Pooled Income Fund: A Charitable Trust That Brings Multiple Returns
A pooled income fund is a form of charitable trust created by a private foundation or qualified charitable organization.
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
- And ultimately, 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 as a mutual fund and seeks donations. The fund is called a “pooled trust" because the funding organization pools the donations of a number of charitable donors.
In addition to cash contributions, donors (also called grantors) can donate stocks and bonds as long as they are not tax-exempt ones. Some funds allow grantors to donate life insurance policies, tax-exempt securities, cars, real estate, personal property, and even cryptocurrency like Bitcoin. The value of these assets is invested.
A pooled charitable trust is an irrevocable trust. The donor cannot regain control of the assets they have contributed, which is why the donor receives some tax benefits for their charitable giving.
The grantor receives scheduled income distributions. When the grantor and other fund beneficiaries die, any remaining funds are distributed to the charitable organization.
Who Chooses a Pooled Trust Account?
Many people use pooled charitable trusts as a supplemental source of income during their retirement. This is a great option for people who do not have large amounts of cash or a large investment portfolio. Once the minimum donation amount is met, which is set by the charity, the grantor can continue to donate even just 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 at any time. Many people choose to defer receiving a distribution until they reach 65 or 70 in order 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?
The charity is required to pay income distributions to the grantor or their named beneficiaries. These payments are made quarterly or annually from the trust's assets, although some trusts allow the grantor to choose the frequency of payment.
There is no minimum payout rate. The amount of payment is 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 and the life expectancy of the donor (from IRS life expectancy tables) to determine income distribution amounts. 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 be receiving some 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 and so are no longer considered part of the donor's estate. A pooled charitable trust, then, can be used as part of an estate plan strategy to reduce federal estate taxes.
Exemption from the Capital Gains Tax
Grantors are allowed to donate securities to the pooled income fund that have increased in value. This enables the grantor to earn income from their appreciated securities without having to pay capital gains tax.
A charitable trust can also be used to avoid the capital gains tax on donated property if that property has been held by the donor for at least a year before donation. It is for this reason that well-performing securities that have been held for over a year are the preferred gift to a pooled charitable trust.
The charity is allowed to 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 derive much income for her. If she sells the stocks, she would have to pay a hefty capital gains tax on her gain.
Instead, Amy donates the total amount of stock to a pooled charitable trust. When the public charity takes possession of the stock, it sells it off. Because the gift is for charitable purposes, there is no capital gains tax as Amy held the stock for more than one year.
The initial tax deduction Amy can take would be calculated by taking the market value of the donated stock— $20,000 — and subtracting the value of 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 have to pay capital gains tax on the $19 a share gain that she saw.
Avoidance of Probate
Assets held in 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 is now making $100,000 a year. John loves to relax in his favorite park, so he decides to donate $10,000 to the park's pooled charitable trust. John will be able to deduct a portion of this $10,000 from his income taxes.
For the next 15 years, John continues to enjoy the park and makes regular donations 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, as well as interest income on that amount.
When John dies, the public charity that runs the fund receives the balance of the gift without having to go to court to argue over the owner.
Alternatives to a Pooled Income Fund
Charitable Remainder Trust: A charitable remainder trust (or a CRT) comes in a variety of forms. It operates much like a pooled charitable trust. The donor can gift appreciated assets while avoiding sales tax. The donor can receive a lifetime income. CRTs have a required minimum payout rate of 5%. The donation qualifies for an immediate tax break and estate taxes are reduced after death.
The primary difference between the two is that a charitable remainder trust is a private trust, established with the assets of one donor or donor family. A pooled income fund invests the assets of a larger number of donors in order to earn a return. The amount a donor would need to contribute to a charitable remainder trust in order 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, but all of 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 also very similar to a pooled income fund in that it provides an income, an income tax deduction for some grantors, and provides a charitable gift to a nonprofit. It 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 timing of payments to the grantor. The grantor can claim a partial charitable deduction on your taxes for the year in which the gift annuity is established. It can reduce or eliminate capital gains tax.
Perhaps one of the biggest differences between a charitable gift annuity and a pooled income fund or CRT or CLT is that payments are fixed and 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, offered pooled charitable trusts. They may also offer CRTs, CLTs, and annuity funds. Before you invest, consider how much money you have to invest, the income stream you need, and the tax liability reduction goals 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 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