Asset Conversion Planning

by Shaun Sommerer

Last month in this column I presented Part I of an example case study where a Charitable Remainder Trust (CRT) is used as part of an asset conversion plan for a couple considering retirement.

For this couple, establishing a CRT was the solution to assist them in meeting their goals and the strategy was outlined in this column last month. However, the couple was faced with the challenge that the principal from the CRT will ultimately pass to their parish in this case rather than to the couple’s children and grandchildren. So what can be done for the heirs?

This couple can provide for their heirs by establishing an irrevocable life insurance trust. This is also known as a "Wealth Replacement Trust" because it is commonly established to replace assets contributed to a CRT. The purpose of the second trust is to replace for the family the value of the assets passing to the parish from the CRT.

To achieve this, the couple will establish an irrevocable life insurance trust and make annual gifts of roughly $8,500 for ten years to this trust. The trust will purchase and own a $500,000 second-to-die life insurance policy on the couple’s lives. The premium for such a policy averages roughly $8,500 for ten years. The trust can be structured so that the annual gifts made by the couple to the trust will qualify for the $10,000 annual gift tax exclusion.

After both husband and wife die, a death benefit of $500,000 will be distributed to the children (and grandchildren if desired) income, gift and estate tax free. The amount of insurance and the premium are at the discretion of the couple. The next question is likely, "but what is the source of the insurance premiums?"

The insurance premium would be just a portion of the increased cash flow generated by the CRT and would only be payable for ten years. Recall, the couple elected to be the income beneficiaries of the CRT meaning they will receive a life-time income from the trust based upon a fixed percentage. In their case they chose 5% of the annual trust value. Therefore, the premium might be 25% of the cash flow generated by the CRT. In this example, the total cost of replacing $500,000 would be $85,000 or 17-cents per dollar.

At this point the comment is usually, "This sounds too good to be true, is it?" or "Does this really work?" The answer to both questions is yes! It is the combination of the CRT with an irrevocable life insurance trust that makes this plan work resulting in a whole that is greater than the sum of the parts.

The laws governing the establishment of CRT’s are part of the Internal Revenue Code and reflect the intention of Congress to motivate charitable giving. In essence, the government says that you can pay your tax now, or enjoy the use of all of your money during your lifetime if you agree to leave it to a charity at your death. The decision is yours.