© Stephan R. Leimberg, Daniel B. Evans, 1999. All Rights Reserved.
Reprinted with Permission.
Section 7520 /1/ of the Internal Revenue Code, adopted as part of the Technical and Miscellaneous Revenue Act of 1988, significantly changed the way life estates, annuities, and remainders are valued for federal estate and gift tax purposes. It required the use of (a) a discount rate calculated monthly from the applicable federal rates derived from the yields on federal securities /2/ and (b) a mortality table to be revised periodically.
Section 7520(c)(3) mandated that Treasury issue revised actuarial tables not later than December 31, 1989, to take into account the most recent mortality experience available as of the time of the revision, and to revise those tables at least every 10 years thereafter to take into account the most recent mortality experience available at the time of the revision. The 100-plus page change in the valuation tables effected by proposed and temporary regulations (REG-103851-99; T.D. 8819), which were released April 29, 1999, and became effective as of May 1, 1999, is the result of that mandate. (For the full text of the proposed and temporary regs, see 1999 TNT 89-149 or Doc 1999-15969 (2 original pages.) It significantly affects the valuation of both inter vivos and testamentary transfers of interests dependent on one or more measuring lives. (Because of the uncommonly short notice, the temporary and proposed regulations provide transitional rules to alleviate adverse consequences from the regulatory change.) A complete set of the annuity and life interest factors will be found in the forthcoming Treasury 1999 guidance, Publications 1457, "Actuarial Values, Book Aleph," 1458 "Actuarial Values, Book Beth," and 1459, "Actuarial Values, Book Gimel." /3/
As noted, these new tables will have significant effects on both advisers and their clients and on the tools and techniques of financial, estate, and employee benefit planning. Specifically, the new tables, based on the 1990 census, change every actuarial factor in every table involving one or two lives. /4/
To those who are not mathematically oriented or who cannot find or create software to handle the task, working with time-value- of- money sensitive financial and estate planning tools and techniques can resemble a very bad dream. For instance, valuation of life estates, remainders, and annuities is done actuarially and is affected by the assumptions underlying the tables used by the IRS. In updating software used for valuing these interests, we discovered some very interesting consequences of the new tables, particularly in the choices that practitioners have for May and June 1999 under the transition rules that apply in those months.
This article will explain the problems and opportunities and illustrate ways to cope with this continuing nightmare.
We will cover:
o the changes that are required;
o the process for routine computations;
o the general implications of higher (or lower) interest rate
o the general implications of longer mortality assumptions; and
o how grantor retained annuity trusts (GRATs), qualified
personal residence trusts (QPRTs), private annuities,
charitable remainder and charitable lead interests, and other
time-value-of-money sensitive tools and techniques are
The Mortality Changes
To understand what has happened and to set the stage for the implications on planning, it is necessary to know how various interests are valued.
The actual value of a life annuity, life estate, or remainder interest to the owner of such interest will depend on:
o the rate of return actually earned on invested assets; and on
o how long the person whose life controls the term of such
Unfortunately (or perhaps, fortunately), neither the rate of return that will actually be earned nor the length of the controlling life are known at the time such interests are created. For tax purposes, however, some value must be placed on such interests when they are created despite these two critical unknowns.
The first step is to determine a proper interest rate that should be used to calculate the present value of future interests. This is called the "interest component" or "discount rate" of the formula. For calculations involving terms of years, the discount rate is the only variable. Factors for term estates, remainders, and term annuities can be calculated easily once the appropriate interest rate has been determined. For example, the future value of $1.00 can be calculated by compounding the annual interest that could be earned for the length of the term. The present worth of a remainder interest is the amount that must be invested presently to produce $1.00 at the end of the term of the trust. This is the future $1.00 divided by the compounded interest. The factor for an income interest, or an annuity for a term, can be calculated from the remainder factor.
When the income, remainder, or annuity is not measured by a term of years, but a life or lives, the calculation is more complicated. Contrary to what many people assume, the calculation of a life estate is not the same as a term for the life expectancy of the life tenant. Instead, it is a series of calculations, based on the probabilities of death in each future year. So the value of a remainder after a life estate is the sum of the value of the remainder at the end of the first year, multiplied by the probability of death in that first year, plus the value of the remainder at the end of the second year, multiplied by the probability of death in that second year, plus the value of the remainder at the end of the third year, multiplied by the probability of death in that third year, and so on.
The probabilities of death in each year are calculated using a mortality table. A mortality table is based on a study of the longevity of a large number of people over a selected period of time. It essentially indicates what probability a hypothetical individual who represents the average experience at each age of life has of surviving from one year to the next. This is called the "mortality component" of the formula.
