Charitable Remainder Trusts

What is a Charitable Remainder Trust, and How Does It Work?

1. What does a Charitable Remainder Trust (CRT) do?

Since 1969, countless families have used charitable remainder trusts (CRTs) to increase their incomes, save taxes and benefit charities.

A charitable remainder trust (CRT) lets you convert a highly appreciated asset (like stock or real estate that have increased in value since your purchase of the asset) into a lifetime income stream, for you and your spouse, or other family members or loved ones. It reduces your income taxes now and reduces your estate taxes when you die. You pay no capital gains tax when the CRT owned asset is sold, and it lets you make charitable contribution deductions to reduce your income taxes, and help one or more charities that have special meaning to you.

If you would like to explore how a charitable remainder trust can help you achieve your estate planning, tax planning, or charitable planning goals, please call us toll free at 1-866-510-9099.

2. How does a CRT work?

A charitable remainder trust (CRT) starts when you transfer an appreciated asset into an irrevocable charitable remainder trust. This removes the asset from your taxable estate, so no estate taxes will be due on your estate at your death. You also receive an immediate charitable income tax deduction for your income tax return for the year of the transfer, to reduce your current income taxes.

The trustee of the charitable remainder trust (CRT) then sells the charitable trust asset at full market value, paying no capital gains tax, and re-invests the proceeds from the sale of the trust asset into income-producing assets. For the rest of your life, or your life and others, the trust pays you an income. When you die, the remaining trust assets go to the charity(ies) you have chosen. That’s why it’s called a charitable remainder trust.

3. Why not sell the asset myself and re-invest, rather than transfer it to the charitable remainder trust?

You could, but you would pay more capital gains income taxes and there would be less assets remaining to provide income for you. Here’s an example.

Years ago, John and Jane Smith (ages 65 and 63) purchased some stock for $100,000. It is now worth $500,000. They would like to sell it and generate some retirement income.

If they sell the stock themselves, they will have a gain of $400,000 (current value less cost) and would have to pay $60,000 in federal capital gains tax (15% of $400,000) (based on current capital gains rates – which could be rising). That would leave them with $440,000 after paying the capital gains tax.

If they re-invest and earn a 5% return, that would provide them with $22,000 in annual income. Multiplied by their life expectancy of 26 years, this would give them a total lifetime income (before taxes) of $572,000 from the direct sale of the asset and reinvestment of the sales proceeds. Because they still own the reinvested assets, there is no asset protection from creditors and no charitable income tax deduction is available to reduce income taxes.

If you would like to discuss how you can avoid capital gains taxes through the use of a charitable remainder trust, please call us toll free at 1-866-510-9099.

4. What happens with the use of a Charitable Remainder Trust?

If they transfer the stock to a CRT instead, the Smiths can take an immediate charitable contribution income tax deduction of $90,357. Because they are in a 35% tax bracket, this will reduce their current federal income taxes by $31,625.

The CRT trustee will sell the stock for the same amount, but because the charitable remainder trust is exempt from capital gains tax, the full $500,000 is available to re-invest for retirement income. The same 5% return will produce $25,000 in annual income which, before taxes, will total $650,000 over their lifetimes. That’s $78,000 more in income than if the Smiths had sold the stock themselves. The assets are in an irrevocable charitable remainder trust, so those assets are protected from creditors’ claims (except the IRS).

For more information on Asset Protection Planning read The Florida Asset Protection and Estate Planning Blog.

5. What are my income options from a Charitable Remainder Trust?

You can receive a fixed percentage of the charitable remainder trust assets (like the Smiths in the illustration above), in which case your charitable remainder trust would be called a charitable remainderunitrust (“CRUT”). With this income option, the amount of your annual charitable remainder trust income will fluctuate, depending on investment performance and the fair market value of the assets owned by the trust valued annually either at the beginning of the year or at the end of the year.

The charitable remainder trust will be re-valued at the beginning of each year to determine the dollar amount of income the charitable remainder trust income beneficiaries will receive. If the charitable remainder trust is well managed, it can grow quickly because the charitable remainder trust assets grow tax-free. The amount of the CRT beneficiaries’ income will increase as the value of the charitable remainder trust assets grows.

Sometimes the assets contributed to the trust (like real estate or stock in a closely-held corporation) are not readily marketable, so income is difficult to pay. In that case, the charitable remainder trust can be designed to pay the lesser of the fixed percentage of the charitable trust’s assets or the actual income earned by the charitable remainder trust. A provision is usually included so that, if the charitable remainder trust has an off year, it can “make up” any loss of income in a better year. The “net income” and the “net income with make-up provisions” may result in a smaller charitable contribution deduction from your income taxes.

