The Net Income Limitation:
The second major initial decision for the donor is
how to deal with the net income limitation on the CRT
payout. The decision here will largely depend on your
CRT investment policy, how immediate your need for
income may be, or whether you wish to postpone income
until a later time. There are four possibilities:
(1) Require annual payout whether or not there is
net income sufficient to pay it, i.e. take some out of
principal. But keep in mind what happens then. The
effect of failing to meet a required payout by even a
small percentage over many years has some dramatic
results. Assuming $1 million invested, an 8 percent
payout and a 7 percent overall investment return, the
principal would shrink to $739,700 in 30 years.
(2) Limit annual payout to available net income,
but include a "catch up" provision allowing shortfalls
to be paid later out of future year excess income.
This is convenient for younger donors who don't want
much income early in the life of the trust, later
switching to high income growth stocks when they
retire. This "growth without income" strategy early on
can be accomplished by investing in growth securities,
zero coupon bonds and deferred annuities. In effect,
this is using an appreciated asset to fund a pension
plan substitute, without all the reporting and
restrictions imposed on pension plans.
(3) Limit annual payout to the lowest of either
the established annual payout amount or, the available
net income. If the CRT is funded with non-liquid
assets like closely held corporation stock or real
estate with little current income, this option is the
best.
(4) Impose no net income limitations, thereby
leaving open the possibility of employing a more growth
oriented investment approach to produce an increased
total return. This makes sense when the CRT is funded
with liquid assets which can easily be invested and re-
invested - and when there is full-time, careful
management.
These sorts of multi-year dollar projections are
easily done by computer and should be available before
choosing the rate of return and any net income
limitations. Also note that when we use the phrase
"annual payout" in all of these alternatives, that
includes the possibility you may elect to have payments
semi-annually or quarterly, both of which are common.
The "bottom line" as they say, on these choices is
that while a CRT is a very useful investment device, in
order to be successful the donor has to take a hard-
eyed look at future economic realities, including
inflation and long-term rates of return, before
choosing an approach that matches the donor's goals.
It also means consideration of a lower payout rate,
which may easily be more productive in the long haul.
On a related point, trust donors can establish a
longer term CRT that benefits them during their lives,
then afterwards benefits successor generations of
children and grandchildren. This has the effect of
maximizing the cumulative impact of tax-free
comdollaring of value. Careful planning must go into
such an arrangement in order to avoid adverse estate
tax and generation-skipping transfer taxes, but it can
be done - and the many years of comdollaring makes it
all worthwhile.
