Flip CRUTs and Deferred Gift Annuities – Know the Difference

Clients sometimes ask us how their donor can establish a deferred charitable remainder unitrust (CRUT). The donor would like to transfer the funds now, receive the charitable deduction now, but delay receiving payments until a later date. The presumption is that the CRUT can be structured in such a way that payments will only begin upon a specified date in the future. Unfortunately, in this situation we must say, “No, that cannot be done.”

While the qualified charitable remainder unitrust can be structured in a number of different ways, the deliberate delaying of payments is not allowed. The trust can be written with annual payments, which might allow for as much as a year between the funding date and the first payment, but that is as long as payments can be delayed. And that would mean that all future payments would also be made annually, which may not be appealing to the donor.

If it sounds like the donor should consider funding a deferred charitable gift annuity (DCGA), that is exactly what we would say. A DCGA allows for exactly what we described above – complete the funding now, receive the charitable deduction now, but receive the payments at a later time. Gift annuities are, in general, a wonderfully efficient vehicle for making a split interest gift to a non-profit organization – the donor or someone else receives payments for life, and the charity receives the residuum (remainder) after the death of the annuitant.

But not all gift opportunities fit easily into the confines of a gift annuity. In some situations, the amount of funding can be a problem. While no one ever wants to say a gift is too large, organizations who sponsor gift annuities tend to shy away from writing gift annuities above a certain amount, such as $500,000 or $1,000,000 (it varies by organization). Were the charity to write a gift annuity that size, it would be taking on a future payment obligation of several hundred thousand dollars – or more. That would make the Finance side of the house extremely uncomfortable.

In addition to concerns about the size of the gift, charities also tend not to favor writing gift annuities that are funded with illiquid assets. Cash is always good, of course, and marketable securities only involve the risk of value fluctuation during the short period of time between funding and the date of sale by the charity. But gifts of real estate, or other more complicated assets, to fund gift annuities entail a level of risk that most charities prefer to avoid.

If a donor wishes to establish a split-interest gift involving illiquid assets, and the charity doesn’t agree to write a gift annuity (of any kind), the gift planning professional might want to suggest a Flip-CRUT. But how does the Flip-CRUT compare to a CGA, and how is it different? Let’s review the basic parameters of such a trust.

A “flip” charitable remainder unitrust is a hybrid of two unitrusts types  – the net income unitrust and the standard unitrust. A Flip-CRUT begins as a net income unitrust (or a net income with makeup unitrust), and then, after a period of time, it “flips” to a standard unitrust (straight payout based on a percentage of principal). The exact timing of the flip is based on the “triggering event,” which can be just about anything that the donor cannot control after the funding of the trust.

The appeal of the Flip-CRUT breaks down into two approaches – the retirement approach and the funding of the trust using an illiquid asset. The retirement approach is straightforward – on a specific date in the future, the trust will flip to a standard unitrust. There is no room for variation, but the actual date the conversion from net income unitrust to standard unitrust becomes effective is January 1 of the calendar year THAT FOLLOWS the date of the triggering event.

In the case of the Flip-CRUT being funded by an illiquid asset, such as real estate, the timing of the triggering event isn’t known in advance, because the governing trust document dictates the flip to occur upon the sale of the real estate. Here again, the trust doesn’t actually convert until January 1 of the calendar year following the sale of the real estate. But it is the funding of the trust with real estate, and the subsequent sale of the real estate inside the trust, that causes the flip to occur at an unknown date in the future.

Whether the Flip-CRUT is funded with cash or securities or real estate, however, the Trustee – and whoever is managing the investment of the trust assets – has the discretion to manipulate those investments. The trust can be invested in a portfolio of investments that yield little to no income during the pre-flip years – the net income trust years. In many cases, the modest amount of income earned is more than depleted by the combination of fees charged by the Trustee, the investment manager, and the entity providing gift administration.

When the Flip-CRUT flips, at that point the asset manager will modify the investment portfolio to something more conventional – a prudent combination of equities and fixed income holdings, so as to balance the income and growth. The Trustee – and its agents – have a fiduciary obligation to balance the income needs of the current beneficiaries with the principal needs of the remainder charity. The Flip-CRUT accomplishes just that objective; typically, both the charity and the income beneficiary interests grow in value over time.
With that said, let’s get back to our original premise: the donor cannot establish a deferred charitable remainder trust that would work like a gift annuity; the rules for CRTs are fairly strict and require income – based on one methodology or another – to be paid out right away. But the Flip-CRUT is a clever way to delay the distribution of taxable income, emphasize growth of principal over the pre-flip years, and distribute a “normal” amount of income in the post-flip years.

And to end on a lighter note, here’s a fun challenge: it is said that the boiler plate trust documents provided by the federal government never actually use the word “flip!” Can anyone out there prove or disprove that assertion? If you are interested, we can provide the boiler plate documents (or show you where they are in PGM Anywhere). We’d love to hear what you find!