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Charitable Remainder Trusts: Do Well for Yourself by Doing Good for Others

January 1, 2010

Americans are some of the most generous givers on the face of the planet. They reach into their pockets and take out their checkbooks on behalf of others more often than any other industrialized nation. There’s a lot at stake for all concerned when it comes to encouraging charitable giving in America.The Charitable Remainder Trust (CRT) is one of the most popular ways that Americans can donate to their favorite cause while doing good for themselves and their families.

How Does the Charitable Remainder Trust Work?

Whether you are a budding philanthropist looking for the best way to contribute to society, or an investor looking for strategies to maximize income and tax breaks, the CRT offers a powerful solution to your needs. It combines current charitable income tax deductions and future estate tax deductions with the opportunity to avoid capital gains tax on a highly appreciated asset. It then goes one step further to provide you with a new source of income.

A CRT delivers best results when benefactors have a highly appreciated asset -- such as real estate or stock -- that provides little or no income. Owning such an asset is a double-edged sword. You can’t sell the asset without experiencing the costly bite of state and federal capital gains taxes. On the other hand, if the asset is still in your estate when you die, it will increase your estate taxes.

Of course, you could donate the asset directly to charity and gain an immediate charitable tax deduction. In one fell swoop, you’d reduce the value of your estate -- and thus future estate taxes -- as well as avoid capital gains taxes.

But you’d miss out on an opportunity to maximize your income.

A Charitable Remainder Trust Overcomes These Problems

When you create a CRT, you transfer your highly appreciated asset to your trust. The asset is usually sold, with the proceeds used to buy income-producing investments. Then, each year for the rest of your life, you’ll receive income from the CRT. When you die, your designated charity will receive whatever remains in your Trust. Hence the name: Charitable Remainder Trust.

The incentives for using the Charitable Remainder Trust include:

An immediate income tax charitable deduction based upon the fair market value of the asset given away (less your reserved interest -- or future income)
An opportunity to put the full value of your appreciated asset to work for you and avoid the costly impact of capital gains taxes
A new source of income
A charitable estate tax deduction on the full fair market value of the asset you’ve donated to the charity when you die
It may sound like the CRT is a complex legal tool. But just the opposite is the case. We can set one up in fairly short order. You decide which charity or charities you want to support. You also decide who will serve as trustee. The trustee can be you, a bank or trust company, or anyone else of your choosing.

The Trustee will follow the directions set forth in your trust document. Among the trustee’s first duties may be selling your donated assets and reinvesting the money in an investment that generates income for you.

You decide who will receive income from your Charitable Remainder Trust and for how long. You may be the only beneficiary, or you may provide that your spouse or children will receive income after you die.

Lastly, you decide how you want to receive your income, and how much you want to receive each year.

Charitable Remainder Annuity Trust and Charitable Remainder Unitrust

Your answers to these last questions will prove critical in determining exactly what type of CRT you choose. Your temperament as an investor will also play a role in these decisions. For instance, conservative investors who want a predictable income year after year may prefer the Charitable Remainder Annuity Trust -- or "CRAT" for short.

You may make only one contribution to your CRAT, which will provide you a fixed annual income, regardless of the investment performance of your asset. Because your tax deductions and income are based on the value of the asset as of the day it was transferred to the Trust, the CRAT is probably better suited to investments in the Trust that you suspect will lose value in the years ahead. Regardless of the economic winds, your income is assured.

So, if your asset doesn’t earn enough to pay your annual income, the principal will be used to make up the difference. On the other hand, if the markets turn bullish and the trust outperforms your expectations, the surplus will be added to the principal the charity will ultimately receive.

With a CRAT, you must be paid an annual income equal to at least 5 percent (and no more than 50%) of the asset’s fair market value, determined on the day it was transferred to your Trust. So, if you donated a stock portfolio valued at $250,000 on the day it was transferred to your Charitable Remainder Trust, your annual income would be at least $12,500. There’s an upper limit to how much you can receive each year, but it isn’t as simply stated. It has to do with your lifespan (as well as the lifespans of any other beneficiaries) and other factors. We can help you determine the percent of interest you will receive.

The chief drawback of the CRAT is also its strength-it protects the donor against swings in the financial markets. In a stagnant or declining market, the donor comes out ahead. But in a strong market experiencing investment growth, it’s the charity that will ultimately benefit the most. That’s why donors who hold more bullish views on investing will prefer the Charitable Remainder Unitrust.

The Charitable Remainder Unitrust ("CRUT") offers a couple of advantages over the CRAT. First, unlike the CRAT, you may make as many contributions as you like to your CRUT. And for the sake of determining annual income, it is the asset’s annual fair market value -- not its value on the date it was transferred to the Trust -- which is used in the calculations.

As for its income opportunities, the CRUT allows the benefactor to ride the financial markets and enjoy the investment performance of the Trust assets. That means, of course, that some years you may receive less, other years more.

The CRUT requires that the donor receive a minimum income of 5 percent of the asset’s current fair market value. You can also opt to receive this 5 percent, or the trust’s net income, whichever is less. When lean years keep you from receiving your full due, a "make-up provision" can allow for additional income in future years to make up for the shortfall.

What about Your Heirs?

So far we’ve focused on the ample benefits that the Charitable Remainder Trust offers you. But what about your heirs? After all, you’ve given away a piece of their legacy in order to gain income and tax advantages for yourself today. One frequently employed solution is the Irrevocable Life Insurance Trust. When used in concert with the Charitable Remainder Trust, it provides your heirs with an income-tax-free legacy equal to the full value of the asset you donate to charity. Here’s how it works.

After you establish your Irrevocable Life Insurance Trust, your trustee then purchases a life insurance policy on your life with your heirs as beneficiaries. Usually, the death benefit of this policy is equal to the after-tax value of the asset you’ve given away. The cost of the policy can be offset by income generated by your Charitable Remainder Trust or the charitable income tax deduction you receive. Upon your death, your heirs will receive an income-tax-free death benefit from the life insurance trust.

Getting Started: A CRT for A Favorite Charity

You don’t have to be a Rockefeller or a Getty to make the world a better place for others. Dozens of organizations that make a positive impact on your community and the lives of those close to you welcome donations large and small. If one has made a difference in your life - and you want to make a difference to it - then talk to us about setting up a Charitable Remainder Trust for your favorite charity. The lifetime gains for you and your community will last a long, long time.

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