Charitable
institutions of all types know the medical community for its generosity. A
great deal of medical research is funded through individual donations, trusts
and foundations. Once you've secured the assets to support your lifestyle, you
may want to do something to help your family, community or favorite charity.
Benefactors feel a great deal of satisfaction knowing they are supporting
worthy causes. You may also be concerned with how your assets will be
distributed when you are gone. While generous contributions can make a huge
difference for others, there are also many practical reasons for giving. A
Charitable Remainder Trust (CRT) can turn your generosity into a sound
financial decision.
The IRS defines a CRT as, "Generally, a charitable remainder
trust provides for a specified distribution, at least annually, to one or more
beneficiaries, at least one of which is not a charity, for life or for a term
of years, with an irrevocable remainder interest to be held for the benefit of,
or paid over to charity."
With a CRT, property or money is donated to a charity, but the
donor can continue to use the property and receive income from it while living.
This type of trust is technically a Charitable Unitrust, but is more commonly
called a Charitable Remainder Trust. CRTs allow taxpayers to reduce estate
taxes, eliminate capital gains tax, claim an income tax deduction and benefit
selected charities. You can even designate how you would like the trust money
used.
The most
popular use of a CRT is to convert a highly appreciated, low income-producing
asset into an income-producing vehicle. Because the funds are destined for
charity, the conversion is completed without incurring a capital gains tax.
CRTs offer additional tax, income, and charitable benefits for a donor family
such as:
- Income Tax
Savings (Charitable Deduction)
- Capital
Gain Tax Savings on Conversion
- Capital
From Tax Savings Kept at Work for Family Benefit (Not IRS)
- Increase
in Family Income
- Reduced
Gift and/or Estate Tax
- Possible
Increased Benefits to Heirs
- Increased
Gifts to Charity in Family Name
Capital Gains Savings
Because the assets placed in a CRT are destined for
charity, no capital gains taxes are incurred. This can be a tax savings of 15%
of an asset's growth in value. For this reason, CRTs are ideal for assets with
a low cost basis but high-appreciated value like stocks or real estate.
For example:
Suppose you originally paid $100,000 for a piece of real estate, and you later
sell it for $1 million. Upon completion of the sale, you would owe capital
gains taxes on the $900,000 difference. That tax could easily top $135,000,
depending on how long you owned the property and your overall tax situation. If
that property were used to fund a CRT, no capital gains would be owed on the
increase in value. Since CRTs have a charitable intent and do not have to pay
capital gains, the full value of the asset transfers to the trust (and thus, to
your beneficiary and favorite charity).
Income and Estate
Taxes
The IRS
considers a CRT outside your estate. Because of this, you may end up saving as
much as 49 cents of every dollar you move to the CRT. Plus, you are not limited
on how much you can contribute by the annual gifting limit or the Unified
Credit.
Because
these trusts benefit charity, you also qualify for an income tax deduction. The
amount of your deduction is the present value of the remainder interest to the
charity. Your current deduction also depends on the type of property you
contribute, as well as the type of charity you name. Average deductions
normally fall in the range of 20 to 50% against your adjusted gross income. Any
deductions not used in the year of contribution may be carried forward for the
next five years.
CRT Funding
A CRT can be funded by an assortment of assets
including:
- Stocks and
bonds
- Real
estate
- Cash and
personal property
- Family
businesses
- Retirement
plans
- Life
insurance
- Livestock
While
commitment of assets to a CRT is irrevocable, the grantor may have some control
over the way the assets are invested, and may even switch from one charity to
another (as long as it is still a qualified charitable organization).
CRTs come in
three types: Charitable Remainder Annuity Trust (which pays a fixed dollar
amount annually), a Charitable Remainder Unitrust (which pays a fixed
percentage of the trust's value annually), and a Charitable Pooled Income fund
set up by the charity, enabling many donors to contribute. The most typical is
the Charitable Remainder Unitrust, which has five sub-types:
- Charitable
Remainder Annuity Trust (CRAT)
- Standard
Charitable Remainder Unitrust (SCRUT)
- Net Income
with Make-up Charitable Remainder Unitrust (NIMCRUT)
- Net Income
Charitable Remainder Unitrust (NICRUT)
- Net Income
with Make-up with Gain Charitable Remainder Unitrust (NIMCRUT
W/GAIN)
Income for the CRT Beneficiary
As beneficiary of the trust, you or
someone you designate can benefit from an annual payment. The payments can be
made in one lump sum each year or scheduled in several installments. The annual
amount paid is a fixed percentage of the fair market value of the assets, as
determined each year. Taxable Income payments of at least 5% annually are paid
by the trust to you or a named beneficiary.
