Question 31: What Is a Charitable Remainder Trust?

Citizens of the United States are charitable by nature if the statistics mean anything at all. American individuals, estates, foundations, and corporations gave an estimated $390 billion to charitable causes in 2016, according to Charity Navigator, a study released by Giving USA Foundation. And the Charitable Remainder Trust (CRT) is one of the most popular ways to give to charities.

A Charitable Remainder Trust permits a donor to defer the income tax consequences on the sale of a capital gain property and make a charitable gift. The donor transfers property to the Trust, retaining the right to receive a stream of annual payments for a term chosen by the donor. At the donor’s death, the remaining assets go to the charity, thus the name Charitable Remainder Trust.

The two most common types are Charitable Remainder Annuity Trusts (CRATs) and Charitable Remainder Unitrusts (CRUTs).

The Benefits of Using a Charitable Remainder Trust

Charitable Remainder Trusts allows for both charitable income tax deductions as well as estate tax deductions upon your death. Additionally, this Trust allows you to defer or avoid capital gains taxes. And finally, it can give you a source of income.

Although an asset can be put into a Charitable Remainder Trust, the best kind of asset would be one that is highly appreciated and provides no current income. An asset that has appreciated can leave you with a large capital gains tax. Putting it into a Charitable Remainder Trust defers or avoids this tax. Plus, the asset, typically real estate or stocks, have not been providing any income. When put into the Trust, they can!

How Do You Start a CRT?

Believe it or not, setting up a Charitable Remainder Trust is a relatively easy thing to do with a qualified estate planning attorney. First, you need to determine which charity you wish to support. Then you determine a Trustee. You can be the Trustee, or you can name a bank, a Trust company, or anyone else you choose.

The trustee of your Charitable Remainder Trust will:

  1. Help you determine the value of the assets you are using to fund the Trust
  2. Follow the Trust documents
  3. Sell the donated assets
  4. Reinvest the money made from the sale of the assets in an investment that provides you with a steady stream of income

Next, you have to determine who will receive income from the Trust. According to the IRS, at least one beneficiary other than the charity must receive income each year. Probably, you will want to be a beneficiary, but you may also want to include your spouse or your children after you die.

The final step is to determine how you want to receive your income and how much you wish to receive each year. Determining these aspects of the Trust will help you decide what kind of Trust to create.

Charitable Remainder Annuity Trust

A Charitable Remainder Annuity Trust (CRAT) is a great Trust for someone who a conservative investor and wants a fixed yearly income. Another good reason to choose a CRAT is if you believe that the asset you transferred to the Trust will lose value over time since your tax deductions are based on the value of the asset at the time it is donated.

For those wanting a steady income, a CRAT can’t be beat. No matter how the economy is going or how the investments are going, you are guaranteed a specific yearly income. If your investments lose money, principal will be used to pay you the designated annual income. If your investments do well, the extra will be added to the principal.

So, just how much can you get in yearly income from a CRAT? You must get an annual income of at least 5 percent of the asset’s fair market value on the day it was transferred to your Trust. Therefore, if you had real estate that was worth $1 million when put into your CRAT, you would earn at least $50,000 yearly. The upper limit of what you can earn is more difficult to compute. It has to do with your life span and the life spans of any other beneficiaries as well as a host of other factors. Determining exactly how much to take yearly from your CRAT is best done with the help of an estate planning attorney.

The drawback of the CRAT is also the strength of the CRAT. In a bad economy, the CRAT keeps you from losing money by delving into the principal to make up any shortfall. However, the same thing holds true in reverse. During an upswing in the economy, you will not get any yearly increase with a CRAT. For those who believe that the market is more bullish and want to see increases when it is, another type of Charitable Remainder Trust is needed.

Charitable Remainder Unitrust

There are two major differences between a CRAT and a Charitable Remainder Unitrust (CRUT).

  1. Unlike funding a CRAT with just one contribution, you can contribute to a CRUT as many times as you like.
  2. The annual income is determined using the asset’s current fair market value instead of its value on the date it was transferred to the Trust, thus your income varies from year to year.

In a bull market, you will likely receive more annual income from a CRUT than from a bear market. If you can handle the ups and downs of the market, then a CRUT may just be the tool for you.

As with the CRAT, the CRUT requires that you receive a minimum of 5 percent of the asset’s fair market value. Remember, with a CRUT, this is a current value. You also have the option to receive 5 percent of the Trust’s net income, whichever is less.

What Happens to My Heirs?

It would seem that a CRAT or CRUT helps you by providing income tax breaks, but ignores your heirs by giving away their potential legacy to a charity. The best way to remedy this situation is to use a CRAT or CRUT along with an Irrevocable Life Insurance Trust (ILIT). Using an ILIT gives your heirs an income-tax free legacy equal to the full value of the asset you donate to charity!

Once you have established an ILIT, your Trustee will purchase a life insurance policy on you with the death benefit equal to the value of the asset you have given away to your CRAT or CRUT. The Trustee will list your heirs be the beneficiaries. The policy can be paid for by income generated by your Charitable Remainder Trust, or you can use your charitable income tax deduction to pay for the insurance premiums. When you die, your heirs will receive the death benefit without having to pay income taxes.

Some might argue that setting up an ILIT is too time consuming and that they can just own the insurance policy outright. The problem is that the death benefit will be included in the value of your estate for tax purposes, thus reducing your heirs’ legacy by 40 percent in 2017. Using an ILIT eliminates the estate tax on the insurance death benefit.

Setting up Charitable Remainders Trusts and Irrevocable Life Insurance Trusts require someone who knows all the tax advantages and rules. Always talk with a qualified estate planning attorney before putting any assets in a Trust.

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