What does philanthropy mean to you? For some it means a donation of their time or resources. For others, it involves making a larger planned gift that is to be donated during their lifetime or at death. This is known as planned giving and is a great charitable giving strategy when the right vehicles are used.
When considering a planned gift, it is important to educate yourself on all the options. Gift plans will consider both estate and tax planning to maximize the value of the gift and benefits for the donor. There are three general categories of planned gifts:
1. Outright gifts that use appreciated assets (ex. gift of stock or real estate)
2. Gifts that return income to the donor in return for donation (ex. Charitable Remainder Trust)
3. Gifts that are payable upon the donor’s death (ex. bequest or beneficiary designation in a life insurance policy)
All of these giving strategies are a way to optimize our donations while providing estate and tax benefits. For years, the Charitable Reminder Trust (CRT) has been a popular vehicle for philanthropic individuals. Donors can gift highly appreciated assets to an irrevocable trust that offers income to the donors or beneficiaries during their lifetime, then bequeath the reminder at death to charities.
How does a Charitable Remainder Trust work?
1. The donor places a highly appreciated asset into the irrevocable trust.
2. The trustee sells the asset at its fair market value and purchases income producing assets with the proceeds. These assets will grow tax-free in the trust.
3. The donor will receive a partial tax deduction for the year the gift is made. (It is important to note that you cannot deduct dollar for dollar the gift you made when using a CRT.)
4. The assets will provide an income stream to the beneficiary of the trust.
5. When the trust beneficiary dies, the remaining value of the assets go to the charity (or charities) the owner has chosen.
What are the benefits?
Estate Taxes: Since the trust is irrevocable, as soon as you place the highly appreciated asset in the CRT it is removed from your estate, therefore lowering your estate taxes at death.
Income Tax: You will receive a partial charitable income tax deduction immediately upon placing the asset in the CRT. The deduction amount will vary depending on what type of asset you put into the trust, terms of the trust, the rate of return, and the assets that will be distributed to the charitable beneficiaries. You can carry that deduction forward for 5 years if you are unable to use it all in the first year.
Capital Gains: You will not be required to pay capital gains tax when the asset is sold in the trust. Therefore, it is an attractive strategy to place highly appreciated assets into the trust, because you can sell the asset without paying taxes on the gains.
Tax-free growth: As the assets grow in the trust, the CRT will not have to pay taxes on the income the assets are generating. The annual income the owner receives will be taxed.
Lifetime Income: You will receive income off the assets in the trust for your lifetime, and the lifetime of your spouse. In some situations, you may also elect for the income to be paid to children or others keeping in mind gift tax considerations. The income received must be at least 5% (but not more than 50%) of the fair market value of the assets.
Proceeds to the Charity: The charity benefits by receiving the remaining value in the trust after you die.
Protection: Due to its irrevocable nature, any assets within the trust are protected from creditors.
What are the different types of CRTs?
Charitable Remainder Annuity Trust (CRAT): The owner will receive a fixed income regardless of the investment performance of the trust. It does not keep up with inflation, but provides peace of mind knowing a set amount will be disbursed to the owner each year. For example: Mr. and Mrs. Smith sell stock for $500,000 in the CRAT and elect a 5% payout income stream each year. In this case, the Smith’s will receive $25,000 every year for the rest of their lives.
Charitable Remainder Unitrust (CRUT): The owner will receive a fixed percentage of trust assets. The income you receive may fluctuate as the investment performance of the trust fluctuates. Because of this, the trust keeps up with inflation. The value of the trust at the beginning of the year will be used to calculate your annual income off the trust. Using the example above, if the Smith’s elected to place their assets in a CRUT instead, they would receive $25,000 in the first year (based on a 5% payout). Their payout would then be recalculated the second year based on what the value is at the beginning of that year. If the assets have gone up, say 10%, and the value is $525,000 in year 2, then the payout would be 5% on $525,000 or $26,250.
Why partner a CRT with a Donor Advised Fund (DAF)?
Although, in most cases, an owner of a trust can change the charity that will receive the remaining assets, there may be significant costs that come as the result of amending the trust. Alternatively, the owner may decide to make the beneficiary of their trust a Donor Advised Fund (DAF). DAFs provide flexibility for granting to various charities while also allowing for an immediate tax deduction and tax-free growth. You can change the beneficiary of a DAF at any time at no cost. You also have the option to allow your heirs to continue managing the DAF after your passing which is a great way to involve family with your charitable giving.
Please contact us if you would like to know more about planned giving strategies including those listed above.