Charitable Remainder Trust

Derek Notman |

How to use a charitable remainder trust to reduce your tax liability, receive income for life, and support a charity.

Although the charitable remainder trust strategy is available for virtually anyone it seems to get a lot of use from people who have created wealth as a founder, entrepreneur, and business owner. 

As a founder of a business, you are most likely navigating your way in and around many financial terms and laws pertaining to business.  This can be an unnerving time for a founder and if you don’t have professional and correct advice on how to manage your income and taxes, you may not be reaping the benefits afforded to you. 

As an experienced financial advisor (Certified Financial Planner®) with vast knowledge and expertise in the industry, I would like to assist you in understanding how you as a founder can utilize a charitable remainder trust to reduce your tax liability whilst still receiving income for life.

What is a charitable remainder trust?

Simply put, a charitable remainder trust (CRT) is a tax-exempt irrevocable trust (an irrevocable trust can't be modified or terminated without the beneficiary's permission. The grantor, having transferred assets into the trust, effectively removes all his rights of ownership to the assets and the trust. This is the opposite of a revocable trust, which allows the grantor to modify the trust).  The CRT is designed to reduce the taxable income of individuals by first dispersing income to the beneficiaries of the trust for a specified time and then donating the remainder of the trust to the designated charity. This is a ‘split interest’ giving process, allowing a trustor (the person who creates the trust) to make contributions, be eligible for a partial tax deduction and donate the remaining assets.

How does one go about setting up a Charitable Remainder Trust?

Consulting with one’s attorney, the donor drafts the trust and appoints the trustee.  A salient point to remember – the trust is irrevocable; thus, the terms cannot be changed once it is established.  During the term of the trust, annual payments of a fixed amount or a fixed percentage are made to the individual beneficiaries.  Upon termination of the trust, the remaining property is transferred to a charitable beneficiary or beneficiaries selected by the donor.

There are two types of charitable remainder trust:

  1. Charitable remainder unitrust (CRUT):

A CRUT pays an annuity amount based on a percentage of the fair market value of the trust, which is valued on an annual basis.

  1. Charitable remainder annuity trust (CRAT):

A CRAT pays a fixed percentage of donated assets regardless of the performance of the trust assets.

As a founder and trustor, your hard-earned money should be placed where it is needed and either type of charitable remainder trust could be useful to reduce the taxes you pay.  A CRUT or CRAT allows you to maintain financial security for yourself and your family while still providing the greatest benefit to a cause you are passionate about.

Who Would Use a Charitable Remainder Trust?

If you are a wealthy entrepreneur or suddenly find yourself with a substantial amount of money due to inheritance, lotto winnings or life insurance proceeds, the charitable remainder trust is a popular estate planning strategy.  This is because a CRT allows a person to give more money to a charity, retain an interest-bearing income for themselves and obtain a significant tax deduction.

Let me give you an example –  A founder can transfer stock or real estate, that has appreciated substantially as they have scaled their startup, to a CRT.

  • The trustor receives a tax deduction and the heirs avoid capital gains taxes.
  • The trustor will receive an income benefit from the assets for their lifetime.
  • The charity or cause would benefit from a higher donation.

Another example would be an 80-year-old woman who wins $10 million in the lottery after initial taxes paid to get the lump sum option.  She could give 10%, 20%, or even 30% to a charity and such a donation would be a noteworthy amount by anyone’s standards.  However, she could put half of it into a CRT and If she did so, she would gain the following benefits:

  • An approximate tax deduction of $500,000.
    • The exact amount varies depending on how long the charity must wait for the balance and interest rates as and when the trust is created.
  • Annual income for the rest of her life.
  • Benefiting a charity of her choice after she passes away.

Trusts that provide a fixed amount each year will not be able to take advantage of future growth or higher earnings of the asset, but they do offer consistent income.  Any income received from the CRT is taxed at the donor’s nominal tax rate but is offset by the tax benefits of the CRT.

What are the tax benefits of a charitable remainder trust?

An investor may use a charitable remainder trust to receive tax benefits, both now and in the future.  The fair market value of the donated assets in a CRT can be deducted over five years on income taxes.  Another significant benefit is as an irrevocable trust, donated assets are not counted against the investor for estate tax purposes.  Make sure you work with an experience tax professional when utilizing this strategy.

Let’s use the following scenario:

You have stock that has appreciated.  You are permitted to donate the stock to a CRUT or CRAT, which will not have to pay any capital gains tax as a tax-exempt organization.  Income from the appreciated stock will still be received and when added up over years, a charitable remainder trust can save significant amounts by avoiding the capital gains tax.  Keep in mind that you should always consult with an experience tax professional, estate planning attorney, and financial planner when considering these types of strategies.

How does life insurance play a role?

A trustor can also purchase a life insurance policy inside of a CRUT, with the benefits payable to a surviving spouse. In some cases, that policy may be owned by a life insurance trust.

An example would be if you have a trustor take out an insurance policy that swells the trust assets and your surviving spouse can receive an increased annuity from the CRUT for the remainder of their lifetime.

The annuity received from the CRUT could also be used to pay for a separate life insurance trust.  By using this method, you can create liquid assets to pay for the estate taxes and if necessary, leave your beneficiaries able to keep liquid assets or sell when financially appropriate.

Do not be misled and accept that investments, trusts or financial entities are reserved for the rich and famous alone. Almost anyone can take advantage of many of the same tools as the wealthy.  The point is that YOU can use strategies like this to improve your live while helping others, how can you not love that!