Charitable Trust
A charitable remainder trust is a tax-exempt irrevocable trust intended to reduce taxable income by first dispersing income to the trust beneficiaries for a specified period of time and then donating the remainder of the trust to the designated charity.
Having a CRT as part of your estate plan strategy is designed to generate income and fulfill your philanthropic goals. Charitable trusts can offer flexibility and some control over your intended charitable beneficiaries as well as lifetime income, thereby helping with retirement, estate planning and tax management.
The Basics of CRTs
Essentially, you create and place specific assets into a CRT. You may continue to manage the assets and you receive an income stream during your lifetime. The charity or charities you designate receive the residual of the trust’s assets after you pass away.
In return for what amounts to a pledge of assets to charity in the future, the donor of the assets placed in the trust receives a current tax deduction for the donation and they avoid any and all capital gains on the donated assets. This means, for example that the donor may place highly appreciated apartment building into the trust, sell the building tax-free and reinvest the proceeds, which are then used initially to provide the income stream to the donor.
The amount of the deduction is calculated in part based on the age of the last income beneficiary.
In addition, the donor receives partial or full elimination of the asset gifted from federal estate tax calculations.
FAQ
Two Sets of Beneficiaries
CRT's are irrevocable trusts that actually provide for and maintain two sets of beneficiaries. The first set is the income beneficiaries (typically you and, if married, a spouse).
The second set of beneficiaries are the charities you name. They receive the principal of the trust after the income beneficiaries pass away.
Income for Donor
Income beneficiaries receive an income stream from the trust representing either a set percentage of trust assets or a specified dollar amount.
In a CRT you can either elect an income stream for a term of years up to 20 years or a lifetime income for up to 5 lives. You can elect either of the two but not a combination of the two. That is, you cannot specify income for your life and then an additional 20 years for the children.
Maintain Control
While a CRT is an irrevocable trust, you and your spouse (if married) may change the charitable beneficiaries at any time. Under certain conditions, you may even serve as trustees of the CRT. As trustees, you can maintain full investment control of the assets inside the CRT.
Capital Gains Strategy
Because their assets are destined for a charity, Charitable Remainder Trusts do not pay any capital gains taxes. These taxes can range from 15% to 25% of an asset's growth in value. For this reason, CRTs are ideal for assets like stocks or property with a low-cost basis but high appreciated value.
For example, suppose you sell one of your rental properties for $1 million. Let's assume you originally paid $100,000 for the property. Upon completion of the sale, you would owe capital gains taxes on the $900,000 difference. That tax could easily top $150,000, depending on how long you owned the property and your overall tax situation.
Funding a CRT with highly appreciated assets (such as real estate) allows you to sell those assets without paying any capital gains taxes. Since CRTs have a charitable intent and do not have to pay capital gains, the full value of any asset transfers to the trust (and thus, to your family and favorite charity).
Specify the Income Stream
The amount of income to come out of the CRT depends upon the payout percentage that you choose, and the amount of income your assets generate while inside the CRT.
The IRS states that, at a very minimum, the CRT must distribute at least 5% of the net fair market value of its assets. If you don't need the income one year, you may elect to defer income through a “makeup provision.” However, the CRT's net distributions must eventually equal at least 5% to be considered valid by the IRS.
When setting the payout percentage, be forewarned: the higher it is, the lower your charitable income tax deduction. Considering market conditions and the possibility that taking out too much may reduce the principal inside the trust, you should probably not receive income of more than 9% each year. Also, when planning the level of income, you wish to receive, you must consider your anticipated investment returns to ensure that at least 10% of the initial value of the Trust will be available to the charity upon the income owners’ death.
Retirement Planning
Many clients use Charitable Remainder Trusts to augment their current retirement plan. By setting one up in your peak earning years, you can make contributions to the CRT in the form of appreciated real property, zero coupon bonds, non-dividend paying growth stocks, or professionally-managed variable annuities. You can then enjoy an increased standard of living immediately.
In special cases you may not currently need the increased income provided through the CRT. By letting the CRT grow without taking income from it during the early years, the CRT can begin making payouts to you when you retire. These payouts can include makeups for any shortfalls in income you did not receive earlier. Unlike IRAs or 401(k) plans, there are no limits on how much you can contribute.
Income and Estate Taxes
A CRT is considered “outside of your estate” by the IRS. Because of this, you may end up saving as much as 48 cents of every dollar you move to the CRT. Plus, you are usually not limited in how much you can contribute by the annual gift tax limit or the Estate and Gift Tax credits CRTs, because they benefit a charity, also qualify you for an income tax deduction. The amount of your deduction is the present value of the remainder interest to the charity. Your current deduction also depends on the type of property you contribute, as well as the type of charity you name as a beneficiary.
Average deductions normally fall in the range of 20-50% against your adjusted gross income. Any deductions not used in the year of contribution may be carried forward for the next five years
Combining with Other Strategies
CRTs are designed to give the principal to charities when you and your spouse pass away. This bypasses any children, which could lead to your heirs feeling slighted.
These feelings of ill-will can be overcome by combining the CRT with another strategy to “make up the difference” that goes to the charity.
For instance, some large estates combine the CRT with an Irrevocable Life Insurance Trust (ILIT) to provide a cash distribution upon the death of the owner. The ILIT then subdivides into individual trusts for each child or named heir.
In this scenario, everyone wins. The estate owner receives income streams and tax deductions, the charity gets the principal of the CRT, and the children receive a tax-free cash distribution from the Life Insurance.