If you would like to discuss how a charitable remainder trust can ensure a lifetime of income for you, please call us toll free at 1-866-510-9099 to schedule your consultation.

6. Can I receive a fixed income from my Charitable Remainder Trust instead?

Yes. You can elect instead to receive a fixed income from the charitable remainder trust, in which case the charitable remainder trust would be called a charitable remainder annuity trust (“CRAT”). This means that, regardless of the charitable remainder trust’s performance, the trust income beneficiary’s income will not change.

This option is usually a good choice at older ages. It doesn’t provide protection against inflation like the charitable remainder unitrust does, but some people like the security of being able to count on a definite amount of charitable remainder trust income each year. It’s best to use cash or readily marketable assets to fund a charitable remainder annuity trust.

In either (charitable remainder unitrust or charitable remainder annuity trust), the IRS requires that the payout rate stated in the charitable remainder trust document cannot be less than 5% or more than 50% of the initial fair market value of the trust’s assets, and there must be at least a 10% likelihood the charitable remainder will in fact receive the amount of the charitable remainder interest deduction that is initially calculated.

7. Who can receive trust income from the charitable remainder trust?

Trust income, which is generally subject to income tax in the year it is received, can be paid to the charitable remainder trust income beneficiary for life. If the charitable remainder trust income beneficiaries are married, the income can be paid for as long as either of the named trust income beneficiaries lives.

The trust income can also be paid to the children of the trust income beneficiaries, for their lifetimes or to any other person or entity the grantor of the charitable remainder trust may desire, providing the charitable remainder trust meets certain requirements. In addition, there are gift and estate tax considerations if someone other than grantor of the charitable remainder trust receives it. Rather than provide that the trust payout income for the lifetime of the life income beneficiary, the trust can also exist for a specified number of years (up to 20).

8. Do I have to take the charitable remainder trust income now?

No. You can set up the charitable remainder trust and take the income tax deduction now, but postpone taking the trust income until later. By then, with good management, the charitable remainder trust assets will have appreciated considerably in value, resulting in more trust income for you.

9. How is the charitable remainder trust income tax deduction determined?

The charitable deduction is based on the amount of trust income received by the charitable remainder trust income beneficiaries, the type and value of the trust asset, the ages of the trust income beneficiaries, and the Internal Revenue Code Section 7250 rate, which fluctuates from month to month. (Our example is based on a 3.0% Section 7250 rate.) Generally, the higher the charitable remainder trust income payout rate, the lower the charitable contribution deduction.

The charitable contribution deduction is usually limited to 30% of adjusted gross income, but can vary from 20% to 50%, depending on how the IRS defines the charity and the type of trust assets. If you can’t use the full charitable contribution deduction the first year, you can carry it forward for up to five additional years. Depending on your tax bracket, type of asset and type of charity, the charitable contribution deduction can reduce your income taxes by 10%, 20%, 30% or even more.

If you would like to discuss how you can obtain a significant income tax deduction through the use of a charitable remainder trust, please call us toll free at 1-866-510-9099.

10. What kinds of assets are suitable to be transferred to the charitable remainder trust?

The best assets for a charitable remainder trust are those that have greatly appreciated in value since purchased, specifically publicly traded securities, real estate and stock in some closely-held corporations. (S-corp stock does not qualify. Mortgaged real estate usually won’t qualify, either, but you might consider paying off the loan before contributing the real estate to the charitable remainder trust.) Cash can also be used.

11. Who should be the trustee of the charitable remainder trust?

You can be the trustee of your own charitable remainder trust. But you must be sure the charitable remainder trust is administered properly — otherwise, you could lose the charitable contribution tax advantages and/or be penalized. Most people who name themselves as trustee of a charitable remainder trust have the paperwork handled by a qualified third party administrator who is familiar with the administration of a charitable remainder trust.

However, because of the experience required with investments, accounting and government reporting, some people select a corporate trustee (a bank or trust company that specializes in managing charitable remainder trust assets) as trustee. Some charities are also willing to be trustees of a charitable remainder trust that names the charity as the ultimate charitable trust beneficiary.

Before naming a trustee, it’s a good idea to interview several and consider their investment performance, services and experience with charitable remainder trusts. Remember, you are depending on the trustee to manage your charitable remainder trust properly and to provide you with trust income.

12. Do I still have some control?

Yes. For as long as you live, the trustee you select — not the charity — controls the assets. Your trustee must follow the instructions you put in your trust. You can retain the right to change the trustee if you become dissatisfied. You can also change the charity (to another qualified charity) without losing the tax advantages.

