• Charitable Lead Annuity Trusts (CLATs) allow donors to support their favorite charities while providing a future financial benefit for themselves or their families.
• CLATs provide a fixed annual payment to a charity for a specified term, after which the remaining assets are transferred to the donor's beneficiaries.
• CLATs offer potential tax benefits, including reduced estate and gift taxes, and can be an effective tool for wealth transfer and charitable giving.

A Charitable Lead Annuity Trust (CLAT) allows individuals to support a chosen charity while also providing a meaningful benefit for non-charitable beneficiaries. 

The structure of a CLAT involves creating a trust, transferring assets into it, and designating a charity to receive a series of payments over a set period of time, which can either be a number of years or the lifetime of one or more individuals. At the end of the CLAT term, the non-charitable beneficiaries receive the remaining assets in the trust.

How CLATs work

To establish a CLAT, the grantor (also known as the donor), transfers assets into the trust. The trustee responsible for managing the CLAT then pays the designated charity a fixed amount, called an annuity, for a specified period of time.

The annuity amount is established at the time the trust is created and is based on a percentage of the initial value of the trust's assets. 

A CLAT is often compared to a Charitable Remainder Annuity Trust (CRAT), in which the grantor receives a series of annuity payments (to a maximum of 20 years), with a charity receiving the remaining trust assets. In contrast, a CLAT is not limited to a set term and can last for the lifetime of one or more individuals or a certain number of years. Whereas a CRAT is required to distribute between 5% to 50% of the initial value of the trust assets on an annual basis, a CLAT has no minimum or maximum annuity amount.

Types of CLATs

There are two types of Charitable Lead Annuity Trusts that affect the overall tax treatment of the arrangement: grantor and non-grantor trusts.  

A Grantor Charitable Lead Annuity Trust is a CLAT in which the grantor or other owner retains some control over trust's income or assets and, subsequently, retains the tax responsibility for the trust’s income.

In this arrangement, the grantor takes an immediate income tax deduction based on the present value of the future charitable payments. Any investment income remains taxable to the grantor of the trust, which could offset the deduction amount.  The deduction amount is limited to 30% of adjusted gross income (AGI), or 20% of AGI for gifts of appreciated property. 

A Non-Grantor Charitable Lead Annuity Trust is a CLAT in which the trust itself remains responsible for the tax liability on its income. As such, the grantor is not allowed to take an income tax deduction on donated assets, but the trust pays the taxes on any undistributed investment income. 

This type of CLAT can claim a charitable deduction each year for the payments that are provided to the charitable lead beneficiary. This type of trust may also help reduce estate and gift tax liabilities if the assets in the trust grow more than the amount of the annuity paid to charity.

Potential applications

A charitable lead annuity trust (CLAT) can serve multiple purposes for individuals with philanthropic goals and financial planning needs. By establishing a CLAT, individuals can support their chosen charitable causes during their lifetime. The payments made to the charity can be used to fund various projects, research, scholarships, or any other endeavors that align with the donor's values and interests. This allows the individual to leave a lasting charitable legacy.

In addition to its philanthropic benefits, a CLAT can also be an effective estate and gift tax planning tool. This is particularly useful for individuals with substantial assets who wish to minimize the impact of gift and estate taxes. A CLAT can also facilitate wealth transfer by providing a means to pass down a significant amount of wealth to future generations while still benefiting a charitable organization. Once the term of the CLAT expires, the assets in the trust pass to the non-charitable beneficiaries, potentially reducing estate taxes on those assets.

CLATs offer control and flexibility, allowing the donor to decide which organizations to support, as well as the duration and amount of annuity payments the charity will receive. 

CLATs can also play a role in business succession planning. By placing business assets in a CLAT, an organization can establish an annuity to benefit charitable endeavors while still allowing the remaining business interests to pass to future generations.

Enhancing a CLAT with life insurance

In some cases, the donor may want to enhance the CLAT by adding life insurance. This will not provide any additional income nor benefit the charity, but it can significantly increase the overall benefit that the remainder beneficiaries would receive in the future. While the income provided to the charity must be accounted for first, any residual income that the CLAT generates can be allocated towards the purchase of life insurance. This will not only increase the amount of wealth transferred, but will also act as a hedge against any fluctuations in any of the other trust assets.  

Tax considerations

Unlike a charitable remainder annuity trust (CRAT), a CLAT is not tax-exempt, and its income is taxed like any other grantor trust. However, a non-grantor CLAT can help reduce estate taxes. The property contributed to the trust remains part of the donor's estate, but a charitable deduction, based on the present value of the charity's interest, can increase the overall wealth passed to heirs. 

Contributions made to a CLAT during the grantor’s  lifetime may be eligible for a gift tax charitable deduction, also based on the present value of the charity's interest. If the beneficiary is not the donor, gift tax may apply to the remainder interest, but with proper structuring, gift taxes can be minimized.