Applying both the discount rate and the mortality table, a valuation table is constructed that converts these two factors (rate of interest and life expectancies) into one factor to be applied to the present value of the property to determine the values of the remainders and life estates, or the amount of the periodic payment to determine the present value of an annuity for a life or lives.
The proposed regulations incorporate revised Table S (Single Life Remainder Factors) and Table U(1) (Unitrust Single Life Remainder Factors) based on data compiled from the 1990 census as set forth in Life Table 90CM. They also make conforming amendments to various sections to reflect the revised tables.
Code Sections Affected:
These changes will affect valuation under sections:
o 170 (charitable contributions valuation for income tax
o 641 (special rules for charitable contribution deductions);
o 664 (charitable remainder trusts);
o 2031 (estate tax valuation);
o 2055 (charitable contributions valuation for estate tax
o 2512 (gift tax valuation);
o 2522 (charitable contributions valuation for gift tax
o 2624 (valuation for generation-skipping transfer tax
Code Sections Not Affected:
It is important for planners to note that the new mortality tables were adopted solely for the purpose of section 7520 and do not affect transactions outside of the scope of section 7520, such as transactions requiring the application of the tables for expected return multiples found in the regulations under section 72. Specifically, the new tables do not apply for purposes of the required distribution or other pension and profit-sharing rules provided in sections 401 to 409 and "any other provision" specified by the IRS. /6/
The regulations, which have been issued under section 7520, state that the valuation rules of section 7520 do not apply to the income taxation of life insurance, endowment, and annuity contracts under sections 72 and 101(b), installment sales under sections 83 and 451, the valuation of deferred compensation under section 457, the income and gift taxation of below-market loans under section 7872, and the value of a nonqualified retained interest under section 2702(a)(2)(A), among others. /7/
The mortality tables used for section 7520 calculations are not tables of life expectancies, but tables of lives in being. The tables start with 100,000 births and then show the number of people who will be alive at each age after that.
The mortality table used from May 1, 1989, to April 30, 1999, was Table 80CNSMT, and could be found in the regulations at the end of Treas. reg. section 20.2031-7. The new table, Table 90CM, will be found in revised Treas. reg. section 20.2031-7, and the old Table 80CNSMT has been moved to Treas. reg. section 20.2031-7A.
A comparison of the two tables showing the number of lives assumed surviving at the end of the year follows:
80CNSMT 90CM Decrease
1 98740 99064 324
2 98648 98992 344
3 98584 98944 360
4 98535 98907 372
5 98495 98877 382
6 98459 98850 391
7 98426 98826 400
8 98396 98803 407
9 98370 98783 413
10 98347 98766 419
11 98328 98750 422
12 98309 98734 425
13 98285 98713 428
14 98248 98681 433
15 98196 98635 439
16 98129 98573 444
17 98047 98497 450
18 97953 98409 456
19 97851 98314 463
20 97741 98215 474
21 97623 98113 490
22 97499 98006 507
23 97370 97896 526
24 97240 97784 544
25 97110 97671 561
26 96982 97556 574
27 96856 97441 585
28 96730 97322 592
29 96604 97199 595
30 96477 97070 593
31 96350 96934 584
32 96220 96791 571
33 96088 96642 554
34 95951 96485 534
35 95808 96322 514
36 95655 96150 495
37 95492 95969 477
38 95317 95780 463
39 95129 95581 452
40 94926 95373 447
41 94706 95156 450
42 94465 94928 463
43 94201 94687 486
44 93913 94431 518
45 93599 94154 555
46 93256 93855 599
47 92882 93528 646
48 92472 93173 701
49 92021 92787 766
50 91526 92370 844
51 90986 91918 932
52 90402 91424 1022
53 89771 90885 1114
54 89087 90297 1210
55 88348 89658 1310
56 87551 88965 1414
57 86695 88214 1519
58 85776 87397 1621
59 84789 86506 1717
60 83726 85537 1811
61 82581 84490 1909
62 81348 83368 2020
63 80024 82169 2145
64 78609 80887 2278
65 77107 79519 2412
66 75520 78066 2546
67 73846 76531 2685
68 72082 74907 2825
69 70218 73186 2968
70 68248 71357 3109
71 66165 69411 3246
72 63972 67344 3372
73 61673 65154 3481
74 59279 62852 3573
75 56799 60449 3650
76 54239 57955 3716
77 51599 55373 3774
78 48878 52704 3826
79 46071 49943 3872
80 43180 47084 3904
81 40208 44129 3921
82 37172 41091 3919
83 34095 37994 3899
84 31012 34876 3864
85 27960 31770 3810
86 24961 28687 3726
87 22038 25638 3600
88 19235 22658 3423
89 16589 19783 3194
90 14154 17046 2892
91 11908 14466 2558
92 9863 12066 2203
93 8032 9884 1852
94 6424 7951 1527
95 5043 6282 1239
96 3884 4868 984
97 2939 3694 755
98 2185 2745 560
99 1598 1999 401
100 1150 1424 274
101 815 991 176
102 570 672 102
103 393 443 50
104 267 284 17
105 179 175 -4
106 119 105 -14
107 78 60 -18
108 51 33 -18
109 33 17 -16
110 0 0 0
As can be seen, almost all ages have experienced an increase in the number of lives in being at that age. The most significant reductions in mortality can be found in infant mortality (before age 1) and in the late 50s through early 80s. At those ages, there is a substantial decline in mortality and a substantial increase in the number of lives surviving.
