Separate trust
A charitable remainder unitrust with a flip provision, or "flip unitrust," is a tax-exempt trust governed by a trust agreement. You choose the trustee who is responsible for administering your flip unitrust and guiding the investment of its assets.
Irrevocable gift
A flip unitrust is an irrevocable arrangement. Once you transfer assets to create the trust, you cannot change your mind and get the assets back. This requirement assures that whatever value remains in your flip unitrust when it ends will go to support The CFMC.
Payments made for duration of trust
A flip unitrust will make payments to individuals, such as you, or you and your spouse, for as long as the trust lasts. The amount of its payments will depend on several factors, including whether or not the trust has "flipped" how it determines payment amounts.
Remaining assets to Community Foundation for Monterey County
When your flip unitrust ends, all of its remaining principal will become available to support The CFMC.
Determination of payment amount before and after "flip"
Initially, a flip unitrust makes payments each year equal to a percentage of its value, as revalued annually, or its net income, whichever is less. If the flip unitrust earns no net income during this period, for example, it makes no payments. After the unitrust "flips," it makes payments equal to a percentage of its value, as revalued annually, regardless of its net income. If it earns 3% net income one year during this period, for example, but has a stated payment percentage of 5%, it will pay 5% of its value from income and realized capital gain for the year.
Designated event causes flip
You designate the event that will cause your flip unitrust to change how it determines payment amounts. The event must be an occurrence that is not within the control of you, the beneficiary, the trustee, or any other person. Popular flip triggering events include a specific date, such as the date you plan to retire, and the sale of an “unmarketable” asset with which the unitrust was funded, such as real estate or a block of closely-held stock. The change in payment method takes effect on January 1 of the year following the triggering event.
You choose the payment %
You choose the percentage of your charitable trust’s value, as revalued annually, that it must distribute to its income beneficiaries each year, once it flips payment methods. This payment percentage must be at least 5%. It may be to your advantage to choose a relatively low payment percentage so that your charitable trust’s assets have the best chance to grow. If the value of your unitrust grows, so will its payments. A payment rate of 5% to 6% is typical. Payments are usually made in annual, semiannual, or quarterly installments.
Who can receive payments?
You decide who will get the payments from your flip unitrust. Usually, this will be you, or you and your spouse. You can, however, select other people to receive the payments. For example, you may wish to provide income for parents, a sibling, or children.
How long do payments last?
While most flip unitrusts last for the lives of one or two payment recipients, other terms are possible. A unitrust can last for more than two lives, for a specific length of time of up to 20 years, or for a combination of lives and a fixed term years.
Tax benefits
- Enjoy immediate tax savings from an income tax charitable deduction, if you itemize.
- Avoid capital gains tax.
- May reduce estate taxes if your estate exceeds the then applicable estate tax credit.
- You may reduce probate costs.
You will receive an income tax charitable deduction in the year of your gift. If you cannot use the entire deduction that year, you may carry forward your unused deduction for up to five additional years.
If you give appreciated assets to fund your flip unitrust, you will not pay any capital gains tax when you make your gift. In addition, because a flip unitrust is a tax-exempt trust, it will not pay any capital gains tax when it sells these assets. This means that your trustee will be able to reinvest the full value of the assets you donate. By removing the gift assets from your estate, you may also reduce estate taxes if your estate exceeds the then applicable estate tax credit. You may also reduce probate costs when your estate is settled.
Taxation of payments
The taxation of flip unitrust payments depends on the trust’s past distributions and investment performance. Payments from a unitrust are typically taxed as ordinary income. If the trust is funded with appreciated assets, a portion of the payments could be taxed at lower capital gains tax rates in some years. It is even possible for a portion of the payments to be tax-free in years when there is not enough ordinary income and capital gain income to make the payments.
Add funds anytime
You can add to your flip unitrust anytime. Additions to your unitrust will generate an additional income tax charitable deduction that could save you income taxes if you itemize. You will also increase your future payments without the hassle or expense of creating and administering a new flip unitrust.
Assets to consider giving
The following assets make excellent sources for funding your flip unitrust:
- Cash that you currently have in a savings account, bank CD, money-market fund, or other safe but low-yielding investment.
- Securities, especially highly-appreciated securities.
- Real estate that is debt-free, closely-held stock, and other assets that may take time to sell.
Flip unitrust as retirement supplement
A flip unitrust can work nicely as a supplemental retirement plan that also supports The CFMC. The trustee of your flip unitrust can focus on asset growth during its pre-flip years, causing the unitrust to make little or no payments to you during its early years when you don't need the income. If you set up your unitrust to flip payment methods in the year you expect to retire, then it will make payments to you equal to its full percentage amount, such as 5% or 6% of its value, starting when you need the income.
Flip unitrust as way to increase income from asset that may take time to sell
A flip unitrust also can work nicely as a way to make a gift of an asset that may take time to sell, such as real estate or closely-held stock, and increase your income at low tax-cost. During your unitrust's pre-flip period, the trustee can focus on selling your asset at a fair price without worrying about making payments to you when there isn't enough income available to make them. The sale of your asset can trigger your unitrust to flip payment methods so that from then on your unitrust will pay you its full percentage amount, such as 5% or 6% of its value, every year. Since your flip unitrust is tax-exempt, your trustee will be able to reinvest all of the proceeds from the sale of your asset.
George Hernandez, 58, made a wise $50,000 investment in Berkshire Hathaway stock years ago. It's now worth $1,200,000. He makes the maximum contribution to his 401(K) retirement plan each year and is interested in options for generating additional retirement income. He also would like to make a leadership level gift to The CFMC.
After consulting with his advisors, George chooses to fund a 5.0% flip unitrust with $1,200,000 in Berkshire Hathaway stock. His unitrust will flip payment methods when he turns 68, the age at which he expects to retire. In the intervening years, his trustee is free to sell the Berkshire Hathaway stock to reinvest in a diversified portfolio without paying any capital gains tax.
Since George doesn't want to receive payments from the trust while he is still working, the trustee can focus on investing for growth and minimizing net income during the trust's pre-flip years. This strategy will allow the trustee to minimize the trust’s payments to George during these years and to maximize them during his retirement years.
Benefits
George will receive an immediate income tax charitable deduction of $402,948. He has enough income to be able to use all of his deduction over his next five tax returns. If he itemizes deductions, the gift will substantially reduce his income taxes during this period. Once George turns 68, he can rely on receiving 5.0% of the value of his flip unitrust each year for the rest of his life.
What’s more, if the income and appreciation of the trust's investments total 7.0% annually and George lives for his life expectancy, over $3,177,033 will be left in his trust to support The CFMC.
George could not be more pleased with his benefits from his flip unitrust and is thrilled to make a gift to The CFMC that is substantially larger than he imagined would be possible.
