Another Case Study to Examine

Another Case Study to Examine

Article posted in Charitable Remainder Trust on 28 August 2014| 7 comments
audience: National Publication, Two Hawks Consulting, LLC | last updated: 28 August 2014


In this brief article, we seek your knowledge and advice on another tricky estate mess. Read on and reply.

by Randy A. Fox

Recently another colleague called me with yet another example of poor design and poor execution in a large charitable gift case. The call to me was to talk through various options to rescue the elderly couple, who were the income beneficiaries of this plan, or at least to mitigate their situation. We made some progress but the issue is still unresolved.

Here’s the story. Many, years ago, the couple, a successful executive and his wife, established a charitable remainder unitrust to benefit their alma mater and several other charities that they were closely affiliated with. The university was the moving force behind the decision and the 80% beneficiary and trustee of the trust. The trust was a net income trust, the only one I’ve ever seen in my career. The trust was funded with $2 million of appreciated securities originally. Those securities were sold and reinvested for income. Later, the trustee convinced the couple to contribute their home to the trust (after they’d moved out and before it was sold, of course). Now the trust was worth close to $3 million but the couple had little other net worth.

Currently, they live in a senior residential community but the expense absorbs virtually all of their income. In today’s low interest environment, the trust is only able to produce $60,000 annually. All that remains of their other assets has been spent and they only have Social Security income as a buffer. This is a situation where the couple’s benevolence has unintentionally impeded their own peace of mind. The couple believes that if they could get enough cash to buy a condo, their living expenses would drop dramatically and they could exist on less money. They’ve asked us to rescue them from this unfortunate mess.

In our several conversations we have considered a number of options. Our first was to bifurcate the trust and sell the remainder interest in one of the trusts. That would provide the couple with enough after tax cash to purchase their condo but would also reduce their income by half. We’ve also considered some sort of judicial reform in order to apply UPIA to produce higher distributions from the trust. We also found a fixed annuity that could raise the income to a little over 3% but what if interest rates rise in the meantime? There are no easy answers to be found, though there seldom are in situations such as this.

Currently the situation is not completely resolved. I’m resigned to the fact that there is not a miracle to be produced and I can’t fix everything for them. They are still fiercely charitable and steadfastly loyal to their institutions of choice. And we’re still working to improve their lives. Suggestions anyone?

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Re: Another Case Study to Examine

Randy, $60k annual income is only 2% of a $3mm portfolio. Why not implement the Household Endowment Model using the Bucket Strategy income plan? Put 25% of assets into an income variable annuity producing at least 4.5% guaranteed with a chance to get raises, 25% into non-publicly traded REITs and BDCs producing 6% to 7.5% of durable income, the balance between short duration bonds yielding about 3.5% and dividend growing stocks offering some growth potential and 4% dividends. We've just increased their income by a ton with very little additional long term market risk.

Re: Another Case Study to Examine

Thanks for your reply. Adjusting the portfolio has been suggested though the trustee, is the Institution with its own portfolio manager. doubt we'll get them to go for the REIT

Re: Another Case Study to Examine

It might be worth taking a close look at the circumstances of the trust's creation and administration to see whether there might be a case for malpractice. Did the couple have independent counsel when the trust was drafted? Was the trust created before the IRS "window" for reforming NIMCRUTs in 1999-2000? If so, why was the trust not reformed at that time? If it was created after that time, why was it structured as a NIMCRUT?

What about the trust's current investment mix? Is it yielding $60K because it's in a diversified portfolio with some potential for growth, or has the trustee piled everything into bonds, trying to maximize what they can currently pay the donors (but exposing the trust to enormous risk if interest rates should rise)?

How old are the beneficiaries? If the trust is diversified and still has a long time horizon, both income and remainder beneficiaries can benefit if assets grow -- but the remainder beneficiaries probably stand to get the lion's share of the benefit. If there is a case for malpractice, could a suit perhaps be filed that would permit a (hopefully quiet) settlement whereby the trustee settles by making some kind of payment from assets other than the trust? (I get that the couple remains loyal to the trustee, but it sounds like the couple may have been genuinely harmed by the trustee.)

It also sounds like it might have been malpractice for the house to have been placed into the trust (or at least a 100% interest in the house), depending upon when it was done. Were the donors eligible for some exclusion from capital gains on the sale of the residence? If so, why did they give the entire residence and not an undivided fractional interest that would enable them to use the exclusion? Again, was there independent counsel? Was the couple even advised to seek independent counsel?

Do the couple have any children? The trustee should consider that if it bears responsibility for the creation of this situation, it is probably only playing ostrich by ignoring these questions during the donors' lifetimes.

All of that said, perhaps some consideration should also be given to whether buying the condo is really a good solution for this couple. If they move to a situation that does not provide the assistance that a residential community provides, are they just kicking the can down the road?

Re: Another Case Study to Examine

Thanks for the great feedback. Remember this is a NICRUT, not a NIMCRUT. It is also unlikely the couple will sue over malpractice though they may have some cause of action, especially as it pertains to the house. I'm still of a mind to think that a judicial reform might make "post gift as income" a reality which would solve a lot of issues.

Re: Another Case Study to Examine

What a great question!! After considering an actuarial split, it occurs to me that the real problem is the 2% income being generated. That could be doubled just by changing investments, there are many safe investments that would generate 4% easily and I have one fund BP PRUDHOE BAY REIT that generates 11%. My point is that we tend to think of the legal solutions when changing investments may well increase the income dramatically without undertaking more radical approaches. As Steve Leimberg would say, "Hope this helps" and have a great Labor Day.

Re: Another Case Study to Examine

Robert, sorry I missed your comment. Adjusting the portfolio is an option though with the Institution as trustee, there are many challenges

Re: Another Case Study to Examine

Without knowing anything of any legal or tax implications.... I'd negotiate with the remainder men to get the now hapless donors a life estate in some dwelling owned by the college (or a friend of the college) in exchange for judicial termination of the CRT to give the college immediate cash.

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