13. Can I make any other changes to the charitable remainder trust?

Generally, once an irrevocable trust is signed, technically you cannot make any other changes. Be sure you understand the entire charitable remainder trust document and that it is exactly what you want before you sign.  Under the Uniform Trust Code, that the State of Florida has substantially adopted, there are certain changes that can be made to an irrevocable trust, with the consent of all of the parties to the trust, including all of the trust beneficiaries, the trustee, and the trust grantor or settlor, if he or she is alive.  In the absences of consent by all parties to the irrevocable trust, the irrevocable trust can only be changed by a court order.  With a charitable remainder trust, in the State of Florida, the Florida attorney general may need to be made a party to any legal action involving changes to a charitable remainder trust, so that the attorney general can represent the otherwise unrepresented charitable beneficiaries of the charitable trust.

14. Sounds great for me. But if I give away my assets to the charitable remainder trust, what about my children?

If you have a sizeable estate, the asset you place in a CRT may only be a small percentage of your assets, so your children may be well taken care of. However, if you are concerned about replacing the value of this asset contributed to the charitable remainder trust for your children, there is an easy way to do so.

You can take the income tax savings, and part of the income you receive from the charitable remainder trust, and fund an irrevocable life insurance trust. The trustee of the insurance trust can then purchase enough life insurance to replace the full value of the asset contributed to the charitable remainder trust for your children or other beneficiaries.

15. What benefit does a life insurance trust provide in conjunction with a charitable remainder trust?

With an irrevocable life insurance trust, the life insurance policy proceeds will not be included in your taxable estate, so you avoid estate taxes on the face value of the life insurance proceeds (yes, life insurance proceeds are otherwise subject to estate taxes in the estate of the insured, if the insured had any incidents of ownership). You can keep the proceeds of the life insurance policy in the life insurance trust for years, making periodic distributions of trust income and trust principal from the life insurance trust to your children and grandchildren. Any life insurance proceeds that remain in the life insurance trust are asset protected from the beneficiary’s irresponsible spending and the beneficiaries’ creditors (even divorcing spouses).

Life insurance can be an inexpensive way to replace the assets contributed to the charitable remainder trust for your children. (Every dollar you spend on life insurance premium buys several dollars of life insurance through the leverage that life insurance provides.) Life insurance proceeds are available immediately, even if you and your spouse both die tomorrow. In addition to avoiding estate taxes if owned by an irrevocable life insurance trust, the life insurance proceeds will be free from probate and income taxes.

16. A charitable remainder trust (CRT) and irrevocable life insurance trust (ILIT) almost sounds too good to be true – does it really work?

Combining a charitable remainder trust with an irrevocable life insurance trust is a winning formula for everyone — you, your children and the charity.

You convert an appreciated asset contributed to the charitable remainder trust into a lifetime income from the CRT, and because you pay no capital gains tax when the charitable trust asset is sold, you receive more income from the charitable remainder trust than if you had sold the asset yourself and invested the sales proceeds. You receive an immediate charitable income tax deduction, reducing your current income taxes. By removing the asset from your estate, you reduce estate taxes that may be due when you die.

With the irrevocable life insurance trust replacing the full value of the asset(s) contributed to the charitable remainder trust, your children receive much more than if you had sold the asset yourself, and paid capital gains and estate taxes. Plus, the life insurance proceeds are free of income and estate taxes, and probate.

Finally, you will make a substantial gift to your favorite charity or charities. The charity knows it will receive the distribution from the charitable remainder trust at some point in the future, so it can plan projects and programs now — benefiting even before receiving the charitable gift from your charitable remainder trust.

17. Benefits of a Charitable Remainder Trust

Convert an appreciated, often illiquid, asset into lifetime income.
Reduce your current income taxes with charitable income tax deduction.
Pay no capital gains tax when the asset is sold.
Reduce or eliminate your estate taxes.
Gain protection from creditors for gifted asset.
Benefit one or more charities.
Receive more income over your lifetime than if you had sold the asset yourself.
Leave more to your children or others by using a life insurance trust to replace the gifted asset.

18. Should I seek professional assistance to set up a charitable remainder trust and irrevocable life insurance trust?

Yes. If you think a charitable remainder trust, with or without an irrevocable life insurance trust, would be of value to you and your family, speak with a tax-planning attorney, insurance professional, corporate trustee, investment adviser, CPA, and/or favorite charity. Be sure an attorney experienced in Charitable Remainder Trusts prepares the documents.  If you would like a consultation with an experienced estate planning attorney about how a charitable remainder trust can help you achieve your estate planning, tax planning, or charitable planning goals, please call the Coleman Law Firm at 904-448-1969 or toll free at 866-510-9099, or email us at Info@TheColemanLawFirm.net .

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