We found it curious that the 1990 census figures show a reduction in the number of persons living past age 105. This appears to indicate an increase in mortality in those advanced ages. The authors are unaware of any explanation for this increase in mortality at a time when medical science seems to be continually increasing life expectancies. One speculation is that the increasing use of "living wills" and the increasing interest in quality of life is leading to less aggressive medical treatment of persons past 100.
Although Table 90CM is not a table of life expectancies, both Table 80CNSMT and Table 90CM can be used to construct a table of life expectancies.
Basically, life expectancy is calculated as the average number of years lived beyond a particular age. For example, life expectancy at age 50 can be calculated by taking the number of people who died before age 51 and multiplying by one-half (assuming that the each lived an average of one-half year), adding the number of people who died between age 51 and 52 multiplied by 1.5, adding the number of people who died between age 52 and 53 multiplied by 2.5, and so forth. The total is divided by the total number of people to determine the average number of years lived.
The life expectancies reflected in Table 80CNSMT and Table 90CM are compared in the following table:
80CNSMT 90CM in Years Increase
10 65.1 66.3 1.2 1.84%
20 55.5 56.6 1.1 1.98%
30 46.1 47.2 1.1 2.39%
40 36.8 38.0 1.2 3.26%
50 27.9 29.0 1.1 3.94%
60 20.0 20.9 0.9 4.50%
70 13.3 14.0 0.7 5.26%
80 8.0 8.4 0.4 5.00%
90 4.4 4.5 0.1 2.27%
100 2.7 2.5 -0.2 -7.41%
As mentioned above, the new mortality table actually reflects a slight decrease in life expectancy after age 95. This is a significant factor that planners should consider in certain cases when deciding whether to use the old mortality table or the new mortality table for valuations in May or June 1999, as discussed below.
For those under age 95, the net effect of these life expectancy improvements will be to:
o increase the value of life estates;
o increase the value of annuities for life;
o decrease the value of remainder interests; and
o decrease the value of contingent reversions (such as are often
retained in QPRTs). /8/
Life Estates and Remainders
As explained above, the increasing life expectancies will increase the value of life estates and decrease the value of the remainders that follow those life estates.
The following two tables, showing factors with a section 7520 discount rate of 6 percent, will help illustrate this impact of the mortality tables:
80CNSMT 90CM in Years Increase
10 0.95973 0.96210 0.00237 0.25%
20 0.93508 0.93865 0.00356 0.38%
30 0.89998 0.90468 0.00470 0.52%
40 0.83957 0.84987 0.01031 1.23%
50 0.75034 0.76498 0.01464 1.95%
60 0.63326 0.64967 0.01641 2.59%
70 0.49359 0.50993 0.01634 3.31%
80 0.34151 0.35604 0.01453 4.26%
90 0.21143 0.21508 0.00365 1.73%
100 0.13673 0.12678 -0.00994 -7.27%
As can be seen, there is a small increase in the value of life estates for very young beneficiaries. This is due to the decline of infant mortality and generally better life expectancies.
The most significant declines in mortality have been in the post-retirement ages of 60 and above. The benefit of those mortality changes are discounted too heavily after 40 or 50 years to significantly affect the value of a life estate for a 20-year old or 10-year old. But the value of a life estate of an older individual, for example, an 80-year old, has increased significantly.
The factors for life estates and remainders always add up to one. So the value of a remainder interest will decrease, dollar for dollar, by the increase in the value of the life estate.
Charitable Remainder Unitrusts
The Taxpayer Relief Act of 1997 imposed a new requirement that the charitable remainder of a charitable remainder trust must have an initial present value of at least 10 percent of the gift to the trust. /9/ This was adopted by Congress to eliminate perceived abuses in the creation of charitable remainder trusts that were designed to minimize income taxes with little or no charitable deduction, and from which charities would most likely receive very little, if anything. However, a somewhat unintended consequence of this change in law was that it became impossible in many cases to create charitable remainder unitrusts (CRUT) for young beneficiaries (for example, those in their early 20s or teens).
