Pooled Income Funds

At a Glance

A pooled income fund is a trust maintained by a charitable organization. The fund is made up of a conglomeration of donor contributions. The gifts are "pooled" for investment purposes with each donor receiving his or her "unit of participation," or portion of the fund's earnings.

Pooled income funds tend to flourish in times when interest rates (which determine the amount a non-charitable beneficiary receives from the fund each year) are high. In recent years, as interest rates remain at historic lows, donor interest in these funds has decreased. In fact, many charities that invested in the funds during their heyday have tried to use the least disruptive method of closing the fund: letting fund beneficiaries die out.

However, if interest rates significantly climb, so will the interest in pooled income funds.

Click here to see a graphic of how a gift to a pooled income fund works.

How Pooled Income Funds Work

Definition & Overview

Individuals who participate in a pooled income fund irrevocably transfer money to the fund, naming one or more persons (including themselves) to receive the income earned by the fund for as long as that person or persons live. After the death(s) of the designated income beneficiary(ies), the money or property will pass to the charity.

Even though the charitable organization will not receive the gift until some future time, the donor can usually claim an immediate income tax charitable deduction for the present value of the time-delayed gift.

The Internal Revenue Code states a trust arrangement will qualify as a pooled income fund if it meets several requirements [IRC §642(c)(5)]. These requirements include:

Maintenance by a Public Charity

The pooled income fund must be held by a 50% type organization, referred to as a "public charity." A public charity allows the donor to take an income tax charitable deduction of up to 50% of the donor's adjusted gross income (60% for gifts of cash). Private foundations cannot maintain pooled income funds.

Contributions of an Irrevocable Remainder Interest

A donor must give the public charity maintaining the fund an irrevocable remainder interest. A remainder interest is considered irrevocable if it is vested and not contingent on any event.

Note: The governing instrument may, but is not required, to list an alternative remainderman should the designated charitable organization be unable to accept the gift.

Creating a Life Income Interest

The pooled income fund will distribute a life income interest either to:

$image\bullet.jpg$ The donor, or

$image\bullet.jpg$ Another beneficiary.

The income interest must be measured by the life of the beneficiary. It may not be based on a term of years or on the life of an individual that is not the beneficiary. Although the income interest must be based on the life of the beneficiary, this does not mean the beneficiary must be an individual.

The Internal Revenue Service has ruled that a trust and members of a class may be income beneficiaries. However, the members of the class must be alive and ascertainable at the time the donor transfers the property to the fund.

Income Paid on Fund's Rate of Return

The pooled income fund must pay annually to each beneficiary an amount of income based on the fund's rate of return for the taxable year. Each beneficiary receives a "unit of participation" representing the donor's ability to receive a proportionate share of the annual income earned by the fund.

Commingling Requirement

All property a donor transfers to a pooled income fund must be commingled, invested and reinvested with all other property transferred to the fund by other donors. However, other property transferred to the public charity which is not given to the pooled income fund, may not be commingled.

Maintenance by the Donee Charitable Organization

The pooled income fund must be maintained by the donee charitable organization. An organization is deemed to maintain the fund if:

$image\bullet.jpg$ The charitable organization has direct or indirect control over the funds

$image\bullet.jpg$ The charitable organization holds the power to remove a trustee and designate a replacement trustee for the fund

Note: The charitable organization does not have to serve as the trustee of the fund. However, neither the income beneficiary nor the donor may act as a trustee.

Prohibition Against Exempt Securities

A pooled income fund must list in the fund's declaration of trust a prohibition against receiving or investing in tax-exempt securities.

Amounts Received From the Transfer

The fund may only accept contributions that meet the requirements for pooled income funds.

Funding Alternatives

A variety of assets may be contributed to a pooled income fund, including the following:

$image\bullet.jpg$ Cash

$image\bullet.jpg$ Publicly traded stocks

$image\bullet.jpg$ Bonds

$image\bullet.jpg$ Mutual fund shares

$image\bullet.jpg$ Appreciated property

$image\bullet.jpg$ Tangible personal property

With the exception of tax-exempt securities, publicly traded stocks, bonds and mutual shares may be transferred to the fund resulting in important tax benefits--especially if the securities are providing a low income yield.

$image\bullet.jpg$ A gift of appreciated property will not result in capital gains tax, no matter how much the property may have increased in value.

$image\bullet.jpg$ A gift of tangible personal property is usually not a suitable gift for a pooled income fund, because tangible personal property often cannot be easily sold to produce income for the designated beneficiaries.

Tax Consequences

Income Tax Deduction for the Donor

Donors giving property to a pooled income fund may deduct (subject to limitations, and assuming the donor itemizes) the present value of the charitable organization's right to receive the value of the gift at some future time. The amount of the contribution will equal the fair market value of the remainder interest as of the date of the transfer to the pooled income fund.

This statement may sound simple enough, but determining the present value of a future remainder interest involves a multi-step equation. The actual charitable deduction will depend on:

$image\bullet.jpg$ The age of the income beneficiary (or the ages of two income beneficiaries)

$image\bullet.jpg$ The assumed rate of return that will be earned by the fund

$image\bullet.jpg$ The time periods at which income payments will be made (monthly, annually, semi-annually or quarterly).

