Being able to “have your cake and eat it too” may be a tired cliché, but it is an accurate way to describe the estate, tax, and retirement planning benefits available through charitable remainder trusts (CRTs). These vehicles enable high-net-worth individuals to gift assets to the charity of their choice, take an immediate charitable tax deduction on the gift, and earn an annual income stream for a set period based on the value of the assets.
As you make plans for charitable giving before year end, it may be worth considering CRTs as part of your overall financial plan. When structured properly and with the help of an estate planning attorney, CRTs can be a smart way to remove highly appreciated assets from your estate while also fulfilling philanthropic goals.
CRTs can be set up in several different ways depending on your payout preference and risk tolerance. While each CRT structure has its own unique features, they all serve as powerful tools for managing taxes, generating income, and leaving a meaningful legacy. Below, we provide more information on the two main forms of CRTs: charitable remainder unit trusts and charitable remainder annuity trusts.
Charitable Remainder Unit Trusts (CRUTs).
CRUTs are an excellent way to combine charitable giving with income generation. When you create a CRUT, you transfer assets into a trust and receive an annual payout based on a percentage of the trust’s value, which is recalculated annually. This means your income will be variable, fluctuating with the investment performance of the trust assets. After the trust term ends (or upon your passing), the remaining assets go to the charity of your choice. In addition to an immediate charitable deduction, CRUTs remove the transferred assets from your estate and can help reduce capital gains taxes if appreciated assets are used.
For individuals with highly appreciated company stock or other marketable securities with large unrealized capital gains held in taxable accounts or even real estate, funding a CRUT with these assets allows them to be sold by the trust and defer the capital gains tax. The proceeds can then be invested in assets most appropriate to the goals of the beneficiary. The variable nature of CRUTs offers investment flexibility and, in some cases, the ability to invest alongside the charitable beneficiary you have chosen. Some large universities, for example, offer CRUTs that allow you to participate in the investment returns of their endowment.
Charitable Remainder Annuity Trusts (CRATs).
Unlike the variable payout of CRUTs, CRATs provide the beneficiary with a fixed annual distribution for the term of the trust. The distribution can be either a fixed percentage of the CRAT or a fixed dollar amount determined by the value of the initial gifts, which provides predictability. Like CRUTs, CRATs also provide a charitable deduction, reduce your taxable estate, and can be used to avoid capital gains taxes on appreciated assets. However, due to the fixed nature of the distributions, no further contributions can be made to a CRAT once it is established. Once the term ends or the beneficiary passes away, the remaining value of the trust is transferred to the selected charity.
The value of your charitable tax deduction when establishing a CRAT is based on the present value of the future donation. The longer you structure the annual payouts, the lower the value of the deduction. For clients who expect higher levels of future taxable income, structuring a shorter payout term, such as five or 10 years, will provide a higher deduction. Your Leelyn Smith advisor can help project future tax liabilities to help determine the best structure for your specific needs.
Important caveats about trusts.
When considering CRATs and CRUTs, keep in mind that they are irrevocable trusts, which means they cannot be undone or liquidated. CRUTs, however, have additional flexibility, including allowing you to change the charitable beneficiary if you are not satisfied with your original choice. For married couples, CRUTs and CRATs can be structured to continue payouts across both lives, providing a longer income stream before the charity earns the remainder.
It is also important to keep in mind that the planning flexibility offered by CRATs and CRUTs comes with costs, which can be significant. These include setup, management, and administrative fees while the trust is in force and appraisal fees if you are donating assets other than cash or marketable securities. These fees can grow depending on the complexity of the trust and the investments you choose once funded.
As always, it is important to work closely with an advisor to consider the best path for you and your family. Please reach out to the team at Leelyn Smith if you are interested in learning more about how CRUTs and CRATs can help you to pursue your goals for charitable giving and estate planning.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for individualized tax advice. We suggest that you discuss your specific tax situation with a qualified tax advisor.