Using a unitrust as a pension alternative.

• Author: Robbins, Valerie C.

Charitable remainder trusts have many uses, but one frequently overlooked use is as a substitute for a pension.

A charitable remainder unitrust requires an annual payout of a fixed percentage of the trust's assets, valued annually. This fixed percentage must be 5% or more. As long as the trust's assets are growing, the required payout will also increase. At the termination of the trust, all assets go to charity.

To defer distributions, the trust can be designed, under Sec. 664(d)(3), to limit the annual payout to the net income earned each year. In addition, any unpaid amounts may be "made up" in years when trust income exceeds the fixed payout percentage. The result is smaller distributions in the early years and larger distributions in later years. This make-up provision allows a unitrust to function as a pension alternative.

Example: J is 55 years old. He puts $50,000 in a charitable remainder unitrust, naming himself as the income beneficiary for his life with the remaining trust assets going to his favorite charity on his death. He selects an annual payout percentage of 5.1%, limited to the annual income of the trust with a make-up provision for years in which the trust's income exceeds the payout percentage. The independent trustee invests the assets to obtain a 9% total return, but changes the portfolio mix over time:

Age Income Appreciation Total 55-64 2% 7% 9% 65-74 7 2 9 75-90 5.58 3.42 9 During the trust's first nine years, the income earned is substantially below the required payout percentage (2% versus the 5.1% required payout). For the next 10 years, the trust's income is higher than the required payout and J receives the "make-up" amount over this period. For the last 15 years of the trust, the income roughly equals the required payout.

The results: J gets a charitable contribution deduction of $18,392 in the year he sets up the trust (calculated according to Regs. Sec. 1.664-4). J gets an income stream ranging from $1,000 to $2,172 per year (totaling $23,4791 over the first nine years of the trust. This is taxable to J according to a four-tier structure: first, as ordinary income to the extent of the trust's ordinary income; next, as capital gain to the extent of the trust's capital gain; then, as any other income, such as exempt income; and finally, as distributions of...