- Asset Protection Planning
- Business Succession Planning
- Charitable Giving
- Disability and Special Needs
- Elder Law
- Executor and Trustee Responsibilities
- Financial Powers of Attorney
- Inheritance Planning
- Lifetime Gifts
- Medical Directives
- Planning for Minors
- Retirement Accounts
What Are Charitable Remainder Trusts?
Countless families have used charitable remainder trusts (CRTs) to increase their income, save taxes, and benefit charities.
A CRT lets you convert highly appreciated assets like stocks or real estate into lifetime income.
Benefits of a Charitable Remainder Trust
The other benefits this type of trust offers include the following:
- Reduce your income taxes
- Reduce or eliminate your estate taxes
- Pay no capital gains tax when the asset is sold
- Benefit one or more charities
- Receive more income over your lifetime than if you had sold the asset yourself
- Gain protection from creditors if you gift the asset
- Leave more to your heirs by using a life insurance trust to replace the gifted asset
How Does a CRT Work?
You transfer an appreciated asset into an irrevocable trust. This removes the asset from your estate, so no estate taxes will be due on it when you die. You also receive an immediate charitable income tax deduction.
The trustee then sells the asset at full market value, paying no capital gains tax, and reinvests the proceeds in income-producing assets. For the rest of your life, the trust pays you an income. When you die, the remaining trust assets go to the charities you have chosen – hence the name charitable remainder trust.
While you could sell your assets and reinvest them yourself, you'd pay more in taxes and receive less income.
For example, imagine spouses Max and Jane, ages 65 and 63.
Years ago, they purchased some stock for $100,000, now worth $500,000. They'd like to sell it and generate some retirement income.
If they sell the stock, they would have a gain of $400,000 (current value minus cost) and would have to pay $60,000 in federal capital gains tax (15 percent capital gains rate applied to the $400,000 gain). That would leave them with $440,000 ($500,000 minus $60,000).
If they reinvest and earn a 5 percent return, they would earn $22,000 in annual income ($440,000 multiplied by 5 percent). Multiplied by their life expectancy of 26 years, their total lifetime income (before taxes) would be $572,000. Because they still own the assets, there is no protection from creditors, and no charitable income tax deduction is available.
Why Should I Use a CRT?
If Max and Jane transfer their stock to a CRT instead, they can take an immediate charitable income tax deduction of approximately $160,000. They are in a 35 percent tax bracket, so this will reduce their current federal income taxes by $56,000.
The trustee will sell the stock for the same amount, but because the trust is exempt from capital gains tax, the full $500,000 is available to reinvest. The same 5 percent return will produce $25,000 in annual income which, before taxes, will total $650,000 over their lifetimes. That is $78,000 more in income than if Max and Jane had sold the stock themselves. With these assets in an irrevocable trust, they also are protected from creditors.
Types of Charitable Trusts
Charitable Remainder Unitrust
One of your options for income is to receive a fixed percentage of the trust assets. With this option, called a charitable remainder unitrust (CRUT), the amount of your annual income will fluctuate, depending on investment performance and the trust's annual value.
The trust will be revalued at the beginning of each year to determine the dollar amount of income you will receive. If the trust is well managed, it can grow quickly because the trust assets grow tax-free. The amount of your income will increase as the value of the trust grows.
Sometimes the assets contributed to the trust, like real estate or stock in a closely held corporation, are not readily marketable, so income is difficult to pay. In that case, the trust can be designed to pay the lesser of the fixed percentage of the trust’s assets or the actual income earned by the trust. A provision is usually included so that if the trust has an off year, it can make up any loss of income in a better year.
Charitable Remainder Annuity Trust
If you elect instead to receive a fixed income, the trust would be called a charitable remainder annuity trust (CRAT). This means that, regardless of the trust’s performance, your income won't change.
This option is usually a good choice at older ages. It does not provide protection against inflation like a unitrust does, but some people like the security of being able to count on a definite amount of annual income. It is best to use cash or readily marketable assets to fund an annuity trust.
In either type of CRT (unitrust or annuity trust), the Internal Revenue Service (IRS) requires that the payout rate stated in the trust cannot be less than 5 percent or more than 50 percent of the initial fair market value of the trust’s assets.
Who Can Receive Income From a CRT?
Trust income, which is generally taxable in the year it is received, can be paid to you for your lifetime. If you are married, it can be paid for as long as either of you lives.
The income can also be paid to your children for their lifetimes or to any other person or entity you wish, provided that the trust meets certain requirements. In addition, there are gift and estate tax considerations if someone other than you receives it. Instead of lasting for someone’s lifetime, the trust can also exist for a set number of years (up to 20).
Do I Have to Take the Income Now?
No. You can set up the trust and take the income tax deduction now but postpone taking the income until later. By then, with good management, the trust assets will have appreciated considerably in value, resulting in more income for you.
How Is the Income Tax Deduction Determined?
Generally, the higher the payout rate, the lower the deduction. The deduction is based on:
- the amount of income received
- the type and value of the asset
- the ages of the people receiving the income
- the current Section 7250 interest rates (which fluctuate)
The income tax deduction is usually limited to 30 percent of adjusted gross income. However, it can vary from 20 percent to 60 percent, depending on how the IRS defines the charity and the type of asset. If you cannot use the full deduction the first year, you can carry it forward for up to five additional years. Depending on your tax bracket, the type of asset, and the type of charity, the charitable deduction can reduce your income taxes by 10 percent, 20 percent, or even more.
What Kinds of Assets Are Suitable for CRTs?
The best assets are those that have greatly appreciated in value since you purchased them, specifically publicly traded securities, real estate, and stock in some closely held corporations. (S corporation stock does not qualify. Mortgaged real estate usually will not qualify, either, but you might consider paying off the loan.) Cash can also be used.
Who Should Be the Trustee?
You can be your own trustee, but you must be sure that the trust is administered properly. Otherwise, you could lose the tax advantages or face a penalty. Most people who name themselves as trustee have the paperwork handled by a qualified third-party administrator.
Some people select a corporate trustee (a bank or trust company that specializes in managing trust assets) as trustee. Some charities are also willing to be trustees.
Before naming a trustee, interview several candidates and consider their investment performance, services, and experience with these trusts. Remember, you are depending on the trustee to manage your trust properly and to provide you with income.
For as long as you live, the trustee you select — not the charity — controls the assets. Your trustee must follow the instructions you put in your trust. You can retain the right to change the trustee if you become dissatisfied. You can also change the charity (to another qualified charity) without losing the tax advantages.
Generally, once an irrevocable trust is signed, you cannot make any other changes. Be sure you understand the entire document and that it is exactly what you want before you sign.
Gifting the Asset? Consider a Life Insurance Trust
If you have a sizable estate, the asset you place in a CRT may only be a small percentage of your assets. If you give the asset away but are concerned about replacing its value for your children, there is an easy way to do so.
You can use the income tax savings and part of the income you receive from the charitable remainder trust to fund an irrevocable life insurance trust. The trustee of the insurance trust can then purchase enough life insurance to replace the full value of the asset for your children or other beneficiaries.
There are several benefits to this strategy:
- The insurance proceeds will not be included in your estate, so you avoid estate taxes.
- You can keep the proceeds in the trust for years, making periodic distributions to your heirs.
- Any proceeds remaining in the trust are protected from irresponsible spending and creditors (even spouses).
- Insurance proceeds are available immediately, even if you and your spouse both die tomorrow.
- The proceeds will also be free from probate and income taxes.
If you think a charitable remainder trust would be of value to you and your family, speak with an estate planning attorney experienced in CRTs.