The purpose of estate tax planning is to maximize the assets you pass on to future generations by minimizing gift and estate taxes. Estate-tax strategies revolve around the use of irrevocable trusts. This article discusses the most common types of irrevocable trusts that are used to minimize gift and estate […]
Key Points:
In this article, we’ll review how when you take NIMCRUT distributions can affect the returns you receive from the structure. The main question this article looks to answer is if you are trying to maximize the value you get from a Charitable Remainder Trust, should you try to maximize the distributions you take each year or try to leave as much in the trust for as long as you can? To do so, we’ll take a look into three different scenarios and compare the post-tax value after 20 years:
You may be wondering what a NIMCRUT or Net Income with Make-Up Charitable Remainder Unitrust is.
A NIMCRUT is very similar to a standard Charitable Remainder Unitrust (CRUT), with one notable exception. With a standard CRUT, you receive a fixed percentage of the trust’s value as a payout every year, regardless of whether the trust’s assets grow or shrink in value or have any income. With a NIMCRUT, although you are still entitled to that amount every year, you will only receive the trust’s income from the year up to that distribution limit.
In other words, a NIMCRUT pays you the lower of the trust’s net income or the standard payout.
Practically, this means that if the trust doesn’t have enough income to pay out the fixed percentage of the trust’s assets that it owes you, you’ll only receive whatever income the Charitable Remainder Trust has. And if there’s a shortfall — i.e. if the trust doesn’t have enough net income to pay the whole amount it owes you, the difference carries over to future years.
That’s where the “make-up” in Net Income with Makeup Charitable Remainder Unitrust comes from. It’s similar an account receivable that accrues the value of when the NIMCRUT pays you less than what it owes you. Importantly when the trust has income it will start to pay out the amount the trust owes you, or the value of the make-up provision. Why is this distinction important for understanding the NIMCRUT term? Because you can use the make-up account to defer your NIMCRUT distributions and allow your money to grow tax-free for longer in the make-up Charitable Remainder Unitrust and create more wealth for yourself as the longer your assets grow tax free, the faster they will grow. You can read more about the different types of CRUTs here.
Now lets get back to the case study.
Since we are assuming no income is generated from the assets in the form of dividends, at the end of the first year, the trust will be worth $1,110,000. At an 11% payout rate, that means a unitrust amount of $122,100 (as the 11% payout rate in this scenario is based on the end-of-year value of $1.11m instead of the beginning-of-the-year value of $1m). Since there are only $110,000 worth of unrealized gains, when the assets are sold, the maximum amount distributable is $110,000, meaning $12,100 will go into the make-up account. Notice that the trust is now worth $1,000,000 again.
Since we assume a constant growth rate, and the payout rate doesn’t change, every year will be similar, meaning, in every year the trust will:
One thing to keep in mind is that the $110,000 in distributions will be taxed, meaning after-tax you’ll receive $71,500 to reinvest (in this case study, we are growing these reinvested assets at the same 11% growth rate).
After 20 years, repeating this process, here’s how the numbers come up:
In this scenario, at the end of the first year, the trust will also be worth $1,110,000. And the unitrust amount will also be $122,100. However, since in this case the gains are not realized, there’s no distribution to be made. In this case, the make-up account will grow by the entire owed unitrust amount ($122,100).
On the second year, things start to look different from the first scenario. Since you start with the full $1,110,000 in the trust, at the end of the year, the trust’s value is now $1,232,100 after an 11% growth rate. The unitrust amount for year 2 will be $135,531 and the make-up account is now $257,631 (Year 2’s unitrust amount plus the owed distributions from year 1 that weren’t paid out). If you continue this out for 20 years you will notice that every year:
How do the trust numbers look like at the end of year 20?
Since the trust is ending this year, the assets are fully sold, realizing a gain of $7,062,311.54. After paying taxes, you will be left with $4,590,502.50.
In this scenario, when you first sell your assets, you’ll need to pay the 35% tax upfront, meaning you start the term with $650,000. After growing that for 20 years at 11%, you have $4,721,173 for which you will have to pay taxes (only on the appreciation from the $650,000 investment amount), meaning that after taxes, you’ll have $3,296,263.
After all the taxes are paid, the second scenario where you defer distributions yields an extra 31.7% after taxes compared to the first scenario and 39.3% greater than not using the trust.
| Scenario | Personal Value | Make-up Amount | Charitable Donations |
|---|---|---|---|
| Maximizing annual distributions | $3,484,326.62 | $242,000 | $1,000,000 |
| Leaving the assets in the trust | $4,590,502.50 | $6,952,311.54 | $1,000,000 |
| Not using a trust | $3,296,263 | N/A | N/A |
Critically the longer you set up the trust for, the larger the differences in the returns of keeping your assets in the trust. Simply put, the longer your assets can grow and be reinvested pre-tax, the faster they grow and the larger the returns will be.
One important assumption this case is making is that the assets keep growing. The risk involved in the second scenario is that if the assets drop by 20th year, the trust may not have enough unrealized gain to distribute. Or you could distribute less than the full amount owed to you (as you could sell when you notice the assets are dropping, realizing a minor, although still positive gain).
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