What is a Charitable Remainder Trust?

A Charitable Remainder Trust (CRT) is a tax-exempt irrevocable trust where gifts of cash or other property can go to reduce the taxable income of the donor. The CRT then issues an income stream to the donor from the trust for a certain number of years or their life. The named charities receive the “remainder” amount at the end of the CRT’s term.

Charitable Remainder Trusts are a popular strategy to reduce taxable income since donors receive an immediate partial income tax charitable deduction when the trust is funded. The deductible amount is determined by the present value of the assets that ultimately pass to the charities.

How Does a Charitable Remainder Trust Work?

A Charitable Remainder Trust is considered a “split-interest” vehicle since both the donor and one or more charities receive assets. Individuals interested in establishing a CRT can do so by naming themself or someone else as the recipient of the partial income stream for a period not to exceed 20 years or for the life of one or more non-charitable beneficiaries.

A CRT benefits charities since the remaining amount of the trust assets passes to those organizations. A CRT is a common tax-reducing strategy since it reduces taxable income while providing for philanthropic ambitions. At the same time, individuals can still receive income each month, quarter, every six months, or annually for many years. These are popular tools to gift money and assets to foundations and public charities.

CRTs are used to donate cash, shares of stock, real estate interests, a private business, and even privately held equity. The partial tax deduction the trustor receives is based on the type of trust vehicle used, the CRT’s term, and finally, the projected income to be received by the charitable beneficiaries. The Internal Revenue Service (IRS) also determines interest rates used to figure out the growth rate of the CRT’s assets. Financial advisors use CRTs for retirement planning and estate planning purposes.

It’s important to consider that CRTs are irrevocable – they cannot be changed or terminated without the charitable beneficiaries’ approval. Irrevocable also means that the trustor removes all their ownership rights of the assets at the CRT’s creation. According to the IRS, A charitable trust is treated as a private foundation unless it meets the requirements for one of the exclu­sions that classify it as a public charity.

Key Points:

• A Charitable Remainder Trust (CRT) is used to reduce taxes for wealthy families
• Assets in a CRT are irrevocable and give certain non-charitable beneficiaries access to a periodic income stream
• The remaining balance, after the income stream period, goes to charitable beneficiaries named in the trust documents

Two Types of Charitable Remainder Trusts

Financial advisors often work with wealthy clients to construct two types of Charitable Remainder Trusts.

1. Charitable Remainder Annuity Trusts (CRATs): CRATs use the annuity construct to distribute a fixed amount annually. Additional contributions to a CRAT are not allowed. According to the IRS, the annual annuity must be at least 5% of the CRATs value but no more than 50%.
2. Charitable Remainder Unitrusts (CRUTs): CRUTs use a fixed-percentage method to pay out a portion of the trust’s assets. A CRUT structure revalues annually to determine the distribution amount. An upshot with a CRUT is that additional contributions are allowed.

Charitable Remainder Trust: A Step-by-Step Approach

It is important for financial advisors and their clients to understand and consider all the steps involved in the lifecycle of Charitable Remainder Trusts.

1. Donating Assets

Grantors to a CRT gift cash, shares of stock, real estate, business interests, and other property, so they receive an income tax deduction. Donating appreciated assets through a Donor-Advised Fund is a popular method to bolster the total tax benefit. Still, it likely won’t be massive tax savings since a CRT only offers a partial income tax deduction.

Also, consider that an income tax deduction is only valuable once a taxpayer’s itemized deductions total more than their standard deduction amount. Advisors can learn more about the amount of tax savings from donating assets by understanding how the IRS determines the amount.

2. Naming a Beneficiary

Non-charitable beneficiaries are named, and charitable organizations are also outlined. For a period of up to 20 years or their remaining lives, the non-charitable beneficiaries receive income from the trust.

3. Distribution of Assets

After that period ends, which could be the pre-specified timespan, or when the final non-charitable beneficiary passes, the charitable beneficiaries receive the remaining CRT assets. That event is considered the termination of the CRT. A trustee may have the ability to rename the charitable beneficiaries during the CRT’s life, depending on how the CRT was crafted.