The problem is that a CRUT must have a payout rate of at least 5 percent. But an adjusted payout rate of 5 percent results in a charitable deduction of less than 10 percent if the measuring life is 24 or younger. It is possible to set a nominal payout rate of 5 percent, but in actuality have an adjusted payout rate of less than 5 percent if there is a delay between the valuation date and the distributions from the trust. The greatest adjustment occurs if there is an annual distribution and a 12-month delay between the valuation date and the distribution (that is, the valuation is at the beginning of the year and the distribution is at the end of the year). However, even if the section 7520 rate were 9.8 percent (the highest rate recorded since the January 1991 effective date), the beneficiary would still need to be at least age 20 for the charitable remainder to be at least 10 percent of the initial value of the CRUT. For a more common 7520 rate of 6.0 percent, the beneficiary must be at least 22 years old for the trust to qualify.
With the longer life expectancies under the new mortality table, the minimum age for a CRUT with a 5 percent adjusted payout rate has increased from age 25 to age 26.
The changes are even more dramatic for two life unitrusts, as illustrated by the following chart, which shows the minimum qualifying ages under the old mortality table and the new mortality table:
27 59 69 10
28 54 61 7
29 50 56 6
30 48 53 5
31 45 50 5
32 43 47 4
33 42 45 3
34 40 43 3
35 39 42 3
36 38 40 2
37 37 39 2
38 36 38 2
Charitable Remainder Annuity Trusts
Like CRUTs, a charitable remainder annuity trust (CRAT) must satisfy the requirement that the charitable deduction be at least 10 percent of the gift to the trust. However, unlike CRUTs, this requirement can be met as long as the section 7520 payout rate is 5.4 percent or higher, because a CRAT paying an annuity of 5 percent of the initial value of the trust will generate a charitable deduction of more than 10 percent even for a one-year old beneficiary.
For a section 7520 discount rate of 6.0 percent, the following table shows the maximum payouts allowable from a CRAT (ignoring the 5 percent exhaustion test described below):
Payout at 6%
80CNSMT 90CM in Points Decrease
10 5.626% 5.612% 0.014 0.25%
20 5.774% 5.752% 0.022 0.38%
30 6.000% 5.968% 0.032 0.53%
40 6.431% 6.353% 0.078 1.21%
50 7.196% 7.058% 0.138 1.92%
60 8.527% 8.311% 0.216 2.53%
70 10.940% 10.589% 0.351 3.21%
80 15.812% 15.166% 0.646 4.09%
90 25.539% 25.106% 0.433 1.70%
100 39.494% 42.592% -3.098 -7.84%
As expected, the longer life expectancies below age 95 result in higher annuity factors, and so the maximum payouts are lower if the charitable deduction must be at least 10 percent.
In addition to the 10 percent charitable deduction rule, CRATs must also comply with a requirement announced by the IRS in Rev. Rul. 77-374, 1977-2 C.B. 329, that there can be no more than a 5 percent probability that the beneficiary will outlive the exhaustion of the trust fund, and that the charitable remaindermen will get nothing. Stated another way, the payout from a CRAT should not result in an exhaustion of the trust fund while there is a greater than 95 percent probability that the beneficiary is still alive. Fortunately, the increase in life expectancies below age 95 causes at most a one- year increase in the period during which a beneficiary has a 95 percent probability of survival, and sometimes causes no increase at all. This results in a very small decrease in the payout of a CRAT to comply with the 5 percent exhaustion test of Rev. Rul. 77-374.
The chart below illustrates the maximum payouts from a CRAT for one life, based on a section 7520 discount rate of 6 percent, taking into account both the 10 percent remainder requirement and the 5 percent exhaustion test.
at 6%, with 5% test
Ages 80CNSMT 90CM in Points Decrease
10 5.626% 5.612% 0.014 0.25%
20 5.774% 5.752% 0.022 0.38%
30 6.000% 5.968% 0.032 0.53%
40 6.254% 6.239% 0.015 0.24%
50 6.470% 6.441% 0.029 0.45%
60 6.897% 6.839% 0.058 0.84%
70 7.690% 7.570% 0.120 1.56%
80 9.236% 9.236% 0.000 0.00%
90 12.679% 12.679% 0.000 0.00%
100 17.913% 20.336% -2.423 -13.53%
Transition Rule Choices
For deaths, gifts, and other transactions in May or June 1999, the temporary regulations allow the taxpayer to select whether to use the old factors based on Table 80CNSMT or the new factors based on Table 90CM. There are some general rules about which table will yield the best results for different kinds of transactions. These general rules will also show how various tools and techniques of estate and financial planning are affected by the new tables.
