spend everything you put in and to pass on the appreciation," Stannard-Stockton explains.

The less you are required to give to charity each year, the greater the principal you have left to grow for the client's heirs. It's that simple. With interest rates as low as they are, "you don't need high returns to make a CLAT a worthwhile strategy," he says. For example, in 2009, the 7520 Rate never got above 3.4%, which is fairly easy to beat with a moderately aggressive investment strategy, whereas in 2000, the rate hit 8%, the highest it's been this decade, which is a lot tougher to top.

 

SHARK'S FIN

CLATs, which have been around since 1969, came to public attention when one appeared in Jackie Kennedy Onassis' will. But a new form of the CLAT, called the variable charitable lead annuity trust, or VCLAT, just received the green light from the IRS in 2007. This newer trust is also known as a shark's fin CLAT because payments to a charity start small and then rise rapidly at the end of the trust's life to form a fin shape. Of course you need an estate lawyer to set up CLATs and VCLATs. But knowing about them will help you talk intelligently with centers of influence and wealthy clients. And you can still manage the funds in the CLAT for your clients.

Charitable lead trusts have a key advantage over other trust structures, says Richard Fox, a partner and charitable trust and philanthropy expert at Dilworth Paxson, a Philadelphia law firm. Because they donate to charity, the IRS throws them a bone and allows the client to pick the 7520 Rate from the current month or the previous two months, whichever is most favorable.

For even more flexibility, clients can wait to make a decision until the 20th of the month to see what the next month's rate is going to be and simply put off implementing the trust if the later rate is more attractive.

CLATs must donate to 501(c)(3) registered public charities, including a donor's private foundation, of which there are more than one million in the U.S., so the choice is broad. Charitynavigator.org lists and evaluates each 501(c)(3) for efficiency and actual spending by charities, and tracks the outcome of that spending, says Stannard-Stockton. This is important data to gather. Charitable giving tends to follow its own fashion. Alma maters used to be popular beneficiaries, but recent tragedies, such as Sept. 11 and Hurricane Katrina have changed the focus of charitable giving to areas in crisis. Still questions often arise about how effective these new charities actually are. "There was a strong narrative on whether those donations made a difference [to the people they were supposed to help]. It's a difficult problem," he says.

Sometimes your charity ditches you. Therefore it's always a good idea to show the charity of your choice the documents for the trust you'll sign, Fox says. Sometimes they'll find something wrong in the contract and sometimes they won't take money from certain people. Charities that have rejected donors in the recent past include Bear Necessities Pediatric Cancer Foundation, which turned away a donation from disgraced Illinois governor Rod Blagojevich's wife Patti, who won money on NBC gameshow I'm a Celebrity...Get Me Out of Here for eating a dead tarantula; and the University of Pittsburgh, which refused a bequest from George Sodini, the gunman who shot up an L.A. Fitness center.

It's possible to change the beneficiary in a CLAT's documentation, but it's not simple. Instead, many advisors are suggesting that clients name donor-advised funds as the trust's beneficiary because these can function as savings accounts for charitable donations. The client's CLAT can give money to the donor-advised fund, which is registered as a 501(c)(3) charity and which in turn metes out money to a wide variety of charities, and later change his or her instructions to the donor-advised fund about which registered charity to give the money to. Fidelity, Schwab and Vanguard run donor-advised funds for a small fee, about 60 basis points on average.

 

RUNNING THE NUMBERS

Clients can have a regular CLAT or structure the trust as a VCLAT. Fox ran the numbers for both using the modeling software that estate attorneys use to manage the balancing act between growing the assets and spending down the trust's principal. Based on an October 2009 calculation for a regular CLAT, a $1 million transfer for a 20-year trust would be subject to a 7520 Rate of 3.2%. According to Fox's CLAT calculation, the trust would need to pay out $68,464.55 each year to zero out over 20 years. Assuming the principal grows at a rate of 8% each year at the end of the 20 years the trust would be valued at $1,527,884.85, a sum which could go to heirs with no estate or gift tax due.