by David Clark, Gift Planning Advisor for Kendal at Oberlin

What are the Key Elements of a Unitrust?

The Unitrust is a separately invested irrevocable trust for which an individual, bank or other organization can be named trustee. Under very special circumstances, even the donor can be trustee. A charitable remainder Unitrust can be set up to run for a specified period of years or the lifetimes of specified income beneficiaries. At the termination of the trust the principal is distributed to a designated charitable organization for its general purposes or for some purpose designated by the donor. When Kendal at Oberlin (via its Chief Executive) is named the remainderman, it is willing to serve as trustee, offering investment expertise and administrative services at no cost. Such trusts can be created during a donor’s lifetime, offering considerable income tax advantages, or by will, affording estate tax benefits, or by a combination of the two with benefit both to the donor and to designated income beneficiaries.

How is the Unitrust Funded?

The Unitrust can be funded with appreciated assets without capital gains tax liability even if the trustee elects to reinvest in other assets. Changes in investment over the term of the trust are likewise protected from capital gains tax liability. The Unitrust generates an income tax charitable deduction for the donor upon creation. The specific deduction varies with the age and number of income beneficiaries and the amount of income paid to those beneficiaries.

How is the Annual Payout Determined?

The trust instrument specifies a fixed percentage of the market value of the trust’s assets as the required payout. The assets of the trust are reappraised each year and the payout for that year is calculated by multiplying the new principal value by the specified percentage rate. Hopefully, the trustee will be able to make investments whose market values will keep up with changing economic conditions. As market values increase, so will the distributions to the income beneficiaries, thus providing some protection over the years from inflation and the cheapening of the dollar. On the other hand, if market conditions sour, even temporarily, those conditions are reflected in that year’s payout to the trust’s beneficiaries.

Is the Annual Payout Taxable?

The taxability of those distributions varies with the precise investments of the trust. If, for instance, the entire distribution requirement is met with dividend and interest income as earned by the trust, then the income beneficiary is liable for ordinary income tax on the amount distributed. If the trust is invested in tax-exempt holdings, the income distributions are tax-free. If the trust’s income exceeds the distribution requirement, the excess is added to principal without payment of income tax. If earned income is inadequate, then the balance of the requirement is made up by distribution of some principal, which is tax-free unless capital gain has been realized. To the extent realized capital gain is distributed it is taxable to the recipient at the favorable gains tax rate. If the trust realizes gain but does not distribute it, no tax is paid by the trust or otherwise.

How is the Payout Rate Determined?

The payout rate is specified by the donor when the trust is created. The rate is never less than 5% and can be any reasonable rate. Kendal at Oberlin advises that the rate not exceed 8%. The higher the specified rate the lower the charitable deduction available to the donor and, of course, the smaller the remainder ultimately available for charitable purposes.

Is there a Minimum Investment Required?

Because Unitrusts are separately invested and require diversification of investments, Kendal at Oberlin advises that no trust be funded with less than $50,000 in assets. Most commercial trust managers set a minimum of $250,000 or higher. Trusts may be created at any time and may be added to during the donor’s lifetime or by will and can accept any type of property except tangible personal property and property with debt.

A UNITRUST ILLUSTRATION

George and Margaret are 78 and 77. They want to provide help for others coming to Kendal at Oberlin after they leave and are convinced that the most efficient way to do so is to establish a Charitable Remainder Unitrust. They are attracted to an approach that will: 1) increase their income; 2) reduce their taxes; 3) remove assets from their estate; and 4) provide professional management of the invested funds without further concern or expense. Here is what they decide to do:

• Select $100,000 of appreciated stock from their portfolio to fund the Unitrust, avoiding any potential capital gains tax.
• Sign a Unitrust Agreement naming the Chief Executive of Kendal at Oberlin as Initial Trustee. The payout rate is set by them at 7% and payments are to be made quarterly.
• Receive IRS acceptable documentation showing that their gift entitles them to a charitable deduction of $43,000 to be claimed first in the year of their gift. Because the charitable gift deduction limit in any one-year is 30% of their adjustable gross income, they claim the maximum allowed and “carry over” the excess—a tax saver they are allowed to use for a total of six years.

The couple recognizes that the trust payments will vary each year after the year of gift. The Trustee determines the market value of the trust assets on the first business day of the second year, multiplies that figure by the payout rate of 7% to determine the amount to be distributed in that second year. George and Margaret are confident that over time the assets will grow in value even though they are drawing down 7% each year, but recognize that if the market drops in any one year, their income will drop also.

They were previously receiving dividend income on the donated assets of just under 3% and those dividends were fully taxable. They were delighted to discover that their payments from the Unitrust are to be a blend of ordinary income, capital gains income and tax-free return of principal—and that somebody else does all the calculations for them and reports the result each year before tax preparation time. They also are assured that they can get quarterly reports on the status of the Unitrust’s performance via an independent asset custodian.

Best of all, George and Margaret know that they have done something that will help Kendal at Oberlin to help others for years later on.

The information provided on this site should not be construed as tax, legal or investment counsel. We recommend you refer to your personal advisors for legal, investment or tax counsel prior to making financial decisions

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