There are various methods to help a charity or specific cause with your assets after you pass away, one of which is a charitable remainder trust (CRT). It requires a little more work than other trusts, but it has the unique ability to assist a charity, provide a tax credit, and provide income for you/your family.
What is a charitable remainder trust?
A Charitable Remainder Trusts is an estate planning tool that allows you to earn annual income from the initial contribution with benefits such as lowering taxes (most notably estate taxes). These tax-free irrevocable trusts are designed to provide income to a named beneficiary (you or someone else) for a certain period (not more than twenty years). Any remaining value in the trust is distributed to a chosen charity at the conclusion of that time period.
Here’s how a charitable remainder trust works: an appreciated asset is transferred to an irrevocable trust. This eliminates the asset from your estate, ensuring that no estate taxes are required upon your death. You’ll also get a charitable income tax deduction right away.
The trustee has the option to sell the appreciated asset at full market value with no instant capital gains tax liability. If sold, the money can be reinvested in income-producing assets. The trust will provide you with an income for the designated time period. When you pass away, the remaining trust assets are distributed to the charities you have designated.
There are two types of Charitable Remainder Trust:
- CRATs (charitable Remainder Annuity Trusts): The lead beneficiaries will receive the same cash amount each year, regardless of whether the trust value increases or declines. The trust does not accept additional contributions.
- CRUTs (Charitable Remainder Unitrusts): Every year, a specified percentage of the trust value is paid out. The amount will be reassessed each year, with higher payments to lead beneficiaries if the CRUT’s rate of return exceeds the set percentage payout, and smaller payments to lead beneficiaries if the CRUT’s rate of return is less than the fixed percentage payout. There is an option of making extra donations.
Who should get a CRT?
Simply put, charitably inclined folks with appreciated assets who want the tax credit, but still maintain a portion of the asset’s future income. Typically, this would be someone over 60 years of age, typically no children, a desire to defer capital gains taxation, a need to diversify assets, and a need to lower estate taxes are some of the criteria that imply a CRT may be beneficial.
Some examples of a CRT candidate are a business owner who owns a C corporation and is planning to retire or be bought out soon; or possibly a real estate owner who is considering selling but does not want to pay capital gains tax or is tired of the 1031 exchange treadmill and wants to move cash out of the property in a tax-efficient way.
How long is the CRT expected to last?
A CRT might last for the main beneficiaries’ whole lives or for a specific period that cannot exceed 20 years. It’s very important to note that the actuarial value of the CRT remaining left to charity must be at least 10% of the CRT value at the time of funding.
Through statistical analysis, this “10 percent test” establishes a minimum age for lead beneficiaries. The CRT will fail the 10% test if the lead beneficiaries are too young. The lead beneficiaries for a lifetime CRUT must be in their 40s, while the lead beneficiaries for a lifetime CRAT must be in their mid-70s. It will be mathematically impossible for the CRT to leave the minimum value to charity if the trust pays income for too long a period.
Pros of CRTs
- They allow you to donate generously to the charities of your choice, while also providing you with a tax break.
- They provide tax benefits at your death. Any assets in the trust will not count against your overall estate because the charity will absorb everything. This means that the IRS will not charge estate tax on these assets.
- You will be able to, at the very least, defer capital gains tax. If the trustee decides to sell the initial investment, the government will not immediately recognize this as gain. As a result, you or the charity may choose to put the proceeds into an alternative investment that suits your risk and income goals. If you had attempted to sell the stocks yourself, however, the IRS would have taxed all profits as capital gains.
Cons of CRTs
- Charitable Remainder Trusts may not provide as much benefit to those with smaller estates or if the capital is not substantial enough.
- A charitable remainder trust is irrevocable. You are unable to cancel after it has been established. As a result, it’s critical to consider all the possibilities and life scenarios before establishing this form of trust.
- If you decide to open a CRT, keep in mind that most of your decisions and actions are final once you make them. There is no flexibility if your needs were to change. As an example, suppose you start your CRT with $55,000 in annual annuities. After a few years, you decide that $35,000 per year is more appropriate. You won’t be able to make this change.
A well-designed CRT can generate cash for your heirs that are substantially greater than what they would receive if they inherited your property. While there are several advantages to setting up a CRT, it is ultimately a decision that must be made based on your unique circumstances. Do you own appreciated assets that no longer fit your risk profile? Do you wish to postpone paying capital gains tax on the assets you sell? Are you charitably inclined? These are questions that can help you decide whether you should set up a CRT or not.
Written by Eric Keating