Bear Market Provides Boost to a Little-Known Strategy; a Record Low Hurdle Rate

By Mike Spector

Feb. 10, 2009, Wall Street Journal — Investors aren't in a giving mood these days. But the deepening recession presents a rare opportunity for some people: By setting up a special trust, wealthy donors can seed favorite charities, pass money to heirs and shelter potential growth from taxes.

Under the strategy, called a "charitable lead trust," you can transfer assets — cash, stocks and artwork among them — to a trust for a set term of years. Each year, payments are made from the trust to a designated charity or charities. After the trust's term expires, what's left goes to your heirs. By moving the assets out of your estate, the strategy also shelters their potential appreciation from estate taxes.

Because many clients remain shell-shocked from recent market losses, estate planners say they aren't executing a lot of these trusts right now. But because of current bear-market conditions, planners are increasingly advising clients to consider these trusts.

What makes them especially attractive now is an historically low special rate that the Internal Revenue Service uses to predict how much your assets will grow in the trust. Estate-planning lawyers call it the "hurdle" rate because investment gains beyond it can generally pass to heirs tax-free. The rate, which is adjusted monthly, remains locked in for the length of the trust.

February's hurdle rate is 2%, down from 4.2% a year ago. Since many assets, such as securities or businesses, are severely depressed right now, it's likely that they'll appreciate by a margin well beyond the 2% hurdle rate in coming years.

Nancy Ridgley, a 68-year-old real-estate agent in Columbus, Ohio, reaped several hundred thousand dollars in 2004 after selling farmland she inherited from her uncle. Ms. Ridgley wanted to pass that money to her three daughters but also maintain her charitable giving. She also wanted to get the money out of her estate.

How Charitable Lead Trusts Work

* Investors transfer assets — money, artwork, securities or other property — to a trust for a term of years.
* Each year, annual payments are made from the trust to a designated charity or charities. Payments can be a fixed amount, or a set percentage of the trust's value each year, depending on how the trust is structured.
* For tax purposes, the IRS uses a set rate, often called the "hurdle" rate, to project the trust's growth. This determines the taxable gift that will pass to heirs. But if the trust grows beyond that amount, the gains can pass to heirs tax-free.
* To avoid gift-tax consequences altogether on the assets passed to heirs, investors can "zero out" the trust — that is, structure the annual charitable payments so that they equal the original value of the assets put into the trust.

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