Legacy giving, a philanthropic approach that enables donors to make substantial contributions to their chosen charities, has seen significant traction in recent times.
One of the most popular ways to facilitate this is through a trust account, an avenue that provides donors with many tax benefits while letting them retain control over the utilization of their funds. The two primary forms of trusts in the realm of charitable giving are Charitable Remainder Trusts (CRTs) and Charitable Lead Trusts (CLTs).
CRTs and CLTs share a common goal of supporting charities while providing tax benefits to the donor. However, they differ significantly in their structure and the sequence of income distribution.
- With a Charitable Lead Trust (CLT), the chosen charity or charities receive an income stream from the trust for a specific period, and once this term concludes, the remaining assets in the trust are transferred to non-charitable beneficiaries, such as the donor’s heirs.
- A Charitable Remainder Trust (CRT) on the other hand, takes an alternate approach. The donor, or a specified beneficiary, receives an income stream from the trust for a designated period or for life. Upon the termination of this term, the remaining assets in the trust are donated to the chosen charity or charities.
Understanding the Differences Between Charitable Remainder Trust Types
A Charitable Remainder Trust (CRT) can take one of two forms: a Charitable Remainder Annuity Trust (CRAT) or a Charitable Remainder Unitrust (CRUT). Both are types of CRTs that provide income to a non-charitable beneficiary with the remainder of the assets eventually going to charity. However, they differ in terms of how the income distribution is calculated and some other features:
- Charitable Remainder Annuity Trust (CRAT): This type of CRT pays out a fixed annuity each year, which is set at a minimum of 5% and a maximum of 50% of the initial fair market value of the assets contributed to the trust. Because the annuity is fixed, it does not change with the market value of the trust assets over time. This means the beneficiary will receive the same amount each year, regardless of whether the value of the trust assets increases or decreases.
- Charitable Remainder Unitrust (CRUT): A CRUT, on the other hand, pays out a fixed percentage of the current market value of the trust assets, recalculated annually. This means the payout can fluctuate from year to year based on the value of the trust’s assets. If the value of the trust assets increases, the payout will also increase, and vice versa. This type of trust can be more flexible and may be better suited to donors who are comfortable with a variable income stream and want the potential for growth in income if the trust assets appreciate.
It’s important to note that once the trust term ends (which may be at the death of the income beneficiary or after a certain term of years), the remaining assets in the trust go to the designated charity or charities. The choice between a CRAT and a CRUT often depends on the donor’s income needs and expectations about the future performance of the trust’s investments.
When a Charitable Remainder Trust (CRT) Might be the Preferable Choice
A Charitable Remainder Trust (CRT) could be more advantageous in certain scenarios compared to a Charitable Lead Trust (CLT). Here are some situations where choosing a CRT may be more beneficial:
1. Need for a Reliable Income Stream:
If the donor requires a steady source of income during their lifetime or for a certain term, a CRT could be a better choice. CRTs provide an annual payout to the donor or chosen beneficiaries before the remainder is given to the charity.
2. Highly Appreciated Assets:
If the donor has highly appreciated assets and wishes to avoid significant capital gains taxes, a CRT could be a viable option. When these assets are sold within the CRT, they do not incur immediate capital gains tax, potentially resulting in more income for the donor and more funds for the charitable beneficiary.
3. Desire for Immediate Tax Deduction:
CRTs offer an immediate tax deduction based on the present value of the remainder interest that will eventually go to charity. This could be beneficial for individuals facing a large tax liability in the current year.
4. Retaining an Income Stream for Loved Ones:
If the donor wishes to retain an income stream for their spouse, children, or other loved ones after their death, a CRT would be a better option. The trust can provide income for the lifetime of the beneficiaries or for a specific term, with the remainder going to the charity.
Benefits and Potentials Drawbacks of Charitable Remainder Trusts (CRTs)
A Charitable Remainder Trust (CRT) is a trust in which a donor contributes assets. The trust then makes payments to one or more non-charitable beneficiaries for a predetermined period or even a lifetime. After the death of the beneficiary or the end of the term, the remaining assets are transferred to one or more charitable organizations. This type of trust is popular for several reasons, such as:
- TAX BENEFITS: Transferring assets to a CRT gives donors an immediate income tax deduction. It may also help avoid capital gains taxes on the sale of appreciated assets
- INCOME STREAM: The non-charitable beneficiaries of the trust receive regular payments from the trust for a set period. This system can provide an income stream.
