Optimized CLAT FAQs, Part 3: The Charitable Lock-Up Period

The Optimized CLAT (OCLAT) is a special version of a charitable lead annuity trust (CLAT) that has been designed to optimize the tax and economic benefits to the contributor.

For an overview of the OCLAT strategy and to provide perspective for the FAQs below, we suggest that you first review our short article, “Optimized CLAT: ‘Opt Out’ of Immediate Income Taxes by Promising to Make Charitable Gifts in the Future.“

FAQ INDEX

THE CHARITABLE LOCK-UP PERIOD: ADMINISTRATION

Who invests the OCLAT funds? You are the sole person on the OCLAT account (as Trustee) and have total control of the OCLAT investments.

Are there investment restrictions? Virtually none, except (i) you cannot use the OCLAT funds for your business operations, and (ii) there are tax penalties if you take extreme risks with the funds (the OCLAT is essentially subject to a “gross negligence” standard).

How much does the OCLAT pay to charity? This depends on the length of the term, the funding amount, and the IRS-set charitable hurdle rate in effect at funding. As of Q3 2026, the IRS rate is ~5% which translates to a 30-year $1M OCLAT paying ~$3.5M to charity over the 30-year term (with most of the ~$3.5M paid in the final 5 years, as discussed below).

Why can’t I use a shorter charitable term? You could, but it’s probably not worth it. If you select a short term (say, 10 years), the OCLAT won’t have enough time to grow since too much is donated to charity, too soon. The OCLAT’s premise is to push off the charitable payments as long as possible, giving the OCLAT time to grow before donations become due. There is no maximum term (the IRS has approved a 118-year CLAT), but most clients select a 20-30 year term.

When do the charitable payments from the OCLAT become due? There is a fixed schedule at the time of funding. The IRS has approved the OCLAT’s “backloading” of charitable payments (i.e., there are very small charitable payments in the early years which gradually increase, such that most of the OCLAT’s required donations do not occur until the final 5 years of the term). This is optimal since it gives the OCLAT assets plenty of time to appreciate, as well as time to make up for “bad markets” in early years (as proven by variable/stochastic Monte Carlo models assuming a 20+ year term.)

What if I need to change the charity or if I’m not sure which charity I want to select when setting up the OCLAT? Good news. Each year, the OCLAT’s required charitable payment is paid into a separate charitable account known as a “donor advised fund” or “DAF”. Once the funds are inside your DAF, you can continue to invest those funds (free of taxes) although all your DAF funds must be paid, at some point in the future, to charities of your choosing. At any time, you can direct as much or as little from your DAF to any charities that you like.

Can the OCLAT transfer stock to the charity/DAF as its annual payment? Yes; however, the IRS takes the position that the OCLAT sold the stock immediately prior to the transfer so this might result in capital gains.

If the OCLAT has interest income or sells an asset for gain, who pays the tax? All income and gains (and deductions and losses) generated by the OCLAT assets flow through on a Form K-1 to your personal Form 1040 tax return. Thus, you must pay the OCLAT’s income taxes using assets outside the OCLAT. However, this is a tremendous benefit as it allows the OCLAT assets (which are exempt from creditors/lawsuits and exempt from the 40% gift/inheritance tax) to grow, without the drag of income taxes. Assuming your investment managers properly diversify the OCLAT’s investments and utilize tax loss harvesting strategies, your OCLAT might not generate significant taxable income for the first 5-20 years.

THE CHARITABLE LOCK-UP PERIOD: UNEXPECTED PROBLEMS & CIRCUMSTANCES

What if I need to withdraw the OCLAT funds before the end of the charitable Lock-Up Period? Good news. The IRS has approved termination of the OCLAT before the end of the charitable Lock-Up Period; however, this requires that the OCLAT pay all the remaining charitable payments. This is a particularly attractive solution when OCLAT asset performance greatly exceeded expectations (a “homerun” OCLAT) and you want early access to the OCLAT funds.

What happens if I make bad investments inside my OCLAT and it runs out of money – say, halfway into the charitable Lock-Up Period – and cannot make the remaining promised charitable payments? Good news. First, you still enjoy the upfront tax deduction in the year of funding – that is not taken away. Second, you have no liability to make the OCLAT’s remaining payments – rather, charity simply doesn’t receive the full promised amount from the OCLAT. Third, you would have enjoyed all the OCLAT’s tax losses on your personal Form 1040 tax return. (Example: a $1M failed OCLAT would give you $2M in tax deductions ($1M upfront; $1M capital loss as the OCLAT assets went to zero). This provides a nice “hedge” since, worst case, you enjoyed $2M in tax deductions on a $1M transfer to the OCLAT.)

What are the tax consequences if I die before the end of the charitable Lock-Up Period?

The good news is that your family does not have to pay the 40% federal estate tax on any of the OCLAT assets – this is true even if you die the next day after funding your OCLAT. Therefore, in addition to the upfront income tax deduction, there is effectively a 40% estate tax savings enjoyed as soon as you fund the OCLAT.

The potential bad news is that, if you die early in the charitable Lock-Up Period,¹⁴ a portion of the upfront income tax deduction may be subject to “partial income tax recapture”, i.e., your estate may have to pay some income taxes. In most OCLAT cases, the client is relatively young (ages 30-70), healthy, and not contributing a significant portion of their net worth to the OCLAT; therefore, recapture risk is typically not a material factor. For other clients, there are techniques we can use to “hedge” or minimize recapture risk.¹⁵ Recapture is probably the most complex concept vis-à-vis OCLAT planning; for more information, please refer to PDF page 36 of the separate Estate Planning article.

OK I understand the tax consequences if I die before the end of the Lock-Up Period – but what happens to the OCLAT? The OCLAT just “keeps on going”…just like you are still living. You name a successor trustee (such as a child, sibling or friend) to manage the OCLAT investments and make the charitable payments. However, as explained above, the successor trustee may decide to pay the charity early and terminate the OCLAT to “unlock” the balance for heirs.

FOOTNOTES

¹⁴ The Tax Code provides that the amount of recapture income that your estate must pay depends on the amount of taxable income that the OCLAT produced during your lifetime – the greater the amount of income that the OCLAT produced, the less the recapture amount. In most financial projections, the amount of recapture steadily decreases and eventually goes to zero at some point between years 10-20 of the charitable Lock-Up Period.
¹⁵ For older clients or clients who are contributing a significant amount of their net worth into the OCLAT where recapture would cause a significant liquidity issue at death, we may (i) purchase term life insurance outside the OCLAT to provide the necessary liquidity to pay the recapture tax, and/or (ii) contribute low basis assets to the OCLAT and then sell the assets immediately within the OCLAT to immediately reduce (or eliminate) the amount of potential recapture.

FAQ Index

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