Charitable Remainder Trusts: A Strategic Tool for Philanthropy and Wealth Management
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If you have read our articles or watched our videos about Revocable “Living” Trusts then you have completed “Estate Planning 1”. As you learned, a Trust is a fiduciary arrangement where Grantors (also known as Trustors or Benefactors), create and fund the Trust, and the Trustees hold and manage the trust assets for the benefit of the Beneficiaries until they are fully distributed by the end of the trust administration process. Revocable “Living” Trusts are widely-used estate planning structures that are a must for the vast majority of folks who own real estate and/or have an estate valued in the high $100,000s or more. Unless you’d like to put your heirs through the arduous legal process known as Probate, which involves court hearings, attorneys and judges and lasts a year or more, transferring your assets to a Living Trust is a no-brainer. One reason is, they are “revocable” trusts, so they can be modified (“amended”) or terminated (“revoked”) at any time, making them a stress-free choice. In a typical Living Trust, the Grantor is also the Trustee, so the person(s) creating the Trust have total and complete control over it.
Trusts 101: Irrevocable Trusts
Now let’s move up to the upper division of the wonderful world of trusts. Many of these more advanced trusts are Irrevocable, meaning that they cannot be terminated, and for the most part cannot be modified. Once the Grantor executes an Irrevocable Trust, they lose control over its assets, and the Trustee, who usually is a third party, must strictly follow the trust’s terms as originally set. You may be asking, “Why on earth would I want to lose control of my hard-earned assets?” The short answer is, if you no longer have control over it then you no longer legally “own” it, and if you no longer “own” it then you no longer have ownership and tax liabilities. For example, I “own” my home because I can sell it, take out loans on it, rent it out, paint it hot pink if I like, etc. In short, I have control over it. On the down side, if somebody gets hurt on my property, they can sue me; and, of course, I’m paying for the property tax and insurance personally.
Ironically, there are several advantages to giving up ownership of assets. Since Grantors have no “control” over the assets in an irrevocable trust, these trusts are treated as separate tax entities. This means the assets within the trust are not included in the grantor’s taxable estate, potentially resulting in tax savings. Additionally, creditors (or sometimes ex-spouses) cannot utilize the assets in an irrevocable trust to satisfy the grantor’s debts, since they are no longer legally “owned” by the Grantor. And the good news for the Grantor is, due to the terms of the Trust, he can still “enjoy” the assets. In other words, the Trustee won’t be kicking you out of your home even if it is in an Irrevocable Trust. And if the property has tenants, the rental income will still be finding its way to you.
Charitable Remainder Trusts (CRTs)
Probably my favorite Irrevocable Trust is the Charitable Remainder Trust, a unique estate planning tool that combines the benefits of philanthropy with financial and estate planning. Most often used by wealthy Grantors, the Charitable Remainder Trust (CRT) provides substantial tax advantages to the Grantors and Beneficiaries with a specific format that pays Grantors and/or Beneficiaries a regular income during their lifetimes and then distributes the remainder to a designated Charity or Charities. It’s a brilliant win-win scheme which benefits the Grantors, Beneficiaries and of course the Charities. CRTs are particularly attractive to those who wish to support charitable causes while also benefiting from tax advantages and ensuring income for themselves and/or their beneficiaries.
You may ask, how does a Charitable Remainder Trust Work? The CRT is created when the Grantor transfer assets such as cash, stocks, or real estate into the trust. This “donation” qualifies for a partial tax deduction. In return for this charitable gift, the CRT regularly pays out a fixed percentage of the trust’s assets to you or other designated beneficiaries for a specified period, which can be up to 20 years or for the life of the beneficiaries. The payout can be set up as either a fixed annuity or a percentage of the trust’s annual value. At the end of the trust’s term, the remaining assets in the trust are donated to one or more designated charitable beneficiaries, which can be private foundations as well as public charities, that were specified by the trust’s creator. This remainder interest in the trust is where the trust derives its name.
Six key Characteristics of CRTs
- Creation of the Trust: The Grantor (Trustor) establishes the CRT by transferring assets into the trust. These assets can be cash, securities, or real estate. Once transferred, these assets are owned by the trust, which is managed by the Trustee according to the terms of the trust. Take note that the Secure 2.0 Act, included in the Consolidated Appropriations Act of 2023 and signed into law by President Biden on December 29, 2022, introduces special provisions that allow for a one-time qualified charitable distribution of up to $50,000 from an IRA to be made to a CRT.
- Irrevocable Nature: A CRT is irrevocable, meaning that once it is established and assets are transferred into it, the trustor cannot change the terms or reclaim the assets. This irrevocability is a key feature that ensures the assets will ultimately benefit the chosen charitable organization(s).
- Management of the Trust: The assets within the CRT are managed by the Trustee, who is responsible for investing in the assets and making distributions according to the terms of the trust. It’s common for the designated charity to be the trustee, but the trustee can be a financial institution, an appointed individual or entity, or even the trustor himself. Yes, the trustor can be the trustee of a charitable remainder trust, but only if they meet IRS eligibility requirements. Surprisingly, the trustor can redirect trust investments, manage distributions, and pay trust expenses Nevertheless, it can be in the trustor’s best interest to appoint an independent trustee, such as when the trust’s beneficiaries are family members who might disagree or minors, who can’t immediately manage the assets.
- Income Generation: The CRT is designed to pay out income to the trustor or other named beneficiaries. This income is distributed either as a fixed annuity (in a Charitable Remainder Annuity Trust, or CRAT) or as a percentage of the trust’s assets, recalculated annually (in a Charitable Remainder Unitrust, or CRUT). The income can be distributed for a specific number of years (up to 20) or for the lifetime of the beneficiaries.