Life Estates and Remainders
As noted above, the new mortality tables reflect longer life expectancies for those under 95 years of age. So the value of life estates will be greater for those ages, and the value of the remainders following those life estates will be less.
Whether to elect to use the old valuation tables in May and June 1999 will depend on the purpose of the valuation and whether a higher or lower value is desired. If the valuation is of an annuity included in the gross estate for federal estate tax purposes, during the transition period, the executor may wish to use the older tables, in order to reduce the value of the gross estate. However, there may be some purposes for which a higher value is desired, and so the new tables should be used.
Qualified Personal Residence Trusts
A QPRT is an irrevocable trust into which the grantor places a personal residence and retains the right to use the residence for a fixed period of time. At the end of the specified period of years, the residence will pass to a beneficiary such as a child. Essentially, the grantor is making a future interest gift of the residence at the end of the term (that is, the client is making a gift of the remainder) while retaining the right to the use of the residence during the term (the client is keeping an income for a fixed term of years). A QPRT is one of the exceptions to the valuation rules contained in Chapter 14 of the code. It is one of the few remaining ways in which a grantor can give a significantly discounted future interest in property to a child or other family member.
Because a QPRT is normally for a fixed term of years, the changes in the mortality table do not affect the value of the term interest. However, most attorneys draft the QPRT to provide that the grantor retains the right to a reversion of the trust back to the grantor's estate if the grantor dies during the term of the trust. This increases the estate's liquidity and ability to pay the tax. (If the grantor dies during the term of the trust, the residence will be included in the grantor's taxable estate anyway, because of section 2036.) Retention of the possible reversion has a significant pre-mortem planning impact. It further reduces the value of the remainder interests, and so reduces the taxable gift to the remaindermen.
The new mortality table reflects a longer life expectancy for those 94 years of age and younger. That, of course, according to the new tables, makes it less likely that the grantor will die during the term of the trust than under the old tables. All other things being equal, the new mortality tables will result in a larger taxable gift if the grantor is less than 94 years of age or younger, but a smaller taxable gift if the grantor is 95 years or older. This can be illustrated by the following table, which shows the present values of the remainder interest using a 10-year QPRT and assuming the grantor retains a reversion upon the grantor's death during the term of the trust:
80CNSMT 90CM in Factor Increase
50 0.50127 0.50743 0.00616 1.23%
55 0.47825 0.48600 0.00775 1.62%
60 0.44667 0.45713 0.01046 2.34%
65 0.40365 0.41656 0.01291 3.20%
70 0.34669 0.36157 0.01487 4.29%
75 0.26974 0.28799 0.01825 6.77%
80 0.17962 0.19838 0.01876 10.45%
85 0.09883 0.10835 0.00952 9.63%
90 0.04452 0.04578 0.00125 2.82%
95 0.01945 0.01526 -0.00419 -21.52%
Generally, during the transition period of May and June 1999, it is advantageous to use the old mortality tables for QPRTs with contingent reversions.
A private annuity is an arrangement between two parties, neither of whom is an insurance company, in which the transferor (annuitant) conveys complete ownership of property to a transferee (the person who will then own the property and who will be obligated to make payments). Payments typically last for (no longer than) the life of the annuitant (or the joint lives of two annuitants).
Private annuities are typically used to transfer assets from older family members to younger family members when the older family members still need (or want) a stream of cash from the transaction. They are also incredible ways to shift rapidly appreciating property from one generation to another and freeze the estate of the senior generation. Private annuities are particularly indicated where, because of health or any other reason, the client has a lower than normal life expectancy and it's likely or probable that he/she will die sooner than the mortality tables would predict (but not so soon as to remove the transaction from the application of section 7520, based on the principles set forth in Treas. reg. section 20.7520-3(b)(3)).
The advantage of a private annuity is that it is not a gift (if properly valued) and, if the annuitant dies before normal life expectancy, the total of the payments made by the purchaser may represent less than the fair market value of the assets purchased. /10/
When a private annuity is used as part of an intrafamily transfer, the usual goal is for the annuity payments to be as low as possible. This makes it easier for the purchaser, typically a junior family member or sometimes an employee purchasing the stock of a business owner to pay as little as possible for the asset, and equally as important for the annuitant to have as little as possible added back to his or her taxable estate. In that case, the new mortality tables, which are based on a longer life expectancy, will produce a larger annuity factor and a correspondingly smaller annuity payment.
