Charitable giving can be extremely rewarding. But did you know it can also provide major tax benefits? Enter the Charitable Remainder Trust (CRT). This unique estate planning vehicle allows you to donate appreciated assets tax-free while securing lifetime payments for yourself or other beneficiaries.
Though complex, CRTs unlock tremendous tax-slashing potential. Read on to learn how they work, the major benefits, and why professional guidance is critical.
How Charitable Remainder Trusts Work
A CRT is a split-interest trust agreement between three parties:
- The grantor, who establishes and funds the trust
- The trustee who invests and manages the assets
- One or more income beneficiaries who receive distributions
- A qualified charitable organization that ultimately receives the remaining assets
The grantor contributes appreciated property like stocks, real estate, or art to the trust. The trustee sells these assets tax-free and then reinvests the proceeds.
The income beneficiaries get set payments over a certain amount of time. These payments can be a set dollar amount (charitable remainder annuity trust) or a percentage of the trust assets (charitable remainder unitrust). When the trust terminates, the remaining assets pass to the charity.
The powerful tax benefits
Funding a CRT triggers major tax breaks.
- Income tax deduction for the present value of the charity’s remainder interest
- Capital gains elimination on the sale of the appreciated assets
- Reduced estate taxes since assets are removed from the taxable estate
The deduction is capped at 30% of adjusted gross income, but any excess can be carried forward for five additional years.
Pro Tip: The larger the income payout, the lower the charitable deduction since less is ultimately given to charity. But reduced payments mean more compounded growth inside the trust. It’s a strategic balancing act.
Even though beneficiaries’ lifetime payments are subject to ordinary income tax, doing so frequently results in lower taxes than selling the assets outright. This further increases cash flow.
Choosing between CRATs and CRUTs
There are two main types of CRTs:
|Charitable Remainder Annuity Trust (CRAT)||Charitable Remainder Unitrust (CRUT)|
|Pays a fixed dollar amount to income beneficiaries, regardless of trust performance.||Pays a percentage of trust assets, so payments fluctuate based on investment returns.|
|No additional contributions are permitted after establishment.||Additional contributions are allowed over time.|
|It is better for predictable, fixed payments.||Preferred for adjusting income to market conditions.|
A financial advisor can help assess which structure better aligns with your goals and cash flow needs.
What assets can fund a CRT?
The most effective assets to fund CRTs are those that are highly appreciated in value but generate little income. This includes:
- Publicly traded stocks and bonds
- Closely held business interests
- Real estate
- Collectibles like antiques or rare coins
Illiquid assets can work but require a careful cost-benefit analysis. Other considerations are the size of the asset and the debt encumbering it.
Pro Tip: Municipal bonds and tax-exempt securities don’t make good CRT assets since no tax is avoided on sale. Cash also fails to provide a deduction.
CRTs: Not Just for the Ultra-Wealthy
Contrary to popular belief, CRTs aren’t just for the ultra-rich. With the right assets, they can benefit individuals and families with a net worth ranging from $500,000 to $5 million or more. The key is having highly appreciated property that can be contributed.
For example, imagine a retired couple in their 70s who purchased tech stocks decades ago:
- Cost basis of $500,000
- Current value of $5 million
If sold, they face $4.5 million in capital gains tax! By contributing the shares to a CRT instead, the tax is avoided completely.
The couple can receive 6–7% of the trust annually to supplement their retirement. When they pass, whatever remains goes to their favorite charities. This plan provides tax savings and retirement cash flow while fulfilling their philanthropic wishes.
CRTs: The Importance of Professional Guidance
While CRTs provide phenomenal tax benefits, they are complex vehicles requiring administrative rigor. As fiduciaries, trustees must ensure compliance with complex rules to preserve the arrangement’s legal status.
It’s essential to work with specialized professionals when considering a CRT.
Estate planning attorney
- Provides personalized counseling based on your financial situation and goals.
- Determines the optimal trust structure and analyzes tax implications
- Drafts the legal trust document and works with the trustee to administer the CRT.
- Calculates the income and estate tax deductions allowed.
- It helps properly report annuity payments for income tax purposes.
- Assesses which assets should be used to fund the trust.
- Works with the trustee to develop an appropriate investment strategy for growth.
- Serves as an independent trustee overseeing the administration.
- Objectively manages the assets and makes annuity or unitrust payments.
By tapping this coordinated professional team, you can implement an effective CRT with minimal risk and maximum reward.
Is a charitable remainder trust right for you?
While not a strategy for everyone, CRTs can help certain investors, particularly those with:
- Highly appreciated assets with large latent capital gains
- A desire to supplement retirement income from their assets
- An interest in philanthropy and leaving a charitable legacy
To determine if a CRT could benefit your situation, the first step is scheduling a free consultation with an estate planning attorney. They can provide an initial analysis based on your assets, income needs, and charitable motivations.
With creative planning, a CRT can help you slash capital gains while benefiting yourself, your family, and your favorite charitable causes. By donating appreciated assets tax-free, you can do well for your future while also doing good.