- Tax Benefits: When assets are transferred into the CRT, the Trustor receives an immediate charitable income tax deduction based on the present value of the remainder interest that will eventually go to charity. The value is calculated using IRS tables that estimate your life expectancy (or that of whoever is the income beneficiary), current interest rates, and what the charity is expected to receive wen the income beneficiary’s interest ends. The more the charity is expected to get, the larger the tax deduction. (Note: Because IRS calculations are influenced by prevailing interest rates, the exact value of a gift to a CRT depends on when the gift was made.) You will want to see an expert who has the most current IRS tables. Many large charities have staff who will calculate your actual tax deduction for you. Additionally, the CRT can sell appreciated assets without incurring capital gains taxes, as it is a tax-exempt entity. This allows the full value of the assets to be reinvested, potentially increasing the income payouts.
- Remainder to Charity: After the income distribution period ends—either after a set number of years or upon the death of the beneficiaries—the remaining assets in the CRT are transferred to one or more charitable organizations designated by the trustor. These organizations can be public charities or private foundations.
Strategic Uses for CRTs
By combining charitable giving with income generation and tax advantages, a CRT offers a strategic way to achieve both philanthropic and financial goals. One of the strategic uses of Charitable Remainder Trusts is that CRTs are often used by individuals who have significant appreciated assets, such as stocks or real estate, and wish to avoid the high (capital gains) tax burden associated with selling these assets outright. By placing these assets in a CRT, you as a donor can enjoy an income stream, receive immediate tax benefits, and ultimately support a charitable organization. But wait, there’s more.
You can use a CRT to turn highly-appreciated assets in cash without paying any capital gains tax up front. If you donate a non-income-producing asset to a CRT, the charity can convert it into an income-producing one. If the charity sells it for its current market value, the charity retains all the money received, without any subtraction for capital gains tax. You as Grantor benefit in two ways: First you get an immediate tax deduction based on the sale price of the asset at current fair market value. Second the income you receive from the trust property will be based on this amount, which will obviously be higher than if capital gains tax had to be paid out of the sale’s profits.
CRTs are also beneficial for those who are charitably inclined and want to make a significant impact on a cause they care about. By deferring the charitable gift until after the term of the trust, you can still benefit from the income generated by the assets during their lifetime or a set period. Additionally, CRTs can be used in conjunction with other estate planning tools, such as life insurance, to further enhance the financial legacy left to heirs while also fulfilling philanthropic goals.
If you want make significant donations to charity but are afraid that your inheritors might need the money, you are in luck (assuming you’re in good health). One strategy is to “Replace the Donated Money.” Take the money saved by the income tax deduction to purchase life insurance to cover the money “lost” by the charitable gift. You can then remove the life insurance from your estate for estate tax purposes.
Varieties of CRTs
There are two primary types of CRTs: Charitable Remainder Annuity Trusts (CRATs) and Charitable Remainder Unitrusts (CRUTs).
In a Charitable Remainder Annuity Trust (CRAT), the trust pays a fixed dollar amount annually to the beneficiaries, which is determined when the trust is created and does not change. This fixed payment provides certainty, but it does not account for inflation or changes in the trust’s value over time.
On the other hand, Charitable Remainder Unitrust (CRUT) pays a fixed percentage of the trust’s value, recalculated annually. This means that the payouts can vary each year depending on the trust’s performance. CRUTs provide more flexibility and potential for growth but also carry more risk if the trust’s assets underperform.
Tax Benefits of Charitable Remainder Trusts
CRTs offer significant tax advantages, especially for assets that have significantly appreciated since your purchased them. When you transfer appreciated assets into a CRT, you can avoid immediate capital gains taxes. This is because the CRT, as a tax-exempt entity, can sell the assets without incurring capital gains tax. As a result, the full value of the assets can be reinvested within the trust, potentially increasing the payout to the beneficiaries. In addition, you can claim a charitable income tax deduction in the year the CRT is funded. The amount of the deduction is based on the present value of the remainder interest that will eventually go to charity. This deduction can provide substantial tax relief, especially in high-income years. Another tax advantage is that the assets transferred into a CRT are removed from your estate, which can reduce potential estate taxes. This makes CRTs a valuable tool for wealthy individuals looking to reduce the size of their taxable estate while supporting charitable causes.
Is a Charitable Remainder Trust Right for You
Establishing a CRT requires careful planning and legal guidance. The process typically involves working with an attorney to draft the trust document, selecting a trustee to manage the trust, and deciding on the payout terms and the charitable beneficiaries. It’s also important to consider the potential impact on your overall financial and estate plan, including how the trust aligns with your income needs, tax situation, and philanthropic objectives. Estate planning law firms such as Simone Legal PC as well as Financial institutions and large charities, such as the Salvation Army, offer CRT services and can provide guidance on managing and distributing the trust’s assets, and as . The IRS also provides guidelines and requirements for CRTs, ensuring that they comply with federal tax laws and maintain their tax-exempt status.
A Charitable Remainder Trust is a powerful tool for those who want to combine their philanthropic goals with financial planning. It provides a way to support charitable causes while enjoying tax benefits and an income stream. Whether you are looking to minimize taxes, provide steady income for your family, and/or leave a lasting charitable legacy, a CRT can be a strategic addition to your estate plan. As with any financial decision, it’s essential to consult with legal and financial professionals to ensure that a CRT aligns with your overall goals and circumstances.
