Charitable Remainder Trusts: A Custom Income Gift Solution

An issue many generous people face is how to make gifts while providing for oneself or the needs of one’s family. Gifts that return income present one possible solution, as they simultaneously generate income for the donor and family while supporting a cause important to the donor. The charitable remainder trust (CRT) is the most flexible and versatile type of these gifts (the other type being charitable gift annuities), allowing donors to customize income to their needs, convert illiquid assets into a new stream of income, or a host of other financial and estate planning goals that can be accomplished through a charitable trust.

Setting up a new CRT

CRTs are standalone legal entities, and usually are established with the help of an attorney who advises on the endless trust and payout options available and can customize the trust to the donor’s goals and needs. The IRS publishes sample trust language that exemplifies qualified charitable trusts in several variations. In establishing the trust, the donor must decide the following four things: 

1. The trustee and charitable beneficiary that will receive the remainder funds. The donor can name more than one charitable organization, and reserve the right to change charitable beneficiaries.
2. The people to receive income, deciding if they should receive income for a term of years or for life, and deciding if income shares are concurrent or simultaneous.
3. The type of income: if the CRT pays out a fixed percentage (minimum 5 percent) of its value annually, called a unitrust (CRUT), or pays out a fixed dollar amount annually, called an annuity trust (CRAT). Alternatively, the trust can pay out the lesser of net income or a fixed percentage, called a net income unitrust, which possibly might have the ability to make up payments for a prior year in which only net income was paid. Unitrusts can take multiple donations and are suitable for illiquid assets like real estate. Annuity trusts only can be funded once and should only be funded with readily sellable assets.
4. The timing of the income: Either the income starts immediately, called a standard trust, or the trust pays only net income until the sale of the illiquid asset or other future triggering event, called a flip unitrust, where it converts from a net income unitrust to a standard unitrust.

While there are no state-of-residency requirements, there are modest legal expenses to establish the trust along with annual maintenance expenses paid by the trust. 

Benefits of Charitable Remainder Trusts

Donors would not go to the trouble to establish charitable trusts if there was not a big payoff for the donor and the causes they care about. The reasons donors establish charitable trusts include:

Donors receive a charitable deduction equal to the calculated remainder value of the trust. The deduction amount is inversely proportional to the amount of income paid out by the trust. The longer the income, and the higher the income, the lower the deduction. Likewise, having multiple income beneficiaries or younger beneficiaries would lower the deduction. Trusts must generate a deduction of at least 10 percent or more of their face amount to qualify as a charitable trust.

Donors avoid recognizing capital gains upon of transfer of assets into the trust, which means CRTs represent a tax-efficient way to convert highly appreciated stocks and other assets into a tax-efficient stream of income. CRT income is taxed according to a four-tier system, in which all ordinary income is taxed first, followed by long-term capital gain income, tax-exempt income, and return of principal. Thus, while the donor would pay LTCG tax on CRT payments as they are received, the sale itself is untaxed and the full amount is put to work within the trust. The trustee can manage and invest the assets in ways to minimize taxes on future payments.

When donors own assets that produce little or no income, donating them to a CRT can increase current spendable income and augment retirement income from other sources. If the income is not needed until a later date, the donor can design the trust to pay the lesser of net income or 5 percent until the donor reaches a certain age, after which time the trustee starts pays a fixed 5 percent of the trust value for the rest of the donor’s life. A strategy like this maximizes three things: the future payments to the donor, the future remainder gift to charity, and the immediate charitable deduction.