Charitable Remainder Trusts

A type of irrevocable trust is a charitable remainder trust. It’s an instrument you may finance and once you put assets in, you can’t pull them out or change the trust’s conditions. A charitable remainder trust, unlike most other irrevocable trusts, is set up to benefit both you and the charity of your choice. 

The first step in creating a charitable remainder trust is to draft a trust agreement, which lays out the trust’s conditions, including naming a trustee and naming the charity(ies) to which you intend to leave money after your death. 

You finance your trust with an appreciated asset once you’ve formed it which is an asset with a higher market value than book value or taxable value. If sold it will generate capital gains. 

The assets you transfer to an irrevocable trust no longer belong to you or your estate, so there will be no estate taxes to pay when you die. Because it’s a charitable remainder trust, you’ll get a tax deduction right away as it is labeled a charitable contribution. After that, the trustee sells the appreciated asset at full market value where there are no capital gains taxes to pay. 

The trustee uses the trust’s liquid assets to reinvest the funds in income-producing assets. The trustee takes the revenue generated by those assets and returns it to you, the grantor. This may happen right away, or you could set up the trust so that payments start later, once the assets have (ideally) increased. These payments will continue for the rest of your life once they begin. The remaining assets are given to the charity(ies) of your choice in the manner you specify in the trust upon your death.

A benevolent remainder trust can be established in two ways. The first, known as a charitable remainder unitrust (CRUT), ties your annuity (the income generated by the trust and distributed to you) to a proportion of the fair market value of the donated assets. As a result, the annual income will fluctuate with the market and the trust’s annual value. The CRUT is revalued each year to determine your income, but you can include a provision that allows for an increase in income in a good year to compensate for a decrease in income in a bad year. There are no taxes on annual gains because the government wants you to leave money for charity when you die (at least 10% must be left).

A charitable remainder annuity trust, or CRAT, is another alternative. A CRAT is intended to give a steady income rather than one that fluctuates. Your income is constant regardless of how the assets perform. If the CRUT or CRAT assets represent all or most of your assets, but you still want to leave something substantial for friends or family, you can do so relatively cheaply by using the charitable remainder trust’s income tax savings to purchase life insurance and fund an irrevocable life insurance trust. It’s a technique to replace the gifted asset on the cheap so you can benefit from a charitable remainder trust while also leaving something to your children.

How could a charitable remainder trust play out in real-world terms?

Suppose you have a property with a significant value, perhaps a property purchased by an ancestor that has greatly appreciated over the decades. You’d like to get the cash out of that property, but you don’t want to get “hammered” by a huge tax bill. A charitable remainder trust can be an excellent way to handle the situation. Here’s how it can work.

First set up the charitable remainder trust. Then transfer the property into the trust. This is a non-taxable event. The ultimate beneficiary of the trust must be a legitimate charitable beneficiary, a 501(c)3. It can be the community college, your church, your own foundation, or any number of things. Most often the property goes into the CRT and is then sold to someone with the proceeds going to the charity. This is usually set up as a 20-year process in which you get the use of the income during that period. Once the funds are in the CRT, you set up a 20-year annuity at a payout of eight percent. The income can be considerable.

For instance, if the trust has $1 million in it, your yearly income is $80,000. The deal is better than that because you also get a current tax deduction, which is generally 40 percent of the donation. Using this example, that’s a $400,000 tax deduction – right now. Who could complain about a deal like that? The kids, that’s who.

Lawyers frequently hear from kids whose parents have created a Charitable Remainder Trust. “They’re giving away my inheritance!” There are ways to create a CRT and still provide an inheritance. Here’s how you do it–again, using the $1 million previously mentioned example:

Set up an irrevocable life insurance trust. Use for example $20,000 per year for the first five years in a second to die policy for mom and dad. That twenty grand so massively funds the program that you never have to pay a premium again. Those are covered by the cash values in the policy. Get a whole life policy which can never be cancelled. At $20,000 a year you can acquire a substantial policy, say $1 million or $2 million. You get a current tax deduction of eight percent guaranteed for life.

Ultimately, the charity gets the property, you get income from the CRT, and the kids get a couple of million dollars tax free. Everybody wins.

Keep an important point in mind. A Charitable Remainder Trust is a terrific vehicle for tax planning, but it’s difficult to use for asset protection. It’s just too complex a process to be effective for most people.

Let’s look at the pros and cons.