What Is a Charitable Remainder Trust: How it Works and What the Tax Benefits Are
Theresa de León
Many successful investors like to give back to the community. But just because you're philanthropically minded doesn't mean you simply want to give everything away. Those who give frequently and in large amounts may benefit from philanthropy trusts like a charitable remainder trust (CRT), which allows you to make tax-deductible charitable donations while still generating income through a trust.
What is a Charitable Remainder Trust?
A charitable interest trust is what's known as a "split-interest" giving vehicle. These tax-exempt, irrevocable trusts help reduce the taxable income of individuals while also generating a potential income stream for the donor to the CRT or their beneficiaries. When the trust's term ends, or when the trustor dies, the remaining amount of the trust is dispensed to designated charities. Presuming the trust holds income-generating assets, it continues to earn even as the trustor uses it.
How Does a Charitable Remainder Trust Work?
A charitable remainder trust primarily aims to reduce the trustor's tax liability. A CRT usually looks like this:
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Transfer assets like cash, stocks, real estate, private business interests, and private company stock to an irrevocable CRT to receive a tax deduction for the year in which you make the donation.
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Designate a trustee to sell the assets and reinvest the proceeds without paying capital gains tax.
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The trustee pays the trustor or beneficiaries an income out of the trust for a set period of time or the rest of their lives.
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When the trust's term ends, or you pass on, the remaining assets go to a designated charity.
The maximum term you can pay out noncharitable beneficiaries is 20 years or the life of one or more of them. Trustees can make payments annually, semiannually, quarterly, or monthly, based on the trustor's preferences.
Because CRTs are irrevocable, they cannot be modified or terminated without permission from the charitable beneficiaries. Once a trustor moves assets into the trust, they effectively lose ownership rights over the assets. This also removes it from inclusion in a trustor's estate, meaning it will not be part of the probate process after their death. Instead, all assets transfer immediately to the designated charity or charities.
While the trust will continue to earn untaxed income and trustors and noncharitable beneficiaries still get an income through the trust, you cannot change your mind and decide you actually want those Meta stock options back after moving them into the trust. As such, it's essential to be absolutely sure before you move assets into an irrevocable trust.
Types of Charitable Remainder Trusts
The two most common CRT types are charitable remainder annuity trusts (CRATs) and charitable remainder unitrusts (CRUTs). Each allows annual payments of at least 5% and no more than 50% of the trust's assets, but each is valued differently.
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CRAT: Valued upon creation and does not allow additional contributions after initial setup. Beneficiaries may receive either a fixed dollar amount or a fixed percentage for up to 20 years or for the life of one or more noncharitable beneficiaries.
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CRUT: Revalued at the end of each year to determine the fair market value of assets. Beneficiaries then receive a percentage of fair market value annually, so incomes may vary depending on the assets' performance. However, trustors may make additional contributions.
Benefits of a Charitable Remainder Trust
Charitable remainder trusts are particularly useful for investors looking to do some good while also reaping significant tax benefits. Some of the main advantages of CRTs include:
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Tax savings: In addition to a partial tax deduction for donations to the trust, trustors will also enjoy a reduction in capital gains, gift, and estate taxes. Trustors get especially good tax savings on highly appreciated assets like stock, real estate, or a closely held business.
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Income: CRTs pay income to beneficiaries, making them useful for retired trustors living on fixed incomes.
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Family planning: Because you can select multiple beneficiaries, a CRT is a great way to help family members.
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Estate planning:After a trustor's death, a CRT protects assets from creditors, misuse by family members, and the IRS by passing the assets directly to designated charities.
With a Charitable Remainder Trust, you can more effectively plan for retirement, reduce your tax liability on high-value assets, and plan your estate.
Drawbacks of a Charitable Remainder Trust
While CRTs offer trustors significant tax and estate planning benefits, they aren't without drawbacks:
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Irrevocable nature: The biggest con of a charitable remainder trust is that it's irrevocable. The trustor has no access to or control over assets after being put into the trust, and it is nearly impossible to alter the terms of the trust once finalized.
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Complexity: Setting up a charitable remainder trust is complicated, time-consuming, and will require significant legal help. Not only that, but you must perform a thorough cost-benefit analysis on every asset you plan to put into the trust to ensure you're okay with essentially losing control of that asset and making it a charitable donation. Arden Trust has the experience and expertise to help guide you through these complexities.
Although CRTs offer excellent tax and estate planning benefits, their inflexible nature makes it especially important to consider a CRT's benefits before setting one up. Trust and estate planning have nuances and complexities. You can best navigate those issues under the guidance of your financial advisor, tax advisor, and an experienced trust planning expert.
Next Steps for Your Trust
A charitable remainder trust is a great way to manage your assets and support your favorite charitable organizations. A CRT can help you manage your income in retirement, reduce your tax obligations, and give you some additional peace of mind that your estate is in good shape for when you pass on. However, they're complicated to set up, and their irrevocable nature means you must be positive you want to donate an asset before you move it into a trust.
Giving back is an important part of anyone's legacy. If you're interested in improving your philanthropic efforts and supporting your favorite charities, check out Arden Trust's philanthropy page to see how we can assist with your charitable giving efforts.