Pooled Income Fund: A Charitable Trust That Brings Multiple Returns
A pooled income fund is a charitable trust created by a private foundation or qualified charitable organization.
A pooled income fund is a charitable trust created by a private foundation or qualified charitable organization. Trusts are a diverse and versatile class of property management and estate planning tools. All trusts involve an arrangement in which a grantor (also known as a settlor or trustor) transfers assets to a trustee on behalf of the beneficiary.
The trustee owns the assets. The trustee does so, subject to a strict fiduciary duty. A grantor can set up a trust for the benefit of family members. Pooled income funds are a particular type of trust.
Pooled income funds offer a variety of benefits to fund donors, such as:
- An income stream for the remainder of the donor's life
- An immediate partial tax deduction
- Avoidance of capital gains tax
- Avoidance of probate
- A charitable donation to a nonprofit organization the donor cares about
Pooled Trust Accounts: How They Work
A qualified nonprofit organization, or its investment company, sets up a pooled income trust. It is structured as a mutual fund and seeks donations. The fund is called a "pooled trust" because the funding organization pools the donations of several charitable donors.
In addition to cash contributions, donors (also called grantors) can donate stocks and bonds as long as they are not tax-exempt. Some funds allow grantors to donate:
- Life insurance policies
- Tax-exempt securities
- Real estate
- Personal property
- Cryptocurrency like bitcoin
The value of these assets is invested. A pooled charitable trust is a type of trust known as an irrevocable trust. The terms of the trust would require the donor to relinquish donor control of the assets contributed to the charitable beneficiary. This explains why the donor receives some tax benefits for their charitable giving.
The grantor receives scheduled income distributions. The charitable organization receives the remaining funds when the grantor and other fund beneficiaries die.
Who Chooses a Pooled Trust Account?
Many people use pooled charitable trusts as a supplemental source of income during their retirement. This option is great for people with little cash or those without an extensive investment portfolio. Once the donor meets the charity's minimum donation amount, the grantor can continue to donate even small amounts into the trust over the years.
A grantor can join a pooled charitable trust at any age and may receive an income distribution anytime. Many people only receive a distribution once they reach 65 or 70 to have additional income during retirement.
The income distribution the grantor receives will be taxed just like normal income. Many retirees have a lower income than their working years, so their tax rate would be lower.
Why Invest in a Pooled Charitable Trust?
Below are a few reasons why you might want to invest in a pooled charitable trust.
The charity must pay income distributions to the grantor or their named beneficiaries. These payments are made quarterly or annually from the trust's assets. Some trusts allow the grantor to choose the payment frequency.
There is no minimum payout rate. Income distribution amounts are determined by:
- The fair market value of the donor's contributed assets at the time of the transfer
- The fund's performance in the market
- The life expectancy of the donor (from IRS life expectancy tables)
The donor will be receiving an income until they die, so the fund must consider how many years of payments it will be making.
Income Tax Deduction
Every time a grantor donates to a pooled charitable trust, they can take an income tax deduction on their tax return. However, they can't deduct the full amount because they will receive income from the trust. The amount that the grantor is allowed to deduct depends on:
- The gift's fair market value
- How long the trust's beneficiary is expected to receive income
- The yield of the fund
Reduced Estate Tax
As an irrevocable trust, assets placed in the pooled income fund are no longer accessible to the donor. The trust funds are no longer considered part of the donor's estate. A pooled charitable trust can be used as part of an estate plan strategy to reduce federal estate taxes.
Exemption From the Capital Gains Tax
Grantors can donate appreciated securities to the pooled income fund. This enables the grantor to earn income from their appreciated securities without paying capital gains tax.
A charitable trust can also be used to avoid the capital gains tax on donated property. This is the case if the donor has held that property for at least a year. For this reason, well-performing securities held for over a year are the preferred gift to a pooled charitable trust.
The charity can sell them at present-day market value and pay no capital gains tax. This adds up to a larger investment into the trust by the donor and more income over time.
Example of Exemption From the Capital Gains Tax
Amy has held 1,000 shares of stock for 10 years. The stock has increased in value from $1 a share to $20 a share. Despite the increase in the stocks' value, Amy is disappointed that they do not produce much income for her. If she sells the stocks, she would have to pay a hefty capital gains tax on the gain.
Instead, Amy donates the total amount of stock to a pooled charitable trust. When the public charity takes possession of the stock, the charity sells the stock. Because the gift is for charitable purposes, there is no capital gains tax. Amy held the stock for more than one year.
The initial tax deduction Amy can take would be calculated as follows:
- Taking the market value of the donated stock— $20,000
- Subtracting the value of the payments that Amy can expect to receive during her lifetime
This estimate is derived from looking at the recent performance of the trust. Amy will never pay a capital gains tax on the $19 share gain she saw.
