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The advantages of attracting deferred charitable gifts.

How 501(c)(3)s can benefit from charitable remainder trusts.

In this lackluster economy, nonprofit 501(c)(3) organizations have been scrambling for new ways to stimulate contributions. For some, methods of deferred giving, especially charitable remainder trusts (CRTs), offer previously untapped options.

As explained in Charitable Giving Today by Paul J. Lochray (Prentice Hall, 1992), a CRT is a type of charitable transfer by which "the donor gives cash or other property to a qualified charitable organization. In return, the charity promises to pay the donor a specified sum ... or percentage (an annuity) each year for the remainder of the donor's life ... or |until~ the expiration of a term of years.... While the gift is made at the present time, the |nonprofit organization's~ use ... is delayed until the death of the income beneficiaries or until some future date.... The charity ultimately receives the trust property."

Nonprofits failing to take advantage of CRTs generally cite their complexity as the reason. Many nonprofits lack the internal resources or financial sophistication to manage CRT assets. But the advantages to both donor and nonprofit are numerous.

CRTs have made a tremendous difference in both the number and size of contributions to City of Hope, an international nonprofit medical and research center in Los Angeles dedicated to research and treatment of cancers, childhood illnesses, diabetes, and other life-threatening diseases. Over the last six years, we jumped from $8.5 million in deferred gifts--which we thought was impressive given the flat economy and the fierce competition for philanthropic dollars--to more than $60 million in deferred gifts.

This achievement was due primarily to two factors: an increased emphasis on CRTs by our seven-member planned giving department and the decision to transfer the management of our CRTs to an outside trustee, Wells Fargo Bank, headquartered in San Francisco.

Advantages for donors

Individuals who choose to donate assets using a CRT enjoy myriad advantages. They can make a significant donation to their favorite nonprofit, secure a sizeable tax deduction, avoid capital gains liability on appreciated assets, and receive a steady income stream for life. They also have the option of postponing payments until retirement. When the donor dies, the assets pass to the nonprofit. Donors retain the asset's earnings while alive, so they are able to confer more than they normally might with an outright gift.

Individuals with a heavy concentration of assets in corporate stock, perhaps acquired through employment purchase options, and often on a low-cost basis, find CRTs an especially appealing vehicle. That's because all or a portion of the stock, once inside the CRT, can be converted into a more diversified portfolio that offers greater protection from market fluctuations.

In addition, the substantial capital gains tax ordinarily associated with liquidating the stock is bypassed, as is the estate tax--as high as 55 percent--on the remainder when the donor dies.

The subject of estate taxes frequently surfaces in discussions with potential donors, who are naturally concerned that their heirs may suffer if assets are donated to a nonprofit instead of willed to family members. One solution is to combine the CRT with a second trust, funded with an insurance policy. The policy can be paid for with savings realized from capital gains and income tax savings, or from income generated by CRT assets.

Heirs are made beneficiaries of the insurance policy, and when the second spouse of the donating couple dies, policy proceeds are paid to beneficiaries through the trust, avoiding income and estate taxes. If the policy payout is structured to match the value of the donated assets, the heirs are assured of receiving a comparable inheritance.

The donor's tax deduction is based on the value and type of asset, life expectancy, and class of the nonprofit. With the income tax increases of the Omnibus Budget Reconciliation Act of 1993, the value of the CRT deduction is correspondingly higher. Unused portions of the deduction can be carried forward for up to five years. Because a CRT is irrevocable once it is established, the donor has no legal ownership of the assets in trust and no control over their investment and administration. Therefore, assets in a CRT cannot be reached to satisfy a judgment or the claims of creditors. While the income received by the income beneficiary of a CRT can be attached, it can also be deferred until the situation has been resolved.

On the down side, CRTs are subject to complex Internal Revenue Service (IRS) regulations. These planned-giving vehicles are legal documents that must comply with specific state and federal requirements. CRTs must also protect both the donor and trustee. Enormous repercussions can arise from seemingly insignificant errors, and since the trusts are irrevocable, the damage can't be undone, as the following examples illustrate.

Complex underpinnings

As noted earlier, one of the chief benefits for an individual using a charitable trust is avoiding capital gains on the sale of an appreciated asset. However, the IRS may disqualify a CRT and nullify its tax savings benefits if it is improperly drafted, if the overriding reason for its establishment is not charitable in nature but rather tax-savings driven, or if the transfer of property is improperly handled.

If the IRS makes this ruling, all profits become immediately taxable to the donor, who becomes responsible for capital gains taxes on money not received, because even though the trust may not produce desired tax benefits, it is still legally irrevocable and its provision, including the ultimate distribution to charity, will be followed.

