Planning for a time when you’re no longer around is hard. The most important thing is being able to continue to protect the people you love. Beyond that, a growing number of people are interested in leaving a philanthropic legacy. According to a recent survey, the top reasons for creating an estate plan are 1) to provide for your family financially (76.3%), 2) to streamline the inheritance process (65.5%), and 3) to leave a lasting legacy (36.8%).1
Today, we’re going to look at a strategy particularly oriented towards charity while still providing income for living expenses. A Charitable Remainder Trust is able to accomplish both of these. This type of trust accomplishes a lot across generating retirement income, estate planning, tax management, and creating a philanthropic legacy.
The Structure and the Advantages
A CRT is an irrevocable trust that generates income for you and/or another person(s) for a period of time and the remainder of the assets are donated to the charity(ies) of your choice.
- Current Tax Deduction for Donation – You are able to take an income tax deduction for the present value of the expected future donation. Since a portion of the Trust is being paid out as income this limits the full deductibility.
- Income Stream for a specified period of time – The Trust can be set up to distribute income annually, semi-annually, quarterly or monthly. The income must be at least 5% of the assets but no more than 50% of assets. The duration of the Trust is either a specified period of time (usually 20 years) or the death of the last income beneficiary. More details are below in the next section.
- The CRT itself does not owe taxes – A CRT is a great tool for donating low-basis, highly appreciated assets. When these assets are sold in the CRT, the Trust does not owe capital gains taxes on the sale. The Trust does not pay income tax on its regular income & dividends. The assets grow tax-free inside the trust.– However, the income beneficiary does pay income taxes on the income they receive. This is complicated. How the income is recognized often differs from year to year and is taxed on a worst-first basis. Consulting your Tax Advisor is recommended.
- Remainder Gift to Charity – The amount left in the CRT is donated to the charity(ies) designated. This can be a meaningful donation for their operations and mission. It is a way to continue to support their efforts beyond your annual gifts.
- Reduction or Elimination of Estate Taxes – The assets put into a CRT are moved out of your estate by moving them into an Irrevocable Trust. That means they are not included in determining your taxable estate.
- Protection from creditor claims – Since these assets are effectively out of one’s estate, they are protected from claims by creditors.
Two Options for Creating an Income Stream
A CRT has two ways the income can be structured. The income stream can be either a fixed percentage of the value or a fixed dollar amount.
- Charitable Remainder Unitrust (CRUT) – This payment uses a fixed percentage of the fair market value of the trust assets. The trust is valued annually to determine the new payout. The same fixed percentage is used; however, the payout will differ based on the amount the assets moved up or down. This means the income stream is variable.
- Charitable Remainder Annuity Trust (CRAT) – This payments is a fixed dollar amount. It is calculated in the first year using the initial fair market value of the assets. This amount remains the same regardless of subsequent valuations.
Remember, in both the CRAT and CRUT, the IRS dictates that distributions to an appointed beneficiary be no less than 5% and no more than 50% annually. Furthermore, the charitable organization must receive at least 10% of the initial donation you made to the trust.
The terms of termination of the trust are determined by the trust document, and the remainder of the trust’s assets are then transferred to charity.
The Bottom Line
As with most estate planning tools, there is a level of complexity. When it comes to creating your legacy, it’s important to develop the right strategy aligned with your goals. I highly recommend coordinating with your Financial Advisor, Estate Planning Attorney, and Tax Advisor for CRTs and your overall estate plan. CRTs are a powerful structure to generate income for your living expenses and contribute to your charitable legacy.
Suh, Elissa. Survey: Nearly 40% Of People Feel Increasing Urgency To Get A Will Because Of COVID-19. PolicyGenius. December 2, 2020.