What if you could support the causes you care about and generate income for yourself or your loved ones, all from the same financial strategy? A charitable remainder trust (CRT) makes this possible.
In this guide, we’ll explore how CRTs work, their benefits, and how they can support your tax management and estate planning goals.
Key Takeaways
● A charitable remainder trust allows you to transfer assets into an irrevocable trust that provides income to beneficiaries before the remaining assets go to charity.
● You can choose between two types of charitable remainder trusts: a CRAT pays a fixed amount annually, while a CRUT adjusts its payments based on the trust’s annual value.
● CRTs can preserve the value of your appreciated assets and lower your tax burden, while providing opportunities for asset diversification.
● Since CRTs are both irrevocable and complex to set up, establishing one typically requires careful planning and the guidance of a qualified attorney, financial professional, and tax professional
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What is a Charitable Remainder Trust?
A charitable remainder trust is a type of irrevocable trust. It lets you put assets such as cash, investment assets, or real estate into a trust and get a current year tax deduction.
You can name yourself or another person to receive income from the trust for a set period of no more than 20 years, or for the lifetime of one or more noncharitable beneficiaries. After the specified term or the death of the last income beneficiary, the remaining donated assets go to one or more designated charities.
Types of Charitable Remainder Trusts
There are two main types of CRTs that primarily differ based on how they pay noncharitable beneficiaries. They include:
● Charitable remainder annuity trusts (CRATs): These trusts pay noncharitable beneficiaries a fixed amount annually. The amount beneficiaries receive is set when the trust is created, and it must be at least 5% and no more than 50% of the assets in the trust. Charitable remainder trust distribution rules require that the percentage beneficiaries receive doesn’t change, even if the value of the trust’s assets increases or decreases. Additionally, CRATs don’t allow for additional contributions.
● Charitable remainder unitrusts (CRUTs): These trusts pay noncharitable beneficiaries a variable amount. Payments are based on the balance of the trust assets, which are revalued annually. While CRUTs pay a variable income, it must be at least 5% and no more than 50% of the assets in the trust, similar to CRATs. However, unlike CRATs, CRUTs allow for additional contributions.
So, which trust should you choose between a charitable remainder annuity trust vs. a charitable remainder unitrust? A CRAT may be better suited for you if you want a predictable, fixed annual income. Alternatively, you may prefer a CRUT if you want payments that can potentially increase over time as the trust’s assets grow and are comfortable with variable income that can increase or decrease based on market performance.
That means there’s no one-size-fits-all option. The right choice depends on your income needs, assets, tax situation, and legacy planning goals.
How a Charitable Remainder Trust Works
Regardless of whether you opt for a CRAT or a CRUT, here’s how a CRT works:
- A donor (in this case, you) establishes an irrevocable trust.
- You contribute assets such as cash, stocks, or real estate to the trust.
- A designated trustee (selected by you) sells the assets and reinvests the proceeds.
- The trustee pays you or another designated noncharitable beneficiary based on the trust’s terms.
- The payments continue for a specified term of no more than 20 years or for the lifetime of one or more noncharitable beneficiaries.
- After the specified period or the death of the last beneficiary, the remaining trust assets go to one or more selected charities. The remainder donated to charity must equal at least 10% of the value of the trust when it was created.
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Benefits of a Charitable Remainder Trust
A CRT can be an excellent way to achieve multiple financial goals at the same time, particularly if you own highly appreciated assets like low basis stock, investment real estate, or business interests. Key benefits of charitable remainder trusts include:
Preserving the Value of Appreciated Assets
A CRT can allow you to sell appreciated assets without paying the immediate capital gains tax so you can reinvest the full sales proceeds. As a result, setting up a CRT can be especially beneficial if you have an asset that has grown significantly in value, and want it to continue generating more money for the income and eventual charitable beneficiaries.
Potential Income Tax Deduction
You may receive a partial income tax deduction in the year you create and fund the CRT based on a calculation of the remainder interest projected to pass to the charitable beneficiary. However, the deduction amount depends on several factors such as the trust term, payout rate, and IRS valuation tables. Consult a qualified tax professional to learn more about your specific numbers.
Tax-Exempt Growth and Asset Diversification
A CRT is generally exempt from income tax at the trust level, allowing trust assets to be sold and reinvested without immediate taxation. Beneficiaries generally pay tax on distributions they receive under the four-tier distribution rules laid out in IRC § 664(b).
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CRTs and Taxes
Donating assets to charity through CRTs can potentially lower your tax liability. However, the tax savings you stand to get may vary depending on your specific financial and tax situation. That said, here are ways a CRT can help you reduce your tax burden:
Income Tax Charitable Deduction
When you establish a charitable remainder trust, you can claim an immediate income tax deduction based on the present value of the remainder interest expected to go to charity.
The remainder interest is calculated based on the trust’s terms, alongside the IRS Section 7520 rates at the time of the trust’s creation and the IRS actuarial Table B.
For instance, suppose you own a commercial property used by your business valued at $1.5 million, but your tax basis is $500,000. If you sell the property yourself, the $1 million of appreciation could create a significant tax liability.
Alternatively, if you transfer the property to a CRAT that then sells it, you could receive annual income payments of $75,000 (5% of the trust’s value at creation) for a specified period and also claim a charitable remainder trust tax deduction based on the estimated value of the assets expected to remain for charity. However, the exact tax benefits would depend on your trust’s terms and your circumstances.
Estate Tax Considerations
Besides reducing your tax burden, charitable remainder trusts can also help with estate and legacy planning.
A CRT is irrevocable, meaning you can’t change or terminate it once you create it unless the trust’s terms and applicable law allow it. When you transfer assets into the trust, you give up your ownership of those assets.
Since the assets are no longer owned by you personally, they may be excluded from your probate estate, and depending on your circumstances, may not be subject to estate taxes. That’s why you should include them as part of your estate planning considerations.
Tax-Exempt Status of the Trust
As a split interest trust, a CRT pays no income tax on the investment income or gains it earns. This includes income from the sale of appreciated assets donated to it.
But there’s a caveat. While the trust itself doesn’t pay income tax, the designated noncharitable beneficiaries will owe tax on the distributions they receive. Discuss this with a tax advisor to determine whether creating a CRT aligns with your tax management goals.
Connect with the Fiduciary Advisors at JNBA for Financial Planning Support
Understanding CRTs and using them can be an excellent way to minimize your tax burden, but it’s important to remember that a charitable remainder trust is not a one-time decision. It is a commitment that unfolds over years, sometimes decades, and the advisor who helps you structure it should still be there when the distributions begin, when tax laws change, and when your family’s priorities evolve.
That’s where JNBA comes in. Most of our client relationships span generations, and having an advisor who knows your full picture from the beginning changes what good advice looks like over time. Contact us today for guidance tailored to your unique situation.
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