In my blog post last month (A Simple Strategy for Achieving Clients’ Charitable Goals: the Donor-Advised Fund), I provided an overview of the potential benefits of using donor-advised funds (DAFs) as part of a charitable giving strategy. Although DAFs are great for relatively simple planning situations, what if your charitably minded clients have more complex needs and goals?
Over the past few years, improving stock market conditions, rising income tax rates and a growing number of baby boomers seeking ways to supplement retirement income have contributed to a resurgence in the use of the charitable remainder trust (CRT). A general understanding of how the CRT works can help you determine whether it’s an appropriate charitable planning vehicle for your clients.
How CRTs Work
A CRT is a split-interest trust, meaning there are two beneficiaries: an individual income beneficiary and a charitable remainder beneficiary. The trust can be established to pay income at least annually for a term of years (no more than 20) or for the lifetime of the income beneficiary.
The income stream can be structured as a fixed dollar amount, as in the case of a charitable remainder annuity trust (CRAT), or as a percentage of the trust’s annual fair market value, as in the case of a charitable remainder unitrust (CRUT). For the trust to qualify as a CRT, the payment must be 5% or more of the trust’s fair market value.
Upon completion of the trust term or the death of the last income beneficiary, all remaining assets pass to the charitable organization named as the remainder beneficiary.
A Compelling Tax Situation
This may not sound too exciting up to this point, but naming a charitable organization as the remainder beneficiary creates a very compelling tax situation: it makes the trust tax exempt. Because the trust is tax exempt, the client funding a CRT will receive an income tax deduction equal to the present value of the remainder interest, and the assets will be removed from his or her taxable estate.
In addition, the trust will not be liable for any taxes when it sells assets used to fund the trust.
The income beneficiary will have to pay tax on payments received from the trust; however, if properly managed, the taxation of those payments may be at rates no higher than preferred capital gains rates.
How a CRT Works: John