What Is a Charitable Remainder Trust (CRT)?
It is a “split interest” vehicle.
Depending on the type of trust, income from a CRT can either be distributed as a fixed annuity or a fixed percentage of the trust balance at that time.
The main advantage of charitable remainder trusts is tax savings. Income derived from CRTs is eligible for tax exemption.
Trust grantors can also save on estate taxes and capital gains taxes by placing their assets inside a CRT.
The disadvantage of putting assets into a CRT is that they cannot be removed from the trust, even during an emergency.
Before opting for a charity remainder trust, you must think carefully think through its pros, cons, and idiosyncrasies.
How Do Charitable Remainder Trusts Help in Estate Planning?
Charitable remainder trusts help grantors achieve three goals within a single investment vehicle.
First, they provide a regular stream of income to the trustors or grantors from their asset portfolio.
Second, they provide income tax deductions to grantors based on the amount or percentage of trust value set aside for charity.
Third, a charitable remainder trust enables trustors to target their charity goals by making payouts to their favored causes or charities.
After the CRT term is over, the remainder of the assets are automatically turned over to the charity of their choice.
For the reasons outlined above, charitable remainder trusts can be an ideal vehicle for retired individuals.
They can turn over their assets to a trust and enjoy tax benefits on their annual income, while donating to a charity of their choice.
There are two main types of charitable remainder trusts.
The Charitable Remainder Annuity Trust (CRAT) makes annuity-styled payouts and distributes income as a fixed amount that is set at the time of trust creation.
The Charitable Remainder Uni-Trust (CRUT) distributes an annual fixed percentage of the trust value i.e., the composition of the trust asset balance at that time.
Consider the case of two individuals, Julie and Jim, who have each setup trusts with a value of $10 million.
Both trusts grow at an annual rate of 10 percent.
Jim has opted for CRUT income distributions while Julie wants CRAT-style fixed amounts each year.
At the end of the first year, their income distributions are $100,000 i.e., they are the same amount.
Subsequent distributions for both will be different.
While Julie will continue getting the same amount from her trust, Jim’s distributions will be a function of the balance remaining in his trust.
So, he will get 10 percent of the remaining $990,000 at the end of the second year and so on.
Payouts to beneficiaries and charities change based on trust earnings.
Thus, if the trust earns more in a year and has fewer beneficiaries, then a charity might get more of the original trust value.
In the example above, if there were more beneficiaries and the trust failed to earn at the given growth rate, then the charitable beneficiary would earn less.
There are multiple variations of trusts, such as STAN-CRUT (standard CRUT) and NI-CRAT (Net income CRAT), within the CRUT and CRAT universe.
Therefore, it is always a good idea to consult with an investment professional before actually making a commitment to any investment vehicle.
What Are the Advantages and Disadvantages of a Charitable Remainder Trust?
The advantages of a charitable remainder trust are as follows:
- They provide tax exemptions and savings: CRTs provide an array of tax exemptions and savings for donors. When an asset belonging to a trust is sold, it is not subject to a capital gains tax. Therefore, selling an expensive property or a highly valuable stock holding from within a trust multiplies profits because capital gains tax is not incurred. CRTs are also not subject to estate tax savings and, therefore, save taxes for beneficiaries. Finally, donors or grantors for CRTs receive income tax exemptions based on the amount set aside for charities from the trust’s total value.
- They help diversify portfolios: CRTs can be an interesting means to diversify portfolios because asset sales from within the trust do not incur capital gains taxes. Therefore, highly-valuable asset sales, which would have triggered massive capital gains tax outside of a trust, can be sold inside a CRT and the trust can make additional purchases to diversify its holdings and maximize income.
- They ensure charitable giving and income at the same time: As mentioned earlier, CRTs are used to achieve the twin objectives of income and charitable giving at the same time. They provide a regular income stream while ensuring that the grantors favored causes or charities benefit after his or her death.
The disadvantages of a charitable remainder trust are as follows:
- They lack flexibility: The main disadvantage of a charitable remainder trust is that they are irrevocable trusts. Therefore, assets that are once conveyed to the trust are no longer available to their owner. Withdrawing them from a trust becomes an expensive and time-consuming affair.
- They may not provide income security: The minimum percentage requirements for charities in CRTs can potentially mean that some grantors may not have as much income security as originally planned. For example, in cases when the trust’s growth rate slows down, the grantors may receive less income than originally planned. If they planned to make regular income distributions to charity, then the minimum requirement may further eat up their income.
Things to Consider for CRTs
While the idea of a trust that provides for income and donates to charities may sound attractive, there are caveats attached to it.
For starters, income generated from a CRT depends on the beneficiary’s age.
The present value in remainder interest generally decreases with increasing age, leaving little for beneficiary payouts.
Therefore, if an individual establishes a charitable remainder trust at an advanced age, then there might be a possibility that they might not get as high a percentage of the trust value as payouts than if they had established the trust earlier.
Adjusting payout amounts for inflation is not allowed in CRTs and could result in tax deductions.
There are also restrictions on the types of assets that can be placed in a CRT.
In the past, when there were no set income designations for charities, CRT beneficiaries could get as much as 90% of a trust’s value as income.
Now that figure is much lower.
The transfer of assets, which results in significant tax advantages, must also be planned out in advance.
Assets must be conveyed to a trust before they are appraised or sold.
Otherwise, they might be discounted in their valuation for a number of factors including lack of marketability or minority interest.
For example, if you intend to include property into a trust, it is always a good idea to discuss deal-making after it has been transferred into a trust rather than making a deal for sale before it is included.
How to Create a Charitable Remainder Trust
Most of the steps for the process to create a charitable remainder trust remains the same as for other trusts.
This means that you must make an inventory of assets to decide which ones to include in the trust, identify beneficiaries and trustees, and transfer the title deeds of your assets to the trust.
There are two important additional steps that you need to take while designing a charitable remainder trust.
First, identify the charity or charities intended as beneficiaries of your estate.
They will receive the remainder of your trust value after your death.
You can also choose to make regular disbursements to them during your lifetime and collect tax exemptions for that amount.
Second, identify the amount or percentage of trust value that you’d like to set aside for the charity. As mentioned earlier, you need to earmark a minimum of 10 percent for charities.
Some charities also craft CRTs for donors in return for an irrevocable trust in which only they are beneficiaries.
Typically, a donor chooses beneficiaries for the estate.
The charities design the trust’s terms and payouts in such instances.
Charitable Remainder Trust (CRT) FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.