The IRS collected over $18.4 billion in estate taxes in 2021 alone. [i] If you’re a high-net-worth individual, this should make you pause. But what if you could significantly reduce your estate tax while simultaneously supporting a cause you care about? Let me introduce you to Charitable Remainder Trusts, which provide an estate planning tool to help you do just that and much more.
Please note: this article is intended to provide general information only. Always consult your tax and estate planning professional for advice and specific recommendations.
What Is A Charitable Remainder Trust?
A Charitable Remainder Trust, or CRT, is a tax-exempt, irrevocable trust designed to help you convert highly appreciated assets into lifetime income while helping you support your favorite causes.
Here’s a general overview of how it works:
- Initial Donation. You (the trustor) make an initial donation to the trust. This is often highly appreciated real estate or stock. You will receive an immediate charitable income tax deduction for this transfer.
- Sale of the asset. The trustee then normally sells the assets in the trust at full market value (without capital gains tax) and reinvests the sale proceeds in income-producing assets.
- Lifetime Income Stream. Next, the trust pays an income stream to you or other designated non-charitable beneficiaries (such as your spouse or family members). The payments may be specified for the life of one or more beneficiaries or for a specific term of up to 20 years. [i]
- Final Donation. At the end of the trust term, the remaining assets go to one or more qualified charities of your choice (hence the name charitable remainder trust). At that point, the trust terminates and your charitable gift is complete.
Why Should You Consider A CRT?
As a successful person, at one time or another, you’ve probably been faced with a good problem: you have some assets that you hesitate to sell because of the massive capital gains tax you would owe. This often happens with concentrated stock positions, but it can also be a piece of real estate or other asset that has increased dramatically in value. Often that leads people to take more risk than they should…they continue to hold on when it probably would have been more prudent to cash out. This is where a Charitable Remainder Trust can play a pivotal role in your financial life.
With a CRT, you can cash out of the asset without the large capital gains hit. You donate the asset to the trust, then the trust sells it without that immediate capital gains tax liability.
Specific Benefits Of Using A Charitable Remainder Trust In Your Estate Plan
That’s a general overview of how these trusts can be put to work. Let’s look at its specific benefits a bit closer.
Tax Benefits
There are several ways that a trust can help you with tax savings. As previously noted, the trust avoids upfront capital gains taxes on the assets you transfer into the trust. You also normally can receive a partial tax deduction when you fund the trust. Then, the CRT’s investment income is exempt from tax as well, although interest and gains will be taxed upon withdrawal when paid out to you and other non-charitable beneficiaries. Finally, you can usually avoid any estate taxes on these holdings since the trust now owns the assets (you no longer do).
Asset Protection Benefits
As advisors who specialize in helping high net worth individuals, we know that people often forget about defense. But asset protection is critical as you don’t want to lose what you’ve worked so hard to build. By using a charitable trust, you get assets out of your name and into the name of the trust. That can help protect those assets from any future creditors, family divorces or other situations that can compromise your financial legacy.
Because charitable remainder trusts are irrevocable, the assets are normally protected. That can help ensure the trust will receive the remainder of assets, not a creditor. It can also ensure that this source of your retirement income is safe from unexpected threats.
Estate Planning Benefits
When it comes to estate planning, Charitable Remainder Trusts offer distinct advantages that can simplify the often complex process. Because the trust is irrevocable and separate from your estate, the assets within it are not subject to probate. This means that the transfer of assets to your beneficiaries can occur immediately without the usual legal delays. That streamlined approach helps ensure the remaining trust assets go smoothly to your designated charitable beneficiaries.
Retirement Planning Benefits
CRTs also play a pivotal role in retirement planning. You can set yourself up as an income beneficiary, where you have a trust that generates regular monthly income for you for the rest of your life. You can use it on its own or in addition to other income sources to create an annual income in retirement.
Charitable Remainder Trust Types
There are two main types of these trusts. Your advisors can help you determine which one is a better fit for your needs, and create it as part of the terms of the trust.
- Charitable Remainder Annuity Trust (CRAT): Your first option is a CRAT, which distributes a fixed annuity each year.
- Charitable Remainder Unitrust (CRUT): Your second option is the CRUT, which allows you to receive a fixed percentage of the trust assets each year. Because assets are valued every year, that means that the amount you receive will not always be the same.
The CRAT obviously lends itself to generating a stable income that you and other beneficiaries would receive each month. For those preferring a situation where they can receive a fixed income, the CRAT can often be a better choice.
Example Of A CRT In Action
Sometimes it’s helpful to examine a real-world scenario to illustrate how a Charitable Remainder Trust (CRT) can work to your advantage.