Other Strategies and Reasons to Establish a Charitable Remainder Trust

There are several savvy ways that retirement planners, tax experts, and financial advisors use Charitable Remainder Trusts to reduce the long-term tax burden of families with whom they work while accomplishing philanthropic objectives.

Using highly appreciated assets to form a retirement income vehicle

Rather than selling securities and facing high current-year tax liabilities, individuals and couples can use the CRT vehicle to receive a future income stream, potentially throughout their retirement.

Consider that a married couple can construct the CRT to last 20 years or until both spouses pass away. The CRT is then used to provide an income stream that often makes it easier for retirees to comfortably spend down their assets rather than having to constantly withdraw principal from an investment account. In this case, there are both tax and behavioral benefits to weigh.

Pair a CRT with a Donor-Advised Fund

As hinted at earlier, using a Donor-Advised Fund with a CRT is like the best of both worlds to minimize taxes and accomplish charitable objectives. Donor-Advised Funds have their own rules to keep in mind, however. With a Donor-Advised Fund, the donor can have more control over the amount and timing of the charitable distributions. Advisors must tread carefully regarding the tax rules of both the CRT and a Donor-Advised Fund.

Reduce income taxes owed and defer capital gains tax

Individuals can take a charitable deduction of up to 60% of their adjusted gross income (AGI) if the CRT is funded with cash. Appreciated securities offer a maximum deduction of just 30%, though. These current-year tax deductions should generally be done when an individual or couple is in their peak earning years so that the most value possible from the donation is earned.

According to Schwab Charitable, the donor can carry over the deduction for up to five additional years if the donor does not use the whole deduction in the year of the gift.

Estate planning

We haven’t touched much on the “irrevocable” state of a CRT. Estate taxes can be reduced for wealthy families when the CRT is used strategically. Since the assets in the CRT are considered irrevocable, they are not part of the grantor’s estate when calculating estate tax. Assets within a CRT also avoid the sometimes-painful probate process. Another feature of a CRT is that it can be used to gift assets to a loved one before you pass away, but there are tax impacts.

While many CRTs feature a beneficiary who is the person who established the CRT, someone else can be identified to receive the periodic payments. A taxable gift is made to the non-spouse beneficiary at the time the CRT is established.

Advantages and Disadvantages of a Charitable Remainder Trust

Reducing taxes is undoubtedly the biggest benefit of a CRT. Income tax is often reduced considerably due to the partial tax deduction when putting assets in the CRT. Estate taxes can also be lowered along with snatching capital gains tax savings. Moreover, the owner receives an income stream for up to 20 years, which provides financial peace of mind for retirees who want to give to their favorite causes but are still concerned about their monthly income. A final upshot is that assets in a CRT are kept in private knowledge and are not at risk to creditors since they do not go through the probate process.

There are risks to consider before establishing a CRT, though. Once an irrevocable trust is in place, the trustor no longer controls or has access to funds in the trust. Moreover, a CRT is a complex vehicle and might require the assistance of a tax attorney. Administration and ongoing maintenance might be costly and burdensome, too. For these reasons, individuals and families should sit down with an experienced financial advisor who is well-versed in CRTs rather than acting fast to establish a CRT.

Ask the Experts: What Do Financial Advisors Say About Charitable Remainder Trusts?

For additional insights, we invited financial advisors in the Wealthtender community to offer their perspectives on Charitable Remainder Trusts. Here’s what they said:

Conclusion

A Charitable Remainder Trust is commonly used by wealthy families to reduce taxes while still providing financial gifts to charities. This financial planning tool offers those in or near retirement with an income stream that can last the rest of their lives but no more than 20 years.

The remaining trust balance is then donated to charitable beneficiaries outlined in the CRT documents. CRATs and CRUTs are two types of Charitable Remainder Trusts to consider. Financial advisors skilled in this area help families with their goals and final wishes. Tax and estate planning benefits can be significant when a CRT is tailored to a family’s objectives.

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