The following chart illustrates annuity factors based on a section 7520 rate of 6 percent:
80CNSMT 90CM in Factor Increase
10 15.99544 16.03497 0.03953 0.25%
20 15.58475 15.64413 0.05938 0.38%
30 14.99966 15.07800 0.07834 0.52%
40 13.99280 14.16456 0.17176 1.23%
50 12.50563 12.74970 0.24407 1.95%
60 10.55432 10.82790 0.27358 2.59%
70 8.22650 8.49883 0.27233 3.31%
80 5.69179 5.93403 0.24223 4.26%
90 3.52385 3.58466 0.06081 1.73%
100 2.27879 2.11304 -0.16574 -7.27%
So, for example, a private annuity transaction for a $100,000 asset between an 80-year old parent and a child would require annual payments of $17,569 under the old tables ($100,000/5.69179, so that the annuity times the factor will result in the $100,000 market value for the asset). Under the new tables, the annual payment for the same property would be only $16,852 ($100,000/5.93403), an annual reduction of $717.
Practitioners should remember that the tables under section 72 have not been amended and that the income tax consequences of a private annuity transaction are determined under section 72, not section 7520. So if a private annuity transaction results in capital gain, that capital gain is recognized (and the cost basis is recovered) using the same expected return multiples previously found in the regulations under section 72.
As shown in the above table, the shorter life expectancies above age 95 will result in smaller factors (and larger annuity payments) under the new tables if the annuitant is 95 or older, which means that the old tables are better in those cases and should be used during the transition period.
Charitable Lead Trusts
A charitable lead annuity trust is an irrevocable trust which provides guaranteed annuity of a fixed amount (regardless of how much is earned by the trust) payable each year to a qualified charity. At the end of the trust's term, any remainder is paid to a noncharitable beneficiary.
A charitable lead trust also can take the form of a unitrust. In essence this is a variable annuity paid to the charity for a specified number of years after which the remainder is paid to a noncharitable beneficiary. In this case the amount that must be paid to the charity at least annually is a fixed percentage of the fair market value of the trust, determined annually. As in the case with an annuity trust, the remainder in the unitrust after a specified number of years (or in some cases the life or lives of one or more living individuals) is payable to a noncharitable beneficiary such as the client's children.
In either case the donor receives a gift tax deduction for the present value of the annuity or the income interest provided to charity and pays gift tax only on the future interest gift to the noncharitable remainderman. (A current income tax deduction is allowed only if the trust is a "grantor trust," meaning that the donor is taxable on income received by the trust and payable to the charity, even though the donor receives no additional charitable deduction.)
If the charitable lead trust is for a term of years, then the new mortality tables are irrelevant. But if the charitable lead trust is measured by a life or lives, then the change in the mortality tables will change the value of the charitable deduction for the annuity or unitrust interest. Because the new mortality tables reflect longer life expectancies for those under age 95, charitable interests measured by lives younger than 95 will result in larger charitable deductions under the new tables. Charitable interests measured by lives 95 years of age or older will result in smaller charitable deductions.
An additional complication is that, for charitable lead trusts created in May or June 1999, the taxpayer can choose to value the trust using discount rates for either of the two preceding months. But if the taxpayer chooses to use discount rates from March or April 1999, the taxpayer must also use the old mortality tables for the valuation. For transactions in May 1999, this presents a dilemma. The reason is that the section 7520 discount rate for March was 5.8 percent. This should result in a larger charitable deduction than the 6.2 percent rate that applied in May. But the new mortality tables that apply in May should result in a larger charitable deduction than the old mortality table that applied in March. So which produces the larger charitable deduction, the lower discount rate or the longer life expectancy?
Unitrusts are relatively unaffected by the changes in the section 7520 rates, and so charitable lead unitrusts created in May 1999 (and June 1999) should usually be valued using the new tables, as illustrated by the following chart, showing the charitable lead unitrust factors for a 6 percent payout with 12 months between the valuation date and the annual distribution.
80CNSMT 90CM at Increase/ Percentage
Ages at 5.8% 6.2% Decrease Increase
10 0.95992 0.96191 0.00200 0.21%
20 0.93535 0.93839 0.00304 0.32%
30 0.90034 0.90433 0.00399 0.44%
40 0.84003 0.84942 0.00938 1.12%
50 0.75089 0.76443 0.01354 1.80%
60 0.63386 0.64907 0.01521 2.40%
70 0.49417 0.50934 0.01517 3.07%
80 0.34199 0.35555 0.01356 3.97%
90 0.21177 0.21474 0.00297 1.40%
100 0.13696 0.12656 -0.01040 -7.59%
As shown in the above table, the shorter life expectancies above age 95 will result in smaller factors (and smaller charitable deductions) under the new tables if the measuring life is 95 or older. That means that the old tables are better in those cases.
It also appears that the charitable deduction will be larger for ages around 29 years if the payout is 14 percent or more, but such a trust would be very odd, and the calculation is unlikely to arise.
