Lincoln Fleming, CFP, CPA, PFS and Slava Malkin

September 2022

An investor with a highly concentrated position faces the decision of how much and how quickly they wish to diversify their concentrated risk. Although diversifying is typically the most prudent strategy, the concomitant tax liability and relinquishing of future upside participation in the concentrated stock could create significant challenges for the investor. This problem has spawned numerous solutions that provide different levels of trade-off between speed of divestment and those various hurdles.

Charitable remainder unitrusts (CRUTs) have long been used with great benefit for taxable investors who want an income stream but with eventual disposition of assets to a charity. They have also been used to reduce risk for such investors, especially in the presence of concentrated positions. In setting up a CRUT:

• A donor transfers concentrated property to an irrevocable trust.
• The trustee can liquidate the property and reinvest the proceeds from the sale, as capital gains taxes don’t affect the income beneficiaries until distribution.
• Annuity payments are made to the donor or other noncharitable beneficiaries based on a fixed percentage of the value of the trust assets determined annually.
• Assets remaining in the trust at the end of the specified trust term pass to one or more qualified charities specified by the donor.

In evaluating the usefulness of a CRUT as a divestment solution, we frame the decision investors face around their utility across two dimensions: the magnitude of their concentrated risk exposure and how strongly they want to donate assets to charity. We note that setting up a CRUT allows the investor to immediately diversify a concentrated position; hence, we evaluate CRUTs against alternatives with the same property.

We find that, as a way to immediately diversify a concentrated position, CRUTs can provide superior wealth outcomes:

• Over the long horizons measured from 10 to 30 years.
• In a wide range of market conditions.
• For a broad spectrum of charitable inclinations.

As investors analyze their choices for optimal ways to address concentrated positions, they should start by assessing their utility regarding two separate issues, their risk exposure and their charitable inclinations. The bigger the concentrated risk problem, the more attractive a CRUT becomes. For moderate charitable intent, a CRUT can provide superior outcomes when measuring the combined total of retained interest and charitable donation, although for the highest level of charitable intent, immediate donation of the entire concentrated position provides the highest utility.

Our complete “CRUTs as Tools for Advanced Risk Management” paper examines in detail the circumstances under which CRUTs can be used most beneficially to mitigate concentration risk.

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