Are you Interested in Generating Some Extra Cash?


Choosing the Payout Rate:

Let's consider first the decision concerning establishing the payout rate itself.

If your immediate need is for high income levels, choosing a relatively high payout rate makes some sense. But if you are a donor beginning retirement, you should choose a payout rate that leaves sufficient funds in the CRT each year to keep your trust income ahead of projected inflation.

One approach would be to specify a relatively high payout rate, say 8 percent, and permit payment to be made from principal if trust net income is insufficient to meet this obligation to the beneficiary. In such a case investment would be almost entirely for growth purposes and well-capitalized growth stocks might be the place to look.

From 1946 through 1991, the best U.S. stocks have produced a return averaging about 12.7 percent annually. With an 8 percent payout and a growth stock investment policy, after administrative costs, it can reasonably be expected that about 4 percent of the fund could be added to trust principal each year. The difficulty with this approach is that the annual rate of return left in the CRT each year must at least equal or surpass the annual rate of inflation, in order to preserve the purchasing power of future distributions and the ultimate remainder interest. An equal problem will be that annual payouts will be highly variable from year to year, because of inevitable fluctuations in the stock market. The donor/beneficiary must be willing to put up with this variable payout prospect as the price of higher investment income.

Economic realities in the U.S. and the world will make it difficult, if not impossible, to produce a gross income return in excess of 8 percent, even if the CRT portfolio is invested totally in fixed income holdings, assuming the purchase of investment grade debt instruments. Expenses chargeable to income must also be subtracted, so the net income is likely to be even lower. For comparison's sake, consider that the highest quality long term bond yields have historically averaged about 4 to 5 percent a year. Assuming that the CRT will hold long term bonds to maturity, this part of the trust principal will not grow with inflation. Remember that if the CRT principal does not grow, neither does the income of the beneficiaries. As an illustration of what happens when these factors are applied to CRT investment, a good case can be made that a conservative 5 percent payout rate will have the best all around results in the long term, if there is the right mix of investments and careful management.

Assume in year one $1 million available for investment; a total trust investment mix of about 40 percent bonds with an annual 7 percent rate of return, 30 percent Standard and Poor's 500 stocks with a return of 12.7 percent, and another 30 percent split evenly between fast-growing U.S. and international small equities with rates of return of about 15 to 16 percent plus. Under this investment mix, with a 5 percent CRT payout rate, the $1 million will blossom in 20 years to about $4,800,000, of which $2,326,000 will be paid out to the beneficiaries.

Compare this with the choice of a higher 7 percent CRT payout rate; the same $1 million invested totally in safe no-growth long term bonds at 7 percent net annual return, in 20 years will leave only $1 million in principal, after cumulative annual beneficiary payments of $1.4 million.

Check that comparative 20-year record again: a 5 percent payout rate with a carefully mixed investment policy produces $2.3 million in benefits; a 7 percent payout rate with a no growth investment policy produces $1.4 million in benefits. The 5 percent choice ends up with $4.8 million remainder for charity, the 7 percent, only $1 million - each with concomitant charitable income tax deductions for the donor in the first year based on the rate of payout chosen in year one.