A charitable lead annuity trust is much more sensitive to changes in discount rates than a charitable lead unitrust, and so the choice between the March 1999 tables and the May 1999 tables is much more delicate, as illustrated by the following chart:
80CNSMT 90CM at Increase/ Percentage
Ages at 5.8% 6.2% Decrease Increase
10 16.48875 15.56464 -0.92412 -5.60%
20 16.04162 15.20544 -0.83618 -5.21%
30 15.40836 14.68185 -0.72651 -4.72%
40 14.33666 13.82562 -0.51104 -3.56%
50 12.77282 12.48187 -0.29095 -2.28%
60 10.74154 10.63713 -0.10441 -0.97%
70 8.34059 8.38062 0.04003 0.48%
80 5.74900 5.87382 0.12481 2.17%
90 3.54833 3.56005 0.01172 0.33%
100 2.29029 2.10325 -0.18704 -8.17%
These calculations show that, for ages 67 through 90, the new mortality table produces a larger charitable deduction for a charitable lead annuity trust, notwithstanding the higher discount rate of 6.2 percent, than the old mortality tables and the 5.8 percent discount rate that applied in March 1999. However, for measuring lives that are either 66 or younger or 91 or older, the March 1999 valuation tables will produce a larger charitable deduction. (These results are for annual payments at the end of the year, and different pay periods may result in different recommendations.)
Charitable Remainder Trusts
A charitable remainder trust provides a current income (or estate) tax deduction for the value of the remainder gift to charity that follows the client's (or the client's designated beneficiary's) retained interest. The retained interest can be for a given person's life or for a fixed term of years.
A CRAT is required to pay the noncharitable beneficiary a fixed amount (not less than 5 percent of the initial fair market value of assets in the trust) regardless of trust earnings or must pay a fixed percentage of the initial value of the trust's principal (measured at inception) each year. The client receives a current charitable deduction for the value of the remainder interest to charity, discounted by the appropriate rate, to reflect its present value.
A CRUT pays a fixed percentage amount (not less than 5 percent) of the value of the trust as revalued annually. Similar to the case of charitable lead unitrusts, changes in the section 7520 discount rate will have little or no effect on the amount of the charitable deduction.
If the charitable remainder trust is for a term of years, then the new mortality tables are irrelevant. But if the charitable remainder trust is measured by the life of the beneficiary (or beneficiaries), then the change in the mortality tables will change the value of the charitable deduction for the remainder interest. Because the new mortality tables reflect longer life expectancies for those under age 95, charitable interests measured by lives younger than 95 will result in smaller charitable deductions under the new tables. Charitable interests measured by lives 95 years of age or older will result in larger charitable deductions.
As in the case of charitable lead trusts created in May or June 1999, the taxpayer can choose to value charitable remainder trusts in those months using a discount rate for either of the two preceding months. But if discount rates from March or April 1999 are used, the taxpayer must also use the old mortality tables for the valuation. However, there is not the same dilemma as there is for lead trusts. This is because the section 7520 rate of 6.4 percent for April 1999 was the highest rate for the period for March through June. April's higher discount rate produces a larger charitable deduction. The old mortality table also produces the larger charitable deduction in most cases. So charitable remainder trusts in May or June should usually be valued using the April 1999 discount rate and the old mortality tables.
It therefore appears that charitable remainder trusts created in May or June 1999 should almost always be valued using the section 7520 discount rate (and old mortality table) for April 1999, if the measuring life is 94 or younger, and should be valued using the discount rate for the month of the gift (and the new mortality table) if the measuring life is 95 or older.
Grantor Retained Annuity Trusts (and Grantor Retained Unitrusts)
A grantor retained annuity trust (GRAT) is an irrevocable trust to which the grantor makes a gift of money or property, reserving the right to receive a fixed annuity for the term of the trust, which is usually a term of years. A grantor retained unitrust (GRUT) is similar, except that the retained interest is a fixed percentage of the value of the trust assets, revalued annually. In other words the grantor has retained a variable annuity. Whenever the remaindermen are members of the grantor's family, the GRAT, GRUT, and QPRT (discussed above) are the only forms of trust for which the grantor can claim a discount for the gift tax value of the remainder interests, because of the valuation restriction imposed by section 2702.
Although GRATs and GRUTs are usually established for a term of years, the IRS has taken the position that the value of the trust must be determined based only upon the amounts the grantor is likely to receive during his or her lifetime. The result is that the trust must be valued as though it were established for the shorter of a term or life. See Example 5 of Treas. reg. section 25.2702-3(e).
