Many people wish to leave money to charity, but a traditional last will is not always the best vehicle for accomplishing that.
The deceased does not get a charitable tax deduction, and family members often get mad because of the amount of money left to charity. A charitable remainder trust can help solve many of these problems.
Not only can you continue to use the trust to draw an income during your lifetime, but you can also get the tax advantages of the donation. Plus, the terms of the trust can remain private so that no one else even has to know the specifics of the donation.
If you think a charitable remainder trust might be right for you, keep reading. We will tell you everything you need to know about these useful instruments.
What Is A Charitable Remainder Trust (CRT)?
A charitable remainder trust is a type of living trust created by an individual to help reduce his or her taxable income. The trust makes income payments to its beneficiaries and then donates the remainder of the trust assets to the designated charity.
- A CRT is an irrevocable trust. This means that once the trust is created, the grantor has no authority to modify or revoke the trust. If the trust is not designated as irrevocable, then the grantor would not see the income tax benefits associated with a CRT.
- Remember the difference between an irrevocable trust and a revocable trust. An irrevocable one cannot be changed or revoked while a revocable trust can be changed by the grantor at any time.
- With an irrevocable trust, the grantor must relinquish all ownership rights over the trust assets. The trust cannot be modified or changed without the express consent of all beneficiaries.
- A charitable remainder trust specifies the period for which the beneficiaries receive income payouts.
- After this time expires, the remaining trust assets go to the named charity.
CRTs can be very useful estate planning tools because they can allow for a large income tax deduction while still allowing the grantor to receive income from the assets. In addition, they help the grantor achieve his or her ultimate goal of donating to their favorite charity.
These trusts are often referred to as “split interest” trusts because they allow the trustor to receive a tax deduction and donate assets.
KEY TAKEAWAYS
- Charitable remainder trusts are a tremendous tax-saving strategy for those who want to donate a portion of their estate to charity.
- A CRAT distributes a fixed annuity to the beneficiaries each year; the remainder goes to a charity. In contrast, a CRU distributes income to beneficiaries on a fixed percentage basis, and the remainder goes to charity at the end of the period.
- A CRT is considered an irrevocable trust. Once the trust is created and funded, it cannot be modified.
Types Of Charitable Remainder Trusts
So, now that we have answered the question, “What is a charitable trust?” we will dive deeper into the details. The IRS recognizes two types of charitable trusts. While they are quite similar, there are a few differences between them. Here are the two types and a description of each.
Must read articles related to Trusts
- Overview of “What is a trust?“.
- Deep dive into understanding irrevocable trusts.
- What are the differences between a revocable and irrevocable trust?
- How does a blind trust work?
- Learn about the benefits of living trusts.
How To Establish A CRT
Establishing a CRT is essentially the same process as creating any other type of trust.
- You will need to draft the appropriate trust documents that explain the details of the trust.
- You should name a trustee, income beneficiaries to receive the ordinary income, and the charitable beneficiary.
- In addition, you will need to specify the period for which the beneficiaries will receive income. This could be for your or your spouse’s lifetime or a set number of years.
In most cases, the grantor chooses to receive the income for his or her lifetime or pay the income to a spouse for their lifetime. Depending on when you establish the trust, your life expectancy might be for quite some years.
- After the trust documents are created, you simply need to transfer ownership of the trust assets into the trust.
The trust assets can be nearly anything the grantor chooses. It could be cash, real estate, life insurance proceeds, an IRA, or anything else that can be legally owned by the trust.
When drafting these documents, you should likely seek the advice of an estate planning attorney. You will want to ensure that the trust documents are created appropriately and that the trust is funded appropriately.
Failure to do so can result in a loss of the