Imagine you’re Sarah, a technology professional who was one of the founding team members of a very successful tech company. (Please note this example is hypothetical in nature and not representative of an actual client experience.) The company was bought out by a major industry player. Now Sarah holds shares worth about $7 million. Sarah would like to retire and engage in supporting different charitable endeavors that she’s passionate about, but she’s very concerned about the massive capital gains tax she would have to deal with when she sells her stock. She’s also concerned that the stock price might drop, changing her financial situation. Enter the Charitable Remainder Trust.
So Sarah works with her advisor team and sets up Charitable Remainder Unitrust (CRUT), one of the two CRT trust types. She transfers her full holding into the trust.
Upon transferring the stock, she receives an immediate partial tax deduction based on the present value of the future charitable gift. This significantly reduces her taxable income for the year.
Shortly after, the stock is sold, so Sarah no longer has to constantly worry about market fluctuations. Her financial well-being is no longer tied to the current price of one stock.
Sarah designates an educational foundation as the final beneficiary of the trust. After Sarah passes away, the remaining assets in the trust will go directly to this foundation.
Throughout this period, while Sarah enjoys income from a CRT, the assets are shielded from creditors, helping ensure that both her income source and her philanthropic vision are realized without any hitches.
The Big Catch: It’s Irrevocable
Once you set up a CRT, you can’t undo your donation once complete. You give up all rights to the assets you’ve transferred into the trust. This is a significant commitment, so it’s crucial to be sure this aligns with your long-term financial and philanthropic goals.
Frequently Asked Questions About Charitable Remainder Trusts
How Does The Tax Deduction Work?
Contributions to a CRT can provide you with a charitable deduction based on the fair market value of the assets contributed and IRS regulations. The deduction can help reduce your taxable income and potentially lower your tax bracket.
Additionally, the trust is exempt from the normal federal capital gains tax, providing significant upfront savings. Instead, taxes are only incurred on distributions to you (and your other non-charitable beneficiaries), easing the burden and spreading out taxes over total lifetime income.
Who Can Be A Beneficiary And Receive Income From A CRT?
A charitable remainder trust allows for one or more charitable beneficiaries. These can be organizations or institutions that you choose to support with the amounts remaining in the trust after your passing.
Is A Charitable Remainder Trust Irrevocable?
Yes, a charitable remainder trust is irrevocable. Once you set up the trust, you cannot change or revoke its terms without the consent of the beneficiaries or court approval.
Who Manages The Trust Assets?
The trust assets are typically managed by a trustee of your choice. This is often a bank or trust company. This individual or entity is then usually responsible for trust investments, tax management, and administration.
How Do The Tax Benefits And Income Tax Deductions Of The CRT Work?
The tax benefits of a trust are significant, and normally forming a trust would require a consultation with your tax professional to ensure you understand tax ramifications. But here are some general concepts.
- Normally, the higher your income tax bracket and adjusted gross income, the more beneficial a charitable remainder trust will be for you.
- A primary benefit is that no capital gains tax is incurred on the initial transfer or sale of the asset.
- Then, you can normally receive a partial income tax charitable deduction upon funding of the trust.
- The trust itself normally generates income and enjoys a tax exempt status on investment income, making it an attractive vehicle for diversifying your asset portfolio. It’s worth noting, however, that while the trust’s income is tax exempt, the designated income beneficiary will be responsible for income taxes on the distributions they receive.
- Then, on the trust’s remainder, there is usually no tax due when it finally transfers to your designated charitable beneficiaries. This applies to both charitable remainder unitrusts and charitable remainder annuity trusts.
You can read more about the regulations related to these trusts on the Internal Revenue Service website.
What Are The Pitfalls Of This Type Of Charitable Trust?
As noted previously, there are pros and cons of charitable remainder trusts. One of the negatives is the fact that they are irrevocable. Once the trust is set up, making any changes, or terminating it early, may be very difficult or even impossible. So you need to be absolutely sure upfront about this decision.
The Right Team And Trustee Are Essential To A Successful CRT Strategy
At Holland Capital, our team approach helps make the application of these more sophisticated strategies accessible for our clients. You will work with a dedicated team that includes tax, estate and trust professionals. By engaging our team of specialists, it is much easier to plan for, implement and maintain these trusts. Also, Holland Capital is one of the few firms that includes a trust administration professional on our team, which helps you avoid implementation headaches.
Is A Charitable Remainder Trust Right For You?
If you’re looking to make a meaningful impact through charitable giving while also securing tax, asset protection and estate planning benefits, a Charitable Remainder Trust could be an excellent option. However, it’s not a decision to be taken lightly since it is irrevocable. Consult with your tax and estate planning experts to ensure it aligns with your overall financial strategy.
But bottom line…a Charitable Remainder Trust can be a powerful tool for estate planning and philanthropy. It allows you to leave a legacy that reflects both your financial acumen and your values.
[i] https://taxfoundation.org/data/all/federal/estate-tax-returns-data/
[i] https://www.irs.gov/charities-non-profits/charitable-remainder-trusts#
