Charitable Lead Trusts: Pros, Cons, How They Work
Charitable lead trusts help you donate to an organization while preserving the remaining inheritance for your heirs.
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A charitable lead trust is a type of irrevocable trust that makes payments to a charitable organization for a set period of time and then transfers the remaining funds to other beneficiaries, such as family members. Charitable lead trusts, when set up correctly, can help reduce income tax, estate tax or gift tax for estates or their beneficiaries while providing a way to donate some of the estate to an organization the estate owner cares about.
This type of trust is essentially the opposite of a charitable remainder trust, which provides income to beneficiaries during your lifetime or theirs, with the remainder going to charity.
» Estate planning? Start with our 7-step guide.
How a charitable lead trust works
A charitable lead trust is known as a “split interest” trust because it is used to make charitable contributions and pass wealth to noncharitable beneficiaries. Here are the key steps.
1. Fund the trust
The grantor (creator) funds the trust with assets that can include cash, real estate, publicly traded securities, some types of closely held stock or other assets.
The tax consequences of moving assets into a trust can vary depending on the type of asset. Over time the trust may need to sell some of the assets so it has enough liquid funds to make charity payments.
Unlike charitable remainder trusts, investment income generated by assets in a charitable lead trust is not tax exempt. Either the grantor or the trust may owe taxes when the trust sells assets.
2. Make payments to a charity
The charity is called the lead beneficiary. There is no minimum or maximum distribution required, as long as payments are made at least annually. Payments can either be set up as annuities (a specific, fixed amount goes to charity each year) or unitrust (a percentage of the total trust fund goes to charity each year).
The trust is set to a “fixed term,” which is a set amount of time during which the trust makes payments to a charity. The term can be a number of years, or it can be the lifetime of the grantor or their beneficiaries. Charitable lead trusts don’t have a mandatory time limit.
3. Distribute remainder to beneficiaries
The remaining funds go to noncharitable beneficiaries (called remainder beneficiaries) when the term ends.
A charitable leadtrust can be set up so that the grantor receives the remainder — this would be called a reversionary trust. If the funds go to other beneficiaries, it’s called nonreversionary.
Pros and cons of a charitable lead trust
Advantages | Drawbacks |
|---|---|
Can provide a charitable tax deduction for the value of the assets you put in the trust. | Investment income and capital gains within the trust are taxable. |
Can reduce estate taxes. | Can’t change the terms or beneficiaries once the trust is set up. |
Can reduce gift taxes. | Can be complex to set up correctly. |
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Types of charitable lead trusts
You can set up either a grantor charitable lead trust or a nongrantor charitable lead trust. The type you choose can affect the tax features of the trust.
Advantages | Drawbacks | |
Grantor Charitable Lead Trust |
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Nongrantor Charitable Lead Trust |
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» Learn more about estate tax planning
Charitable lead trust vs. donor-advised fund (DAF)
Charitable lead trusts and donor-advised funds (DAFs) are two ways to donate to charitable organizations over time. Both can also reduce your estate taxes (if your estate is large enough to be subject to estate tax).
The main difference between charitable lead trusts and donor-advised funds is the flexibility to change the charity you want to donate to.
Charitable lead trusts are irrevocable trusts, so it can be difficult or impossible to change the recipient once the trust is in motion.
A DAF is managed by a sponsoring organization, but you generally can recommend which charities should get the money you put in the account.
You might be able to use a charitable lead trust and a DAF together to maximize your flexibility and tax savings. First, you set up a charitable lead trust, then name an organization that sponsors DAFs as the lead beneficiary. Next, you recommend charities to the DAF sponsor. In that scenario, you may be able to pass the remainder to your personal beneficiaries.
» Learn more: Rules for tax-deductible charitable donations
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