Financial Planning

What is a Charitable Remainder Trust?

By  Mike Zaccardi

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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

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 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.

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:

Ian Weiner, CFP® Financial Planning made Simple. I’m on a mission to save 1,000 people $1,000,000

Charitable Remainder Trusts (CRT) can be excellent planning tools. Potential benefits of a CRT can be tax-managed income, flexibility of charity choice (including Private Foundations) an opportunity to diversify concentrated equity positions or liquidate complex assets without an immediate capital gain or depreciation recapture event. It is critically important to understand that any gains realized within the trust aren’t “Tax Free” – they will be taxed to the ultimate income beneficiary, which has to be a natural person.

Income is determined by either a percentage of trust assets, a flat rate or amount, or could have variations based on planning objectives.

A Net Income Makeup Charitable Remainder Unitrust (NIMCRUT) can be a powerful tool for diversifying a concentrated stock position, allowing for a large charitable deduction to offset income in the current year (up to 5 years carried forward) and accumulating income inside the trust until a specified date.

Consider a married couple (age 55) who jointly own an equity portfolio worth 2M with 1M of unpaid capital gains. They earn 500K annually, have considerable retirement assets in Traditional IRAs and expect to work for 10 more years.
They recognize that they need a diversified portfolio as they get closer to their retirement date, yet don’t want to realize those capital gains at their current earnings level – as they will be taxed at their highest rate 23.8%

They can gift the 2M to the NIMCRUT – naming a charitable organization of their choice to receive the remainder interest after, say 20 years.

They can determine that they would like to receive income in 10 years, when they retire, but would like to rebalance the portfolio now.

When the gift is complete the positions can be sold immediately, invested in a diversified portfolio and income can be delayed for the next 10 years.

The minimum income payout percentage is based on the clients desires, typically 5%.

Given that this is a Net Income Make-up Trust – the income will accrue inside the trust and be paid out at a higher percentage rate (determined by the trust documents) to “Make Up” for previous underpayment.

The capital gains will be distributed pro-rata at that time to the couple – at a time when they have no other income and can pay those taxes at the lowest rate 0%. If executed correctly, this alone could save approximately $238,000 in Federal Taxes.

Furthermore they can utilize the large deduction they receive up front to make Roth conversions of their traditional IRAs and minimize or eliminate future RMD’s, saving significantly more in lifetime taxation and enjoying tax free growth and income in retirement.

This is just one potential use case for a Charitable Remainder Trust, the possibilities are nearly endless, yet it is critically important that the client is truly charitably inclined, and they are working with a competent estate planning attorney alongside their trusted financial planner to determine the optimal construction and implementation of this strategy.

The key consideration is how much the trust will cost to set up and maintain, and whether or not those administrative expenses warrant the potential benefits. Expect to pay $3,000+ to have the trust drafted, ongoing investment expenses, etc, make this a powerful, yet potentially expensive strategy.

Clients typically opt for charitable remainder trusts when there is a current or future income need, or to fund an ILIT to manage estate taxes, another potential use case.

For those who want the simplest and least expensive solution, without an income component, a Donor Advised Fund is common.

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Ian Weiner, CFP® | Simply Retire

Richard J. Archer, CDAA, CFA, CFP®, MBA People-Focused Financial Planning for Tech Industry Professionals.

Although there are clear benefits to CRTs, we’ve had little demand from clients for them. Our typical client has a net worth between $1 million and $7 million and the preferred vehicle for them has been the Donor Advised Fund or DAF.

Donor Advised Funds are simpler and faster to open and use. Clients can donate to them in higher income years and can choose the charitable beneficiaries each year or wait and let the assets grow tax-free. We like DAFs so much and want to encourage our clients to use them, so we don’t charge them any fees to set up and maintain them.

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Richard J. Archer, CDAA, CFA, CFP®, MBA | Archer Investment Management

Kushal Shah, CRPC Integrity |Trust | Personal Service l Raising the Standard for Financial Balance

The biggest pro of a charitable remainder trust is its tax savings. The trustor not only gets a partial tax deduction for their donation to the trust; they also can see a reduction in capital gains, gift, and estate taxes.

CRTs should be considered when a philanthropically inclined individual or couple wants to diversify a highly appreciated investment portfolio, while generating cash flow and get an immediate income tax deduction.

On occasion we do recommend an alternative that is a Charitable Lead Trust. In a Charitable Lead Trust the income from the trust is paid to the beneficiary, which is the designated charitable organization. This is a ideal for a individual who wants to keep the security but does not need the income. The CLT must donate enough money to the charity to qualify for the estate tax deduction.

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Kushal Shah, CRPC | DaVinci Capital Partners

Darryl Lyons, CFP®, ChFC®, BFA, AIF Fee Based Fiduciary Advisor

I think a Charitable Remainder Trust (CRT) is an excellent tool to create income while making a significant tax-deductible charitable contribution. However, because of the ease of adoption along with less complexity, Donor Advised Funds have been a preferred tool for many of my clients recently. They certainly have a different method and tax structure, but with proper planning Donor Advised Funds can be a very tax-efficient tool for the charitably inclined.

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Darryl Lyons, CFP®, ChFC®, BFA, AIF | PAX Financial Group

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.

Mike Zaccardi CFA

About the Author

Mike Zaccardi, CFA®

Mike is a freelance writer for financial advisors and investment firms. He’s a CFA® charterholder and Chartered Market Technician®, and has passed the coursework for the Certified Financial Planner program. 


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Disclaimer: To make Wealthtender free for our readers, we earn money from advertisers, including financial professionals and firms that pay to be featured. This creates a natural conflict of interest when we favor their promotion over others. Wealthtender is not a client of these financial services providers. Learn how we operate with integrity to earn your trust.