In This Issue

• Have Your Cake and Eat It Too With a Charitable Lead Trust
• The Scoop on 529 Plans

Editor's Note: In the September 2002 Newsletter, we indicated that only trusts "residing" in Ohio are subject to the new Ohio trust income tax. Please also be advised that trusts which may have a residence outside of Ohio but with certain income generated in Ohio could be subject to Ohio income tax. As we urged in September, check with your advisor to determine if your trust is subject to Ohio income tax.

Have Your Cake and Eat It Too With a Charitable Lead Trust

By Erika L. Haupt

Benefactors are often caught between charitable giving and passing assets to family members. While you want to help charity, you also want to help your children. A charitable lead trust ("CLT") may satisfy both goals.

A CLT is split-interest trust with both charitable and noncharitable beneficiaries. The charitable beneficiary receives a series of periodic payments for a set term. At the end of the term, the noncharitable beneficiaries receive whatever trust assets remain.

The primary purpose of a CLT is to reduce, or even eliminate, gift and estate taxes while still transferring significant assets to family members — and making a nice gift to charity. Assume you transfer $500,000 to a CLT today, and you have already exhausted your $1 million gift tax exemption. You designate that a charity will receive a $25,000 fixed annuity each year (5% of $500,000). After 10 years, the remaining trust assets will pass to your children. The present value of the charitable annuity interest is $206,870, which may be structured as an income tax deduction in the year you create the CLT. The present value of the assets passing to your children at the end of 10 years is $293,130, which is subject to gift tax. You will have to pay a gift tax of about $121,000 when you set up the CLT, but writing that check today will result in a big bonus to your children 10 years from now. Even after giving the charity $25,000 annually for 10 years, your children will receive $717,298 (assuming an 8% growth rate) free from additional gift or estate tax. When all is said and done, your family will "net" nearly $600,000 and the charity receives $250,000.

What if you had just held on to that $500,000? Assuming an 8% growth rate, you would have $1,079,462 after 10 years. Deducting income taxes leaves you with about $800,000. If you gave that money to your children under your estate plan, it may be subject to a 50% estate tax, which leaves your children with $400,000. Compared with the CLT, holding on to the money is a bad deal. More passes to your children using a CLT and charity gets $250,000. Essentially, the IRS is your charity if you hold on to the money.

How can a CLT work so well? The IRS recognizes that $1 today is worth more than tomorrow. The Internal Revenue Code takes that time value of money concept into account in prescribing how to calculate the CLT remainder interest gift. It also sets a low growth rate (the applicable federal rate or "AFR") to use in CLT tax calculations. The AFR is based on government bond rates, and the rate a taxpayer could use for December 2002 is 3.6%. Over time, most investors will realize a return significantly higher than 3.6%. It is the potential for "extra"growth to pass to your children gift and estate tax free that makes a CLT so attractive — especially with today's low rates.

A CLT may be created either upon your death or during your lifetime. For CLTs created upon death, your estate is not entitled to an income tax deduction, but it receives an estate tax deduction based on the present value of the charitable interest.

For lifetime CLTs, you may take an income tax deduction for the charitable interest in the year you create the CLT. In the second and following years, you must report the income earned by the CLT even though it is actually paid to the charity in the form of an annuity. Why create a trust that produces a high deduction in the first year but requires you to report income you do not receive in later years? Acceleration of the deduction. Suppose you just sold a highly appreciated asset or you believe you are at your peak earning potential and are thinking about retirement. It is smart planning to have a high deduction in a high bracket year even if you have to report that income in lower bracket years. You are spreading out the income (and the tax) over many years.

You have significant flexibility in drafting the terms of the CLT. An individual, including yourself, or a corporation may serve as trustee. You select the number of years that the charity will receive a benefit. You decide whether the annuity is fixed (a set percentage based on the initial value of the CLT) or variable (a set percentage based on the value of the CLT each year).

CLT is a great planning strategy to consider for lifetime giving or transfers at death. With prudent investing, it allows you to pass assets to your family with little or no transfer tax liability while at the same time including charitable giving in your estate plan.

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The Scoop on 529 Plans

By Erika L. Haupt

A 529 plan — you have heard about it, but what is it? What are the advantages? How do you enroll? Are there drawbacks?

A. What Is a 529 Plan?

A 529 plan is a state-operated investment program providing a federal income tax-free vehicle to save money for college, university, vocational school, or other qualified post-secondary educational institution expenses. There are two types of 529 plans: College savings plans and prepaid tuition plans. Every state offers one option and many offer both. College savings plans are used by beneficiaries for college expenses at any college or university. Prepaid tuition plans allows grantors to lock in future tuition at in-state public colleges or universities at today's prices.

B. What Are the Advantages of a 529 Plan?

1. Earnings are exempt from federal income tax.

2. Withdrawals are exempt from federal income tax as long as the funds are used for college expenses.

3. Contributions may be deductible for state income tax purposes. Ohio allows a contributor (or a married couple) to deduct up to $2,000 each year per beneficiary with unlimited carryforward.

4. Maximum contribution limits are high. Limits vary from state to state, but some states have a ceiling as high as $250,000 per beneficiary.

5. 529 contributions are considered completed gifts and are eligible for the $11,000 per person annual gift tax exclusion. In fact, you may "front load" your annual exclusion gifts for 529 contributions up to $55,000 per person. In other words, you could make a $55,000 contribution to a 529 plan this year without paying gift tax but you could not make annual exclusion gifts to the 529 plan beneficiary for 5 years following the $55,000 contribution.

6. There are investment options for 529 plans. Depending on the state, you may choose from a number of investment options. You may also switch investment options once a year.

7. You may shop around for 529 plans. Most states' 529 plans are open to residents and nonresidents. You may roll your 529 plan of one state into another state's plan without penalty.

8. You may change the beneficiary of a 529 plan to another family member or even yourself.

9. You may terminate the 529 plan or withdraw funds subject to penalty and taxes (see D(2), below).

10. More than one 529 plan may be created for a single beneficiary.

11. There is no penalty if a student attends a post-secondary educational institution outside the state that sponsors the 529 of which the student is a beneficiary.

C. How Do I Enroll?

1. Enrollment in most states' plans is open.

2. Many states have downloadable forms on the internet. See www.collegeadvantage.com for Ohio and www.savingforcollege.com or www.collegesavings.org for other states.

3. The minimum contribution amount may range from $15 to $50.

D. Are There Disadvantages?

1. You control the plan, but your investment options are limited.

2. If funds are withdrawn for purposes other than education, earnings are subject to a 10% penalty as well as federal income taxes. States may also assess penalties.

3. The 529 plan assets may affect a beneficiary's financial aid qualifications.

4. Only cash may be contributed to a 529 plan (not securities, real estate, etc.).

5. A 529 plan may have only one beneficiary.

More and more clients are hearing the buzz about 529 plans. Although the plans have been around since the mid-90s, they have really taken off within the last few years. For many parents and grandparents, a 529 plan is a wonderful college savings option. In virtually every instance, a 529 plan is more attractive than the traditional educational savings options such as Coverdell Education Savings Accounts (formerly Education IRAs) and Uniform Transfers to Minors Accounts.

Plan choices vary from state to state, so it is important to do your homework. The good news is that regardless of the 529 plan you choose, you may change your mind and even unwind the plan. With states competing for your contributions and colleges now having the ability to create their own programs, 529 plans are becoming more flexible with greater tax perks. If you are considering options for college savings, take a look at a 529 plan.

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