If you’re in the process of estate or retirement planning and want to make charitable donations part of your financial strategy, a charitable remainder trust could be the solution you’re looking for. However, navigating the many stipulations and variety of CRTs available can prove difficult without the right guidance.
Donating to charity to reduce tax liabilities is a common strategy in wealth management. With a charitable remainder trust (CRT), you can sell a highly-appreciated asset, avoid the attendant capital gains taxes, and use the resulting funds to create an income stream for yourself and/or your loved ones while also benefitting a charity of your choice. So long as the designated charity is a qualified 501(c)(3) organization, funding a charitable remainder trust (CRT) can prove a valuable tax-saving opportunity for high-net-worth individuals who are looking to diversify their portfolio and offload appreciated assets.
How Does a Charitable Remainder Trust Work?
In short, a charitable remainder trust is a tax-exempt, irrevocable “split-interest” giving vehicle that is designed to create an income stream for the beneficiary (you and/or someone you name) with the remainder earmarked for donation to one or more charitable organizations. Here’s how it works:
Once the trust is created, you (the grantor) transfers an asset (or assets) into the CRT. You can fund the trust with cash, publicly traded securities, real estate, even artwork and other types of assets. In general, however, most people move a highly-appreciated asset into the trust as the goal is to realize the increased value of the asset while avoiding the massive cut that would go to paying the capital gains tax if selling outright.
Next you decide (a) who the beneficiaries will be and (b) the terms of the trust. It’s most common to name yourself and/or your loved ones as the initial beneficiaries and then select one or more charities to receive the remainder of the funds. As for the timespan of the trust, CRTs can be set to (a) end after a specific number of years—10, 15, up to 20—or, more commonly, (b) extended to last for the lifetime of one or more of the non-charitable beneficiaries. You will also determine the beneficiary payment schedule: how often payments are made and what percentage is paid out. Beneficiaries can receive payments from the trust either annually, semi-annually, quarterly, or monthly. Annually these payments must amount to at least 5% of the trust’s assets, but not exceed 50%.
Once the asset (or assets) have been transferred and the terms set, the designated trustee takes over and basically takes ownership of the asset. At this point the asset’s fair market value (FMV) is determined, the asset then sold, and the funds generated create the aforementioned income stream for the non-charitable beneficiaries with the remainder going to charity.
POLARIS PRO TIP: Considering pairing a CRT (Charitable Remainder Trust) with an ILIT (Irrevocable Life Insurance Trust) when estate planning. You can use the income generated from the CRT to pay for life insurance to offset the amount of money you’ve gifted. It’s a win-win situation since you’ll get a big tax write-off and pass your wealth onto the next generation without estate taxes (because the money in an ILIT isn’t considered part of your estate and isn’t subject to state and federal taxation). Contact Polaris Wealth Advisory Group to learn more about how CRTs and ILITs can benefit your estate planning.
Fair Market Value and CRATS vs. CRUTS
As noted, a key step in the administration of a charitable remainder trust is assessing the fair market value (FMV) of the trust’s assets and deciding how much the non-charitable beneficiaries will receive each year. The value of these distributions depends on the type of charitable remainder trust you’re working with, usually either a charitable remainder annuity trust (CRAT) or a charitable remainder unitrust (CRUT). So what’s the difference?
- Charitable remainder annuity trusts (CRAT) cannot be added to. They distribute a fixed annuity based on the value of the assets when they’re transferred into the trust. For this reason, CRATs require a notable asset transfer to generate a reasonable income.
- Charitable remainder unitrusts (CRUT) can be added to. They distribute a fixed percentage payout based on the fair market value of the balance of the assets within the trust, which is reevaluated every year. Ergo, payments will fluctuate with the market.
POLARIS PRO TIP: CRATs and CRUTs aren’t the only kinds of CRTs available to high-net-worth individuals. For example, you can opt for charitable lead annuity trusts (CLATs), charitable lead unitrusts (CLUTs), and more. Give Polaris Wealth Advisory Group a call to learn more about CRTs and how they can work for you.
What Are the Advantages and Disadvantages of a Charitable Remainder Trust?
On the surface, moving your assets into a charitable remainder trust may sound overwhelmingly advantageous. However, you must consider a few potential drawbacks before setting one up, especially given the irrevocable nature of the CRT. So what are some advantages and disadvantages of setting up a charitable remainder fund?
Charitable remainder trusts can reduce income taxes via a charitable income tax deduction. And because assets within the trust aren’t subject to capital gains taxes, you’ll only pay taxes on the distributions from the fund. Also, a charitable remainder trust benefits a good cause. Once the trust period expires, you’ll know the remaining funds are going to your preferred charity.
POLARIS PRO TIP: Consider setting up your own charitable family foundation to receive the remainderment. If you designate your offspring to run the foundation, they can use the funds received from the CRT at the time of its expiration to benefit difference causes as they see fit.
Finally, a CRT provides protection from creditors. Per the nature of irrevocable trusts, assets within them are no longer the grantor’s property. Thus, creditors and debt collectors cannot seize them. (However, income generated from CRATs is seizable, unless the state you live in prohibits creditors from taking annuities.)
Charitable remainder trusts are not for everyone. CRTs require substantial assets to work as intended, making them more suitable for high-net-worth individuals than anyone else. Small contributions won’t generate meaningful income, either for the beneficiaries or the charity in question.
The permanence of CRTs may also make many individuals who prefer more intimate control over their assets uneasy. Since CRTs are irrevocable by design (hence the tax benefits), you cannot remove assets once you establish the trust. Furthermore, you forfeit control of the assets within the trust once you turn them over.
Finally, while the split-interest nature of the trust is appealing for the individual who is also looking to receive later personal benefit, a CRT may not interest someone looking to purely make a hefty donation to charity. The very structure of the trust can create the appearance of a conflict of interest. The more distributions you take from the trust, the less money eventually goes to charity.
Consider Whether a CRT Is Right for You—Talk to a Wealth Manager Today
Establishing a charitable remainder trust may sound like a good decision for you as a high-net-worth individual. On one hand, HNWIs can save a considerable amount of money on taxes while diversifying their financial portfolio. But CRTs force HNWIs to relinquish control of high-appreciating assets in order to do so.
If you’re in the process of estate or retirement planning and want to make charitable donations part of your financial strategy, a charitable remainder trust could be the solution you’re looking for. However, navigating the many stipulations and variety of CRTs available can prove difficult without the right guidance. Contact Polaris Wealth Advisory Group for help understanding the different types of CRTs and deciding which one is right for you!
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