Charitable Remainder Trusts

As we approach the presidential election several months away, there is a lot of concern among investors regarding where tax rates are headed. One proposal would be to double capital gain rates. While no one is certain what will transpire, it is always important to think about different strategies that would help offset an increase in taxes.

One of these strategies is a Charitable Remainder Trust. With CRTs you get the benefits of increased income while incorporating one of your favorite charities which creates a tax deduction. We will now take a more in-depth look at what a CRT is and how it can benefit you.

A CRT is an irrevocable trust established to increase cash flow, reduce estate and income taxation, and ultimately provide a benefit to a charitable organization.

To establish a CRT, a potential donor has an attorney draft the appropriate trust documentation and names a trustee. The donor then transfers assets to the trustee of the CRT. Typically, these assets are highly appreciated - such as a stock with a low-cost basis. The trustee can then sell the assets and reinvest the proceeds for greater return and/or increased diversification. No tax is assessed on the sale of the assets within the CRT.

The trustee then pays an annual payout to a beneficiary or beneficiaries, usually the donor, his/her spouse, or children. After the death of the beneficiaries or at the end of a set number of years (not to exceed 20), any assets remaining in the trust are distributed to a charitable organization of the donor’s choice.

Charitable Remainder Trusts can take two different forms depending on the annual payout method that is chosen. If a donor decides that the beneficiary should receive a fixed dollar amount each year then a Charitable Remainder Annuity Trust (CRAT) is created. On the other hand, if it is decided that the trust should pay a fixed percentage of the value of its holdings, then a Charitable Remainder Unitrust (CRUT) is formed. CRUT assets must be revalued each year in order to determine the payout amount. It should be noted that if the investment return on the trust assets exceeds the fixed payout percentage or dollar amount, a CRUT would provide a greater income benefit to the beneficiary than a CRAT.

A CRUT may also be drafted to pay out less than the established percentage if the trust income earned during the year is less than the required payout percentage. This shortage can be made up for in later years when the trust earns more than the required payout percentage. This variation of the CRUT is called a Net Income with Make-Up Charitable Remainder Unitrust (NIMCRUT).

The only other difference between these two types of CRTs centers on additional contributions in later years. If desired, the CRUT allows additional contributions to the existing trust in later years. On the other hand, if additional contributions are desired in later years to a CRAT, new trusts must be established.

Besides the benefits of increased cash flow and tax avoidance on the sale of the asset within the CRT, two additional immediate benefits exist to the donor. The first is an income tax deduction. The allowable deduction is based upon the present value of the charity’s right to receive the trust assets some time in the future. A complex set of factors is used to arrive at this present value. If the charitable deduction exceeds a certain percentage of the donor’s adjusted gross income for the year of the gift, the excess portion must be carried forward into future years.

Secondly, a benefit is derived from the irrevocable nature of the CRT. Once the asset is placed in the trust and if the income beneficiaries are the donor and/or spouse, the asset and all its future growth avoid estate tax. If there are income beneficiaries other than the donor and spouse, estate and gift tax consequences may exist.

To avoid disqualification, CRTs must meet a stringent set of numerical tests and other regulatory requirements. Therefore, competent legal counsel should be sought if you are planning to establish a CRT. Your financial advisor can help you decide if a CRT is right for your situation and coordinate efforts with a skilled estate-planning attorney.

If you would like to learn more about how a Charitable Remainder Trust can benefit you and add value to your personal estate plan, please contact my office at 412-258-1101 for further information.

Kevin C. Krul is First Vice President and Financial Advisor with Hefren-Tillotson. He may be reached at 412-258-1101 or kkrul@hefren.com. The Wexford office of Hefren-Tillotson is located at 4001 Stonewood Drive.