Investing Charitable Remainder Trusts
in a Charity’s Endowment
Written for Silicon Valley Community Foundation by Jason M. Baxendale, Kaspick & Company

In the fall of 2003, Harvard University received a Private Letter Ruling (PLR) to invest its charitable remainder trusts (CRTs) in the University’s endowment. Since then, other charities have received similar rulings. While the PLR is a creative approach to including alternative assets in charitable trust portfolios, it raises some significant issues.

How it Works: Under the PLR, to earn the return of the charity’s endowment, a CRT does not actually invest directly in the endowment. Instead, the charity creates a contractual obligation under which it issues units in the endowment to the CRT in exchange for the assets of the CRT. The units give the CRT a contractual right to the total return of the endowment and to receive spending distributions from the endowment. The CRT has no direct interest in the underlying investments of the endowment.

The IRS ruled that the endowment distributions received by the CRT are not unrelated business taxable income (UBTI); however, it also ruled that they are taxed as all ordinary income. This approach obviates the need for detailed flow-through accounting of activity within the endowment. It does not, however, eliminate the need to track basis and account for gains when a trust redeems units in the endowment. Only CRTs where the charity is the 100% remainderman are allowed to participate.

This approach gets around the UBTI, investor qualification, tax reporting and valuation issues that would arise if one tried to invest a trust directly in the endowment. This solution, however, required a major compromise, namely that the income beneficiary’s income (the portion up to the charity’s endowment spending rate) be taxed at the highest ordinary income tax rate for non-qualified income.

Summary of the Pros and Cons:

Pros:

• Many donors and income beneficiaries are interested in investing in a charity’s endowment because of the portfolio’s strong historical or expected returns or because it gives them a closer connection to the charity.
  
• If the endowment, with its large size and investment talent, can earn competitive investment returns over time, CRT payments and remainder values will be larger.

Cons:

• The endowment must earn a competitive return significantly ahead of a more tax-efficient investment strategy to make the CRT’s income beneficiaries whole after taxes; unless the incremental return is achieved, the remainderman could benefit, while the income beneficiary suffers (the charity trustee has an obligation to fully disclose this risk).
  
• The equity allocation of most endowments today is 80%-85%, which may not be an appropriate level of risk for many CRTs given their horizons and the way annual trust distributions are calculated (most trust distributions are calculated based on an annual valuation, without the benefit of an endowment-like smoothing rule).
  
• There are likely to be many CRTs that for various reasons cannot participate in this scheme; the charity will have to continue to maintain an alternative investment program for them. Because of the costs incurred in setting up and administering multiple approaches, only charities with large programs will likely find this to be cost effective.

Recommendations: Increasing the expected returns on planned gifts is an objective we all share. However, the approach outlined in the PLR is not an option offered by Silicon Valley Community Foundation due to the significant trade-offs and complexities. When contemplating charitable remainder trusts, professional advisors and their clients should carefully consider their options and ensure their CRT’s trustee and investments works best for individual circumstances.

Jason M. Baxendale
Relationship Manager, Kaspick & Company
Jason joined Kaspick & Company in 2006 after serving as the director of gift planning for The Chicago Community Trust where he was responsible for the management of a comprehensive gift planning program. Prior to joining the Trust he served as the associate regional director/endowment specialist for the Boy Scouts of America. He began his career as a Trust Advisor for UMB Bank in Kansas City, Missouri. Jason holds a BA from Kansas State University, an MBA degree from the University of Missouri-Kansas City and a JD from Washburn University School of Law.