Consider the example of a couple who decided to put their home into a charitable trust. Originally purchased for $400,000, the home increased in value to $1.2 million. The trust sheltered the $800,000 profit and sidestepped about $230,000 in capital gains tax. The house, once inside the trust, was sold and converted into an income-yielding asset. However, the couple had taken the home off the market, where they had a buyer lined up for the house before it was placed into the trust.

Subsequently, the IRS ruled that the intent of the trust was not charitable, but merely to avoid taxes. Regulations state that if the property was being marketed or in any stage of sale negotiation, the IRS can challenge the charitable intent of the trust, precipitating the capital gains tax. The couple, without recourse to the assets in the trust, were forced into liquidating other assets--under duress--to meet this obligation.

In another situation, an individual had bequeathed a note secured by a parcel of land. The property went into foreclosure, and it was discovered that toxic waste was on the land, representing the potential for dozens of lawsuits. Thanks to some knowledgeable legal advice, the charity was able to sell the land before taking title to a buyer who accepted responsibility for the cleanup.

As this example reveals, in some instances a charity, accepting real property as a gift, is confronted with substantial potential liability if it takes title in its own name. Having a CRT take title in the name of an independent fiduciary is one way to avoid some of that potential liability. It is also important to educate staff members on potential liabilities of accepting real property and to conduct some sort of inspection, both physical and of the property's legal title, prior to acceptance. Above all, it is vital to establish a relationship with an attorney knowledgeable in the field to protect your organization.

While these may be unusual cases, they emphasize the complexities of these arrangements and the ramifications of not fully understanding the subtleties of charitable trusts. It's tough enough keeping abreast of the rules for one trust. Problems multiply exponentially when you oversee several hundred. This is only one of several good reasons to seek counsel from professionals who are well-acquainted with the nuances of the law.

Another factor to consider is the impact of an uncertain economy on the investment performance of assets within CRTs. When the economy is robust, yields in the area of 8 percent annually can be achieved without much difficulty. But during tougher times, such as we have experienced in recent years, skillful investment management is needed to maintain earnings flow without dipping into the principal.

If a certain income stream has been guaranteed to the donor, it's critical to not only deliver what's been promised but to ensure that the trust assets remain intact, both to continue producing income for the donor and to be available for distribution to the charity at the termination of the trust.

Relying on outside experts

The City of Hope decided to delegate management of its trust assets to Wells Fargo Bank because of the complexities of CRT structure, asset deployment, and management. The bank is familiar with the intricacies of CRTs and experienced in the legal and tax aspects as well. They took over the day-to-day administration, monitoring, and investment of assets. We also used our own attorneys to ensure that documents were properly drafted.

Another reason we delegated CRT management to outside professionals is that in our arrangement, trust management fees are based on a percentage of the market value of trust assets. Therefore, as the assets in trust grow in value, so do the fees payable to the trustee. Should the value of those assets drop, the fees drop as well. This creates a vested interest on the part of the fiduciary in making the assets grow, because they do not receive commissions based upon the number of trades, as a broker would. The investment strategy is simply to increase the assets, thereby benefiting both the donor and the charity.

Just as important, the cost of administering the trusts doesn't come out of our operating budget, but out of the trusts themselves. This frees up additional funds for planned-giving marketing. As a result, we are saving money by using the outside fiduciary, freeing our staff to do what we do best--raise money.

Prior to this arrangement, a single broker managed most of our CRT assets. Our current arrangement provides us with considerably more control. We receive a monthly statement detailing current assets, their values, and any transactions that may have taken place. We also meet frequently with the administrative and investment personnel involved in the management of our trusts.

The right partner

One reason we chose Wells Fargo was that they provided us with access to their in-house managed diversified investment funds. The substantial holdings in those funds provide reduced costs on transaction commissions, and there are no loads. This alone rendered considerable savings. Most of our individual trusts were too small to have the kind of clout necessary to realize great overall savings, but by investing their assets in the much larger funds, we have realized considerable overall savings, and the investment performance has been excellent.

All of this enabled us to cash in on the economies of scale and get the diversification of a large portfolio, which is normally unavailable to individual assets. Our investment committee can now monitor investment performance by reviewing the statements for each trust. Wells Fargo personnel also attend meetings to present oral and written reports and periodically review these trusts.

There's also a hidden benefit to contracting with an outside trustee. It allows us to deflect criticism and put ourselves in the corner of the donor at all times.

