How to Turn a Windfall Into a Win-Win-Win: The “Give It and Get It Back” Trust

For those fortunate enough to experience a one-time windfall – a large bonus, a liquidation event, a “golden parachute,” even the lottery – there’s one thing you can’t avoid: paying taxes on that income.  Here in California, someone who receives a $1 million bonus can expect to pay roughly half that amount in taxes, assuming the maximum 39.6% federal and a 12.3% state tax rate.

But for someone who is charitably inclined, there is a strategy that can help relieve the tax bite: the technical name for it is the “grantor charitable lead trust,” but I like to refer to it as the “give it and get it back” trust.

Here’s how it works.  A donor places assets into the charitable lead trust.  For a period of years, the trust pays income to one or more charitable organizations.  At the end of the trust term, the assets remaining in the trust revert back to the donor.  In essence, the donor is parking money in the trust for a number of years while the trust “gives” to charity.  Then, the donor “gets it back,” whatever is left.

The donor receives a large charitable tax deduction in the year the trust is funded, receiving credit for all of the future charitable gifts made by the trust during its existence.

Let’s walk through an example.  You receive a one-time windfall of $1 million.  If you do nothing, half of that amount will be paid in taxes.

You decide to establish a grantor charitable lead trust with $500,000 of the windfall.  You decide that the trust will last for 10 years and pay 7% of the funding amount – $35,000 per year – to charity.  Using today’s interest rates, you would receive a charitable deduction of $311,126 (assumes a 2.2% applicable federal rate) – win #1.

After 10 years, the trust terminates.  In those 10 years, you would have given away $350,000 to charity – win #2.  Assuming the trust earns an average 6% annual rate of return, you get back $434,096 – win #3.  Not a bad outcome.

There are trade-offs to the charitable lead trust:

  • You are not allowed to access the funds for personal use while the trust is in existence – only use money in a grantor charitable lead trust that you don’t need right away.
  • You don’t receive any additional charitable tax deductions in future years, since the deductions were front-loaded in the first year.
  • Depending on the trust’s investment performance and the charitable payout percentage, there is a strong likelihood that you will “get back” less than the original funding amount.
  • Finally, you as the donor are taxed on any income generated by the trust’s investments.

The charitable lead trust is a complex instrument – but for someone experiencing a one-time spike in their income, it can produce a triple win: tax deduction, charitable gifts, and getting back what’s left.

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