Comparison of Investment Choices for CRTs
Deferred annuities are the investment of choice for Net Income with Makeup Charitable Remainder Unitrusts (NIMCRUTs) when income deferral is the objective. Renaissance has long endorsed this concept and this material is designed to help a planner understand how and why to use deferred annuities for income deferral in a NIMCRUT. Deferred annuities can also be the investment of choice for NIMCRUTs not in deferral status, as demonstrated by an example later in this section. Deferred annuities may also be used as an investment vehicle in a Standard Charitable Remainder Unitrust (SCRUT).
Planners should take caution when funding any NIMCRUT with an annuity. Income can only be paid to beneficiaries when the annuity has produced a gain over basis. Unlike a mutual fund, which could continue to create dividends and realized gain on the sale of individual stocks within the fund, annuities will not generate net distributable income when their market values drop below the original purchase price.
Annuities in a SCRUT
The use of annuities to fully or partially fund a SCRUT raises a number of total return and taxation issues that must be analyzed by a financial planner before a recommendation can be made. Most would suggest a money management approach for SCRUTs that emphasizes total return with consideration given to the advantage of capital gains versus ordinary income as it relates to four-tier accounting.
Comparing the total returns of annuities to mutual funds presents challenges to planners. It is sometimes stated that annuities trail mutual funds in total return comparisons due to the mortality and expense charges associated with annuities. Other factors affecting total return include sales charges and potential surrender fees. For these reasons, financial planners and money managers should analyze expected total returns of annuities and mutual funds in light of potential fees.
If a SCRUT is funded with a mutual fund, normally the growth from the fund will be split between dividend and capital gains. To the extent non-qualified dividends and short term capital gains - treated as ordinary income for tax purposes - are less than the stated payout rate, the income beneficiary will receive more favorable tax treatment on a portion of the income payment.
The annual gain over basis in an annuity contract is always treated as ordinary income for trust accounting purposes. A SCRUT must distribute a percentage of trust assets to the income beneficiary annually in accordance with the stated payout rate. In accordance with four-tier accounting rules, the tax character on income distributions will first come from ordinary income earned by the trust.
Annuities in a Non-Income Deferral NIMCRUT
Annuities can be an excellent choice for investment strategy in a NIMCRUT that was not designed for income deferral. Annuities provide the easiest method to create net distributable income when the annuity has increased in value. To generate net distributable income, the trustee or independent special trustee makes a withdrawal from the annuity contract. To ensure there is some income it may be desirable to consider a deferred fixed annuity.
Other types of investment alternatives may require the trust to sell a larger portion of the investment to create net distributable income. For example, selling $20,000 of mutual funds shares will not create $20,000 of net distribuatble income because the funds have a cost basis and income must be created before a distribution can be made. This of course assumes the trust document includes capital gains = income language. Please refer to the provided example for more details.
Annuities in an Income Deferral NIMCRUT
Although it is possible to defer income from a NIMCRUT with other types of investments, in practice the annuity has been the vehicle of choice that gives the trustee the most flexibility in controlling the timing of trust income without market timing risk.
Comparison of Investment Benefits
This chart shows the advantages of annuities as compared to other types of deferral investments for a NIMCRUT.
| MANAGED ACCOUNT OR MUTUAL FUNDS | ZERO COUPON BONDS | DEFERRED ANNUITY | |
|---|---|---|---|
| Allows income to be turned on and off at will by the simple election to withdraw from the annuity contract. | No | No | Yes |
| Allows the trustee to make up past unpaid income payments by withdrawing in excess of the payout requirement for the current year. | No | No | Yes |
| Prevents principal loss when switching investments at an inopportune time to achieve income for distribution. | No | No | Yes |
| Allows the trustee to adjust the payout of the trust without revising or reforming the trust to elect a new payout rate. | No | No | Yes |
| Allows the trustee to suspend the payment of income in any year for the beneficiaries' income tax planning needs. | No | No | Yes |
| Provides a flexible income stream to the beneficiaries without subjecting the trust assets to investments beyond their risk tolerance. | No | No | Yes |