The assumed rate of return is the fund's highest yearly rate of return for the preceding three years. If the fund has not been in existence for the preceding three years, the highest yearly rate of return is deemed to be the highest yearly average of the IRC Sec. 7520(a)(2) monthly rate (i.e., 120% of the midterm applicable federal rate) for the three years immediately preceding the year of the gift, reduced by 1% [Reg. Sec. 1.642(c)-6(e)(4)]. The deemed rate for 2024 gifts to pooled income funds that have been in existence less than three taxable years is 3.8%.

Income Tax Consequences to Beneficiaries

The income beneficiary of a pooled income fund will be taxed on the income he or she receives from the fund as ordinary income. The beneficiary will be taxed on any income paid, credited or required to be distributed to him by the pooled income fund during the taxable year, or within 65 days of the end of the year.

Gift Taxation

Whether the donor retains an income interest in the pooled income fund or gives it to others determines whether a gift is made. If the donor retains an income interest for himself or retains a testamentary power of reduction, no gift has occurred.

However, if the donor gives a third-party beneficiary (other than a spouse) an income interest, the donor has made a gift. The gift value will be the amount of the present value of that person's income interest exceeding the gift tax annual exclusion amount (as indexed).

Estate Taxation

If a donor either:

$image\bullet.jpg$ Retains the income interest for his or her life, or

$image\bullet.jpg$ Retains the power to revoke the beneficiary's income interest and the beneficiary survives the donor

the income interest will be included in his or her gross estate.

In these cases the executor of the donor's estate will place the fair market value of the interest into the donor's estate. However, the donor's estate may use the estate tax charitable deduction to offset the taxes.

Capital Gains Taxation

Individuals owning long-term capital gain (LTCG) property find the pooled income fund to be highly advantageous. Upon contribution of the LTCG property to the pooled income fund, no capital gains tax is owed. In addition, an income tax charitable deduction may be taken.

Within the fund, LTCG is not considered income which can be distributed to income beneficiaries. Any long-term capital gains kept in the funds for charitable purposes will be eligible for a charitable tax deduction. However, the fund will be taxed on short-term capital gains, unless the gains are allocated to income.

Jeopardizing Tax-Exempt Status

The pooled income fund is classified as a split-interest trust (meaning the trust interest is divided into a life estate and a remainder). Therefore, the Internal Revenue Code requires the trustee (or fund manager) to be prohibited from engaging in certain activities if the donor wishes to retain his or her charitable deduction. The following is a break-down of the prohibitions.

All pooled income funds must refrain from:

$image\bullet.jpg$ Self dealing (IRC Sec. 4941) which prohibits sales, leases and loans between the donor, fund and trustee; and

$image\bullet.jpg$ Taxable expenditures (IRC Sec. 4945) which prohibits payments to influence legislation or the outcome of elections, or grants to non-operating private foundations.

A public charity that maintains the fund as an income beneficiary must also be prohibited from:

$image\bullet.jpg$ Excess business holdings (IRC Sec. 4943) which prohibits a donor and his family members from owning more than 20% of the voting stock of one corporation; and

$image\bullet.jpg$ Jeopardizing investments (IRC Sec. 4944) which mandates the trustee to exercise ordinary business care and prudence with investments.

Property that is severed from the fund upon termination of the life income interest, and then is retained for the use of the public charity maintaining the fund (unless the organization retaining the severed property is a public charity) must meet minimum distribution requirements (IRC Sec. 4942).

Securities Law / "No-Action" Policy

Normally the pooled income fund would fall under various federal securities laws, resulting in onerous registration requirements for the fund. However, the Securities Exchange Commission staff has implemented a "no-action" policy, meaning if an eligible public charity establishes and maintains a pooled income fund that qualifies as a recipient of tax-deductible contributions, it does not have to register the fund under the various securities acts. The "no-action" policy is subject to three conditions:

$image\bullet.jpg$ The fund must qualify as a beneficiary of tax-deductible contributions under IRC Sec. 642(c)(5);

$image\bullet.jpg$ Each prospective donor must receive written disclosure that fully and fairly describes the pooled income fund's operation; and

$image\bullet.jpg$ All gift solicitors must be either volunteers or persons employed in the charity's overall fund raising.

Although pooled income funds will probably not fall under various securities laws, the anti-fraud provisions of these laws still apply to the funds. Literature distributed about a pooled income fund which contains untrue statements of material facts or fails to disclose material facts may subject the charity to action under federal securities laws. For a charitable organization to comply with the anti-fraud provision and the disclosure requirements, a disclosure statement must be prepared.

Although a pooled income fund may not fall under federal securities laws, state securities laws should be examined to see if they apply.

Pooled Income Advantages

The pooled income fund offers several advantages to the donor including:

$image\bullet.jpg$ The donor or other specified beneficiary is assured of an income for life.

$image\bullet.jpg$ The donor who itemizes gets to take a federal income tax charitable deduction, subject to limitations, in the year of the transfer.

$image\bullet.jpg$ If appreciated property is transferred to the fund, the capital gains tax usually will be avoided.

$image\bullet.jpg$ Cash flow can be increased if a low-yielding, appreciated asset is given to the pooled income fund in exchange for a higher income.

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