Charitable Remainder Trusts (CRTs) are powerful financial instruments that allow individuals to support charitable causes while also receiving significant tax benefits and securing income for themselves or their beneficiaries. In this post, we will explain what CRTs are, how they work, their benefits, drawbacks, and the different types available.

WHAT IS A CHARITABLE REMAINDER TRUST?

A Charitable Remainder Trust (CRT) is a type of irrevocable trust designed to provide a stream of income to the trust’s beneficiaries for a specified period. After that, the remainder of the trust’s assets are donated to one or more designated charities. CRTs are particularly appealing to people who wish to support charitable causes while also benefiting from tax advantages and maintaining an income stream.

HOW DO CHARITABLE REMAINDER TRUSTS WORK?

Establishment: The donor establishes the CRT and transfers assets into the trust. These assets can include cash, stocks, real estate, or other valuable property.
Income Distribution: The CRT pays income to the designated beneficiaries for a set term, which can be a specific number of years (up to 20) or for the lifetime of one or more individuals. The amount distributed annually is either a fixed dollar amount (in a Charitable Remainder Annuity Trust) or a fixed percentage of the trust’s value (in a Charitable Remainder Unitrust).
Tax Benefits: When assets are transferred into the CRT, the donor may receive an immediate charitable income tax deduction based on the present value of the remainder interest that will eventually go to charity. Additionally, assets placed in the trust are typically not subject to capital gains tax if they are sold by the CRT, allowing for the reinvestment of the full proceeds.
Remainder to Charity: At the end of the trust’s term, the remaining assets are transferred to the designated charity or charities. This can also be elected as a Donor Advised Fund (DFA) which allows for more flexibility of donations and for a charitable legacy to be passed to heirs.

TYPES OF CHARITABLE REMAINDER TRUSTS

Charitable Remainder Annuity Trust (CRAT): Pays a fixed annuity amount each year, which is determined at the outset. The payment amount does not change, regardless of the trust’s investment performance. CRATs provide predictability and stability in income but do not allow for additional contributions once established.
Charitable Remainder Unitrust (CRUT): Pays a fixed percentage of the trust’s value, which is recalculated annually. This means the income payments can vary from year to year based on the trust’s performance. CRUTs offer flexibility and the potential for income growth and allow for additional contributions over time.

BENEFITS OF CHARITABLE REMAINDER TRUSTS

Income Stream: Beneficiaries receive a steady income stream for the duration of the trust’s term, which can be particularly beneficial for retirement planning or providing for heirs.
Tax Advantages: Donors receive a charitable income tax deduction upon funding the trust, and the trust’s assets grow tax-free. Additionally, by avoiding capital gains taxes on the sale of appreciated assets, the trust can reinvest the full value, potentially increasing the income generated.
Charitable Giving: CRTs allow donors to make significant contributions to charitable organizations, supporting causes they care about while also receiving personal financial benefits.
Estate Planning: CRTs can be an effective estate planning tool, helping to reduce the size of the donor’s taxable estate. This is particularly relevant given the Tax Cuts and Jobs Act (TCJA) sunsetting in 2025, which has the potential to bring the Lifetime Gift Tax Exemption to $5MM per person.

DRAWBACKS AND CONSIDERATIONS

Irrevocability: CRTs are irrevocable, meaning the decision cannot be reversed once assets are transferred into the trust. Donors must be certain of their choice to use a CRT.

Complexity and Costs: Establishing and maintaining a CRT involves legal and administrative expenses. Donors should work with financial and legal advisors to ensure the trust is set up and managed properly.

DiversiFi has established a relationship with a third party that helps clients set up a trust at no cost. However, there are costs to maintain these trusts, which our advisors can explain in more detail.

Income Variability: While CRUTs offer the potential for income growth, they also come with the risk of income fluctuation based on market performance. CRATs, while providing stable income, do not benefit from potential market gains.

FINAL THOUGHTS

Charitable Remainder Trusts offer a unique combination of benefits, including a reliable income stream, substantial tax advantages, and the satisfaction of supporting charitable causes. They can be an integral part of a well-rounded financial and estate plan. However, due to their complexity and irrevocable nature, it is crucial to seek professional guidance to determine if a CRT aligns with your financial goals and philanthropic aspirations.

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