- CHARITABLE GIVING: The remaining assets in the trust are distributed to one or more charitable organizations, enabling donors to support causes they care about.
- IRREVOCABILITY: Once assets have been transferred into a CRT, the action is typically irrevocable. This means you cannot change your mind and regain control of the assets, barring exceptional circumstances.
- COMPLEXITY: Establishing and managing a CRT can be complex, requiring the assistance of professionals such as attorneys, accountants, or financial advisors. This can lead to additional costs and time commitments.
- LIMITED CONTROL: As the donor, you do not control the assets once they’ve been transferred into the CRT. The trust is managed by a trustee, which can be a financial institution, attorney, or another designated entity or individual.
- POTENTIAL TAXATION: While the CRT itself is tax-exempt, the income beneficiaries may be subject to income tax on the distributions they receive from the trust, depending on the type and source of the income.
- NO ADDITIONAL CONTRIBUTIONS (CRAT): In the case of a Charitable Remainder Annuity Trust (CRAT), one of the types of CRTs, no additional contributions can be made once the trust is established. If you plan to make additional contributions, a Charitable Remainder Unitrust (CRUT) might be a better option.
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Steps to Setting Up a Charitable Remainder Trust
Setting up a CRT involves defining your objectives, choosing the type of trust that aligns with your goals, selecting a trustworthy trustee, drafting the trust document, funding the trust, and obtaining necessary approvals and filings. As it may involve some complexities, this process is typically simplified with professional help from attorneys, financial advisors, and accountants. These professionals can guide you through the process, ensuring that the CRT reflects your philanthropic objectives while complying with all laws.
The process of setting up a Charitable Remainder Trust involves several important steps, which should be conducted with the help of a legal or financial professional. Here is a general overview:
- Define Your Objectives: Identify the specific goals you want the charitable remainder trust to achieve. This may involve providing income for yourself or your loved ones, avoiding capital gains tax on appreciated assets, or supporting a charitable organization you care about.
- Choose the Type of CRT: Decide between a Charitable Remainder Annuity Trust, which provides a fixed annuity payout, or a Charitable Remainder Unitrust, which provides a payout that varies with the value of the trust assets.
- Select a Trustee: Choose an individual, organization, or financial institution to manage the trust and ensure it’s administered according to your wishes. This can be a person you trust or a professional trustee.
The chosen trustee should be well-versed in finance and law to effectively manage the assets and meet all legal and tax requirements. Moreover, the trustee must possess a high level of integrity to act in the best interests of both the beneficiaries and the charities involved. They should also have good communication skills to liaise between all parties and provide clear information about the trust’s operations. Commitment and availability are crucial traits for the trustee to fulfill their role effectively. Often, a professional trustee, such as an entity from a bank’s trust department or an experienced estate attorney, is chosen due to their comprehensive knowledge and experience in managing trusts. Regardless of who is chosen, careful consideration and thorough vetting of potential trustees is a must to avoid any conflicts of interest.
- Draft the Trust Document: Work with your legal advisor to create a trust document that outlines the terms of the trust. This document should specify the trust type, payout rate, term of the trust, and the charitable organization(s) that will receive the remainder interest.
- Fund the Trust: Transfer the assets you’ve chosen into the trust. This could be cash, stocks, bonds, real estate, or other assets. You’ll also need to decide whether these assets are to be sold immediately and the proceeds reinvested by the trust.
- Obtain Tax Identification Number and Register the Trust: Obtain a separate tax identification number for the trust from the Internal Revenue Service and register the trust as required in your state.
- Administer the Trust: Once the trust is established, the trustee administers the trust according to its terms, including making the annual distributions to the income beneficiaries and handling any tax reporting requirements.
- Review the Trust Periodically: Make it a habit to review the trust periodically with your legal or financial advisor to ensure it continues to meet your objectives and responds to any changes in your situation or in tax laws.