Avoidance of Probate
Assets held in a trust pass directly to beneficiaries without going through probate. Let's look at an example of how one might use a pooled income trust to pass assets to a charity:
John has worked hard in his company for the past 20 years and now makes $100,000 a year. John loves relaxing in his favorite park, so he donates $10,000 to the park's pooled charitable trust. John can deduct a portion of this $10,000 from his income taxes.
John enjoyed the park for the next 15 years and regularly donated to the pooled trust. Ultimately, his contributions to the trust total $250,000. John deferred receiving any income from the trust while he was working. Now he's retiring at age 65, and he chooses to receive the payments he deferred and interest income on that amount. When John dies, the public charity that runs the fund receives the balance of the gift.
Pooled Special Needs Trust
In addition to using a pooled trust for charitable purposes, a grantor can set up a pooled special needs trust. These trusts are also known as supplemental needs trusts (SNT).
An SNT is a specialized trust, usually set aside by a family member. It sets aside funds for a beneficiary with a mental or physical disability. A special needs trust can strengthen an individual's financial security and enhance the quality of their lives.
Leaving assets to a loved one with a disability without planning may unintentionally disqualify them from these need-based benefit programs. A supplemental needs trust does not jeopardize the individual's eligibility for need-based government benefits. These needs-based benefits can include:
- Social Security
- Supplemental Security Income (SSI)
Pooled trusts give people with disabilities the ability to access health care benefits and meet other needs. Any excess funds can be deposited into the trust to pay for items and services not covered by other benefits.
For example, New York residents of any age who are disabled, as defined by Social Security Law, can establish a pooled trust. Individuals can deposit excess monthly income. Those funds are excluded from assets when determining a person's eligibility for needs-based government benefits.
There are several benefits of a supplemental needs trust, including the following:
- Allows a disabled individual to maintain eligibility for Medicaid or SSI benefits
- Protects funds for supplemental needs that can increase or enhance the individual's quality of life
- Obtain care and pay expenses
- Eliminates the need to spend down funds quickly
Speaking with an experienced estate planning attorney about different types of special needs trusts is wise. You can discuss what to consider, how to avoid losing public benefits, and any other pitfalls.
Alternatives to a Pooled Income Fund
Charitable Remainder Trust: A charitable remainder trust (or a CRT) comes in various forms. It operates much like a pooled charitable trust. The donor can gift appreciated assets while avoiding tax. The donor can receive a lifetime income. Federal law requires that CRTs have a minimum payout rate of 5%. The donation qualifies for an immediate tax break, and estate taxes are reduced after death.
The primary difference between a pooled income fund and a CRT is that a charitable remainder trust is private. It is established with the assets of one donor or donor family. A pooled income fund, on the other hand, invests the assets of a larger number of donors to earn a return. The amount a donor would need to contribute to a charitable remainder trust to earn a similar return would be much larger.
Donor-Advised Funds: A donor-advised fund is also set up by a nonprofit and offers an immediate tax benefit and a reduction of estate taxes. With a donor-advised fund, all the donor's contributions go to the charitable organization. There is no income stream for the grantor.
Charitable Lead Trust: A charitable lead trust (or CLT) is similar to a pooled income fund. A CLT provides:
- An income
- An income tax deduction for some grantors
- A charitable gift to a nonprofit
A CLT may also distribute assets to heirs, but that would be a taxable gift. Appreciation of trust assets could be subject to capital gains tax.
Charitable Gift Annuity: A charitable gift annuity is not a trust. It is a contract between a grantor and one charitable nonprofit. The terms of the contract lock in the rate of return and the timing of the payments to the grantor. The grantor can claim a partial charitable deduction on their taxes for the year the gift annuity is established. It can reduce or eliminate capital gains tax.
One of the most significant differences between a charitable gift annuity and a pooled income fund or CRT or CLT is that payments are fixed. Charitable gift annuity payments aren't adjusted to inflation or the performance of the market.
Get Lifetime Value From Your Charitable Contributions
Many large charities, like museums, universities, and hospitals, offer pooled charitable trusts. They may also offer CRTs, CLTs, and annuity trusts. Before you invest, consider the following:
- How much money do you have to invest?
- What income stream do you need?
- What tax liability reduction goals do you want to accomplish?
Some tools may be better than others for reaching your particular goals. Many of these investment products are very similar. An estate planning attorney versed in wealth management, elder law, and estate tax avoidance strategies will be able to advise you on the best choice for you and your loved ones.
Can I Solve This on My Own or Do I Need an Attorney?
- DIY is possible in some simple cases
- An attorney is on your side during complicated legal decisions
- Cases with trusts and beneficiaries are rarely cut and dry
- Get tailored advice and ask your legal questions
- Many attorneys offer free consultations