The annuity that zeroes out the gift, the remainder the family receives, what the 7520 rate and the trust's return do to it, and the back-loaded variant.
A charitable lead annuity trust (CLAT) pays a charity a fixed annuity for a term of years and then passes what is left to the family. The taxable gift is the trust's value less the present value of the annuity at the section 7520 rate, so an annuity sized to zero it out makes the gift nil. On an illustrative 10,000,000 over 20 years at a 5.0 per cent 7520 rate, the charity receives 802,426 a year and, if the assets earn 7.0 per cent, the heirs receive 5,801,001 free of gift tax.
Worked in full in The Family Office Professional by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A CLAT is the mirror image of the charitable remainder annuity trust. There, the family takes the annuity and the charity the remainder. Here, the charity takes the annuity first, and the remainder goes to children or a trust for them. The IRS values the charity's annuity at the 7520 rate, published monthly. If the assets earn more than that rate, the excess stays in the trust and reaches the heirs without using any gift or estate tax exemption. The logic is the same as a zeroed-out GRAT, with a charity in place of the grantor as the annuitant.
| Input | Value |
|---|---|
| Assets transferred to the trust | 10,000,000 |
| Term | 20 years |
| Section 7520 rate (illustrative) | 5.0% |
| Return earned by the trust assets | 7.0% |
| Annuity paid to charity | Level, at each year end |
Annuity factor at 5.0% for 20 years = (1 − 1.05−20) / 0.05 = 12.4622
Zeroing annuity = 10,000,000 / 12.4622 = 802,426 a year, 8.02 per cent of the gift
Excel: =PMT(5%, 20, -10000000)
Taxable gift = 10,000,000 − 802,426 × 12.4622 = 0
The charity receives 16,048,517 over the term. On paper that is worth exactly the 10,000,000 transferred, discounted at 5.0 per cent, which is why the gift of the remainder is valued at nil.
Remainder = Gift × (1 + g)n − Annuity × ((1 + g)n − 1) / g
= 10,000,000 × 1.0720 − 802,426 × 40.9955 = 38,696,845 − 32,895,844 = 5,801,001
Excel: =FV(7%, 20, 802426, -10000000)
| Year | Balance |
|---|---|
| 1 | 9,897,574 |
| 5 | 9,410,976 |
| 10 | 8,584,838 |
| 15 | 7,426,138 |
| 20, to the heirs | 5,801,001 |
The balance falls every year, because the annuity of 8.02 per cent exceeds the 7.0 per cent return. The remainder is what is left of the two-point spread between the return and the 7520 rate, compounded for twenty years: in today's money, 10,000,000 less the annuity discounted at 7.0 per cent is 1,499,089, which grows to 5,801,001 by year 20.
| Trust return | Remainder at year 20 |
|---|---|
| 3% | nil, trust runs dry in year 16 |
| 5% | 0 |
| 6% | 2,553,645 |
| 7% | 5,801,001 |
| 8% | 9,888,987 |
| 10% | 21,316,058 |
| 7520 rate | Zeroing annuity | Remainder |
|---|---|---|
| 3.0% | 672,157 | 11,141,434 |
| 4.0% | 735,818 | 8,531,644 |
| 5.0% | 802,426 | 5,801,001 |
| 6.0% | 871,846 | 2,955,106 |
The structure is a bet on the spread. Every point of 7520 rate at funding costs the heirs roughly as much as a point of lower return. When the return falls short of the rate, the family loses nothing to tax, since the gift was nil, but the trust may run dry before the term ends and the charity, not the family, bears the shortfall.
Unlike a GRAT, a CLAT has no rule limiting how fast the annuity may rise from year to year, so some planners back-load it, a structure often called a shark-fin CLAT. Pay the charity 100,000 a year for 19 years and a balloon of 23,326,382 in year 20; at 5.0 per cent that still has a present value of 10,000,000 and the gift is still nil. At 7.0 per cent the heirs now receive 11,370,914, or 5,569,913 more, because more of the money stays invested at the higher return for longer. The charity receives 25,226,382 in total, later. Whether a particular payment pattern is acceptable is a question for counsel; the arithmetic is not.
The cost of the office that runs structures like this, and when it pays, is in the free workbook for this book.
Divide the amount transferred by the annuity factor at the section 7520 rate for the term: (1 - (1 + r) to the power of minus n) / r. For 10,000,000 over 20 years at an illustrative 5.0 per cent, the factor is 12.4622 and the annuity 802,426 a year, which in Excel is =PMT(5%, 20, -10000000). The remainder interest is then valued at 0 for gift tax.
The order of the beneficiaries. In a charitable remainder annuity trust the donor or family takes the annuity and the charity receives the remainder. In a charitable lead annuity trust the charity takes the annuity and the family receives the remainder, which on 10,000,000 over 20 years at a 7.0 per cent return and a 5.0 per cent 7520 rate is 5,801,001.
When the trust earns no more than the 7520 rate used at funding. At a 5 per cent return against a 5 per cent rate the heirs receive 0, and at 3 per cent the trust runs dry in year 16. A zeroed-out CLAT that fails costs no gift tax, but the charity receives less than it was promised.
This article is one calculation from The Family Office Professional. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: private equity and private markets → · All 1340 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.