In 1969 Congress created a new type of trust that helped charities and not-for-profit organizations generate more revenue for their causes. In addition to being an excellent vehicle to make a charitable gift or bequest, a charitable remainder trust is an effective estate planning and income tax reduction tool. This vehicle allows taxpayers to reduce estate taxes, eliminate capital gains, claim an income tax deduction, and benefit charities instead of the IRS.
A charitable remainder trust is established with irrevocable contributions of cash, marketable securities, closely held stock or real estate. The parties to the trust are the Donor, the Trustee, the Beneficiaries (also called the Recipients, and the Charitable Remainder Beneficiaries (Charity or Charities). The Donor contributes assets to the trust. The assets are typically sold and the proceeds reinvested by the Trustee. The Trustee makes payments for life or for a term (not exceeding 20 years) to the Beneficiaries according to the terms of the trust. At the termination of the lifetime interest (death of all primary beneficiaries) or the designated term the Trustee distributes the remaining trust assets to the Charitable Remainder Beneficiaries.
At the creation of the charitable remainder trust, the donor receives an income tax deduction for the present value of the future gift (the “charitable remainder”) the charity will receive when the trust terminates. That value is calculated based on actuarial tables, taking into account the value of the property transferred to the trust, interest rates, the age of each beneficiary, or the term of the trust if it is for a specific number of years. If he or she cannot use the entire deduction that year, it may be used over the next five years.
Once the assets are inside the charitable remainder trust, there are no taxes from the sale of the assets transferred to the trust. Therefore, transferring appreciated assets to a charitable remainder trust, which in turn sells them and re-invests the proceeds in income-producing property, provides the trust the full value of appreciated assets without capital gains. The assets are removed from the gross estate of the donor and the recipient receives an income for life or for a specific term.
While the charitable remainder trust is an irrevocable trust, the donor under certain conditions can be the trustee as well as the beneficiary of the charitable remainder trust. As trustee he or she has control over the administration of the trust and investment of trust assets. That individual can name successor trustees or alternate trustees and can retain the right to change designation of trustee at any time.
At the establishment of the charitable remainder trust, the donor can name his or her self, a spouse, and/or others as beneficiaries. Those named primary beneficiaries will immediately receive the lifetime income. Those named contingent beneficiaries will receive payments only after the death of all primary beneficiaries. Once the trust is established, the designation of beneficiaries may not be changed. All beneficiaries must be living and named when the trust is established.
The charitable remainder trust is structured in one of two ways:
In most cases, payments from a charitable remainder trust are made for the lives of the beneficiaries. However, you can also specify that payments be made for a fixed term of up to 20 years. An example for the use of this option could be to offset the cost of tuition (usually four to eight years) for a child or grandchild. Once the trust is established the payment term may not be changed.
When the trust is established, the donor can retain the right to change the designation of the charitable remainder beneficiaries at any time. At the death of the beneficiaries or the end of the fixed term, the remaining assets in the charitable remainder trust will go the charitable organizations (Charitable Remainder Beneficiaries). The donor can specify how he or she wants the charity to use the money. For example, he or she can specify the money be used as an endowment with only the income from the assets be used by the organization. He or she can also specify for what charitable purpose the donation is to be used.
What about my heirs? If the charity gets the asset my heirs get nothing? Answer: To insure the children’s inheritance stays in tact, some of the monthly income generated by the CRT can be used to purchase life insurance on the donor’s life. When the donor dies, the policy replaces the approximate value that was given to the charitable trust. The life insurance is purchased by an irrevocable life insurance trust to avoid incidence of ownership avoiding the death benefit being included in the donor’s estate.
John Hamilton and his wife, Joan, own an apartment building they bought for $200,000, 20 years ago. If they sold the building today for its market value of $1,000,000 they would have to pay approximately $160,000 in capital gains tax. They could earn 8% or approximately $67,000 per year in income on the remaining amount. When they die, because of all the other assets they own, their estate will be in the 55% estate income tax bracket. Their children would receive approximately $360,000 in inheritance on that asset. They decided to establish a charitable remainder trust. They donated the building to charity. The building was sold for $1,000,000. Their family income was approximately $400,000 annually. They were able to carry the income tax deduction earned by donating the building to charity for three years and saved approximately $100,000 in income taxes. Their income from the building at 8% is $80,000. John and Joan are 60 years old and purchased a 2nd to die life insurance policy with an annual premium of $10,000.
Analysis: John & Joan were able to donate $1,000,000 to their favorite charity. They received a $100,000 savings on their income taxes by donating the building to charity. They earned more money in annual income on the asset and were able to pass on $1,000,000 to their children estate and income tax free.
This is a hypothetical example and is not representative of any specific situation. Your results will vary. The hypothetical rates of returns used to not reflect the deduction of fees and charges inherent to investing.