When establishing a CRT program, check with the trustee regarding minimum account sizes the trustee is willing to administer. Many will not accept trusts smaller than $500,000 or $1 million in size. Others, such as Wells Fargo, accept a charity's trusts based upon the aggregate amount. Trustees typically do not charge set-up costs. The only costs are those incurred internally by the charity for monitoring the trustee's performance.

Given our experience, we believe there's little reason for a nonprofit organization to manage and be responsible for charitable trust investment. Asset management, particularly in an uncertain economy, requires sophistication and experience. Transferring fiscal responsibility to an outside trustee has relieved us of the headaches of administering these trusts.

Having hired an outside trustee for our CRT, our planned-giving staff can focus on maintaining relationships and meeting with potential donors to generate new deferred gifts. In the current economic climate, with increased competition for diminished philanthropic dollars, we believe our CRT partnership has given us a competitive edge.

Selecting an Outside Trustee

An outside trustee is an ongoing business partner. Obviously, you want to be cautious in making your selection and seek a trustee with whom your staff can work comfortably. But besides good chemistry, what other factors should you consider? Here are some suggestions:

* Does the investment philosophy of the trustee mesh with that of your organization? Discuss the investment strategy under consideration. Are you comfortable with the level of risk? Inquire about the track record of the trustee's portfolio managers. Specifically, look at the performance of the trustee's diversified investment funds.

Are the advisers used by the trustee on staff, or does the trustee intend to subcontract asset allocation to another outside source? How much control will you retain over investment performance? How frequent and how detailed will your statement be? Does the trustee offer a sufficient variety of investment vehicles to satisfy all reasonable investment objectives?

* Experience in managing charitable trusts is imperative. These are vehicles unlike anything else in the financial services arena, with their own set of state and federal regulations, so "related" experience is no substitute for CRT knowledge.

* Look into the accessibility of investment and trust officers. Make certain they are willing to meet with your staff periodically to review the trusts. Ask if they are amenable to meeting with potential donors. This is vital, as many donors are uneasy about making sizable bequests and may understandably be reluctant to make a gift until they meet the people who will be handling their money.

* How is the trustee paid for its services: A desirable arrangement is to have the trustee paid a certain percentage--usually between 1 and 2 percent--of the value of the trust principal on an annual basis. This gives the trustee an incentive to boost the value of the holdings. In this way, investment decisions are based purely on merit, and the interests of the trustee are directly aligned with those of your organization.

Getting Started

Many charities over the last few years have devoted themselves to obtaining only current gifts from their donor base. However, with the decline in such gifts in recent years because of the lackluster economic environment, and with the upswing in charitable giving that is likely to result from higher income tax rates, more and more charities are turning their attention to deferred giving as a source of potential future gifts.

The cost of establishing such a program is not great, but it is important to proceed with a definite plan. Here are some suggestions for establishing such a program:

* First, and perhaps most importantly, become knowledgeable about all types of deferred gifts, especially charitable remainder trusts (CRTs), by reading professional journals and attending seminars. Other types of deferred gifts include pooled income funds and charitable gift annuities. Pooled income funds are similar to CRTs except that they are structured for smaller donors--those making $5,000-$25,000 donations. Charitable gift annuities operate the same as an insurance annuity; the donor receives a charitable deduction and receives a guaranteed return on the amount donated based on his or her life expectancy.

* Investigate your donor base. Concentrate on those donors who usually make large gifts or who may have appreciated assets in their estates. Then, establish a relationship with these donors or with others in your organization who may already have such a relationship.

* Collect all available data on any CRTs of which you are already aware. Try to create a program that enhances your charity's relationship with the donors who created those trusts.

* Notify all potential donors of the existence of your new program by letter or newsletter, or conduct a special seminar.

* Be prepared to devote substantial time to obtaining each gift, if necessary. It often takes potential donors a long time to decide to establish a charitable remainder trust. After all, these trusts are irrevocable gifts, and the donor cannot recover the assets.

* Establish a relationship with an attorney who specializes in this area. You will be able to turn to him or her for advice, and the attorney may make referrals of potential donors.

* Offer recognition, such as plaques or publicity in your magazine or newsletter, of donors who have made deferred gifts; this stimulates awareness of the potential of these gifts among other donors.

* Follow up with each donor. Continue to build upon the relationship. Don't underestimate the value of the goodwill that is generated. Your donors may make future gifts or refer you to friends or family members who may also be willing to make donations.

Tonny P van der Leeden is senior vice president of planned giving and endowments for City of Hope, an international nonprofit organization in Los Angeles.
COPYRIGHT 1993 American Society of Association Executives
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:Philantrophies; includes related articles
Author:Leeden, Tony P. van der
Publication:Association Management
Date:Nov 1, 1993
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