Because GRATs and GRUTs must be valued as the shorter of a term or life, a longer life expectancy will increase the amount that the grantor can expect to receive from the trust. This in turn reduces the value of the remainder. The new mortality table, with the longer life expectancies for those 94 years of age and younger, will therefore result in smaller taxable gifts than the old mortality table, and should be used for GRATs and GRUTs created during May and June 1999. This can be illustrated by the following table, which shows the remainder value of a 10-year GRAT paying an annuity of 10 percent of the initial value of the trust, using the May 1999 section 7520 discount rate of 6.2 percent:
Ages 80CNSMT 90CM in Points Decrease
55 0.30738 0.30305 0.00433 1.41%
60 0.32521 0.31939 0.00583 1.79%
65 0.34954 0.34158 0.00796 2.28%
70 0.38388 0.37432 0.00956 2.49%
75 0.43119 0.41931 0.01188 2.75%
80 0.49930 0.48324 0.01606 3.22%
85 0.57959 0.56379 0.01580 2.73%
90 0.66013 0.65362 0.00650 0.99%
95 0.72988 0.73043 -0.00055 -0.08%
100 0.77326 0.78967 -0.01641 -2.12%
Most estate planning tools and techniques affected by the assumed longevity of a client are affected by the new mortality table and the new actuarial tables. Fortunately, the changes are not radical, and will not significantly affect many estate planning recommendations in the future.
However, the choice between the old tables and the new tables for transactions during the transition period in May and June 1999 will require careful consideration to be certain that the optimum tax strategy is elected.
About the Authors: Daniel B. Evans is a practicing estates and trusts lawyer and a consultant to Leimberg and LeClair Inc.
Stephan R. Leimberg is CEO of Leimberg and LeClair Inc. a software company in Bryn Mawr, Pa., and President of Leimberg Associates Inc., a publishing and professional marketing advisory firm.
The authors express appreciation for the comments and contributions of Steve Oshins, Esq. of Oshins & Associates, Las Vegas, Nev.
/1/ Internal Revenue Code of 1986; section 5031(a) of the Technical and Miscellaneous Revenue Act of 1988, and related legislative history; Notice 89-24, 1989-10 IRB 16. Unless otherwise indicated, all section references are to the Internal Revenue Code, as amended, and the regulations promulgated thereunder. Computations courtesy: Estate Planning Tools software: 1-800-879-6665.
/2/ Specifically section 7520(a)(2) requires the use of a discount rate equal to 120 percent of the applicable federal mid-term rate defined by section 1274(d)(1), but rounded to the nearest two-tenths of a percent. A complete history of these rates and the current month's rate can be found at http://www.brentmark.com/AFRs.htm.
/3/ Those publications were scheduled to be available for purchase from the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402, by July 1, 1999.
/4/ Sections 2031 and 2512 state that the federal estate and gift taxes are levied upon the fair market value of the property transferred. Likewise, sections 170, 2522, and 2055, respectively provide that the amount of the charitable deductions allowable for income, gift, and estate tax purposes depends on the value of the interest assigned to charity. Sections 2056 and 2523, respectively state that the value of amounts transferred in an appropriate form to a surviving spouse qualify for the federal estate tax and gift tax marital deductions. See "IRS Actuarial Valuation Tables -- The New Look," Tax Management Memorandum, Vol. 30, No. 7, Mar. 27, 1989, p. 95.
/5/ Special flexibility is allowed under section 7520(a) for valuing property if
"more than an insignificant part of the property qualifies for a charitable
deduction." See also H.R. Rep. No. 1104, page 13. In such cases, in addition to the
month of the actual transfer a client may elect to use the rate for either of the two
months preceding the month in which the valuation falls. This gives the client the choice of months from which to choose.
However, to prevent manipulation against the government, if the transfer involves an interest other than a charitable interest the client must use the same rate with respect to each property interest. In other words, the client cannot use the monthly rate producing the highest value for the deductible charitable interest in, say a lead trust, and a different (lower) monthly rate in computing the gift tax value of the noncharitable remainder interest.
/6/ Section 7520(b).
/7/ Treas. reg. section 1.7520-3(a); Treas. reg. section 20.7520-3(a); Treas. reg. section 25.7520-3(a).
/8/ Although contingent reversions are also often retained in grantor retained annuity trusts or grantor retained unitrusts, the value of the contingent remainder does not affect the value of the gift for federal gift tax purposes. See section 2702; Treas. reg. section 25.2702-3(e), Example 1.
/9/ Section 664(d)(1)(D), added by section 1089 of the Taxpayer Relief Act of 1997.
/10/ Extensive information on private annuities can be found in The Cutting Edge (610) 527-5216; and Tools and Techniques of Estate Planning (800) 543-0874.