For example, you might elect for a CRT to pay out 5%
annually. If the assets were valued at $100,000, the beneficiary would receive
a payment of $5,000 for that year (5% X $100,000). If the assets were valued at
$125,000 the next year, the beneficiary would receive $6,250, still 5% of the
current market value of the trust assets.
The amount of annual income to be paid out of the CRT
depends on the percentage you choose and the amount of income your assets
generate while inside the CRT. The IRS states that, at a very minimum, the CRT
must distribute 5% of the net fair market value of its assets annually. If you
don't need the income one year, you may elect to defer income through a
"make-up provision." However, the CRT's net distributions must eventually equal
5% to be considered valid by the IRS.
When setting the payout percentage, be aware that the
higher it is, the lower your charitable income tax deduction. Considering
market conditions and the possibility that taking out too much may reduce the
principal inside the trust, you should probably not receive income of more than
10% each year.
Depending on how the trust is structured, the payments will
continue for a fixed period of time or until the death of the beneficiary. At
the end of the payment period, the remaining assets are transferred from the
trust to the named charities.
Other Options
A Charitable Remainder Annuity Trust provides a
fixed-dollar amount for each payment to the beneficiary. The annual payment
amount corresponds to a percentage of the original investment. For example, a
$100,000 charitable remainder annuity trust might pay out 7.5% annually. In
this situation, the beneficiary would receive $7,500 each year for the lifetime
of the beneficiary or a fixed period of years. As with CRTs, the $7500 may be
paid in one sum each year, or in several installments. At the end of the
payment period, the remaining assets are transferred from the trust to the
named charities.
A
Charitable Remainder Annuity Trust with optional wealth replacement is another
option. The donor makes an irrevocable gift of a personally held asset to a
CRT. The Trustee sells the gifted asset to a willing and able buyer. Cash is
received by the Trustee and invested into a selected fund. The donor receives
an income tax charitable deduction for the remainder interest and receives
trust income according to the trust document. Optional annual gifts are made to
the Wealth Replacement Trust to replace benefits from assets gifted to the CRT.
The remaining principal is passed to the listed charity and/or the family
foundation at the termination of the CRT. The wealth replacement assets pass to
the listed beneficiaries, typically to family heirs, free of estate
taxes.
Retirement Planning
Many clients use CRTs to augment their current
retirement plan. By setting one up in your peak earning years, you can make
contributions in the form of zero coupon bonds, non-dividend paying growth
stocks, or professionally managed variable annuities. By letting the CRT grow
without taking income during the early years, the CRT can begin making payouts
to you when you retire. These payments can include make-ups for any shortfalls
in income you did not receive earlier. Unlike IRAs or 401(k) plans, there are
no limits on how much you can contribute.
Combining with Other
Strategies
CRTs are designed to give the principal to charities when you
and your spouse pass away. This bypasses any children, which could leave your
heirs feeling slighted. This issue can be overcome by combining the CRT with
another strategy to "make up the difference" that goes to the
charity.
For
instance, some large estates combine the CRT with a Legacy Trust to provide a
cash distribution upon the death of the owner. The Legacy Trust then subdivides
into individual trusts for each named heir. In this scenario, everyone wins.
The estate owner receives income streams and tax deductions, the charity gets
the principal of the CRT, and the heirs receive a cash
distribution.
Charitable Lead Trust
If you wish to reverse who receives income and who
receives the asset, you can create a Charitable Lead Trust (CLT). CLTs also
offer current income tax deductions and a reduction of capital gains taxes. The
only difference is the CLT flip-flops the parties involved. Charities become
the income beneficiaries, receiving a steady stream of income during the
owner's lifetime. At the owner's death, named beneficiaries then receive the
bulk of the CLT's assets. Charitable Lead Trusts also receive the preferential
tax treatment.
Rely on a Professional
If you think a CRT or CLT could be
beneficial to your tax and estate planning, you should talk with a professional
financial planner. This kind of decision should be part of an overall wealth
management strategy. Select an advisor who will take an individualized approach
to your needs and wants and offer you the high quality of service you deserve.
With the complexities of today's wealth management challenges, it makes sense
to rely on professionals with proven experience, knowledge and capabilities.
After all, you worked hard to get where you are. It's only prudent to protect
your legacy and make sure it is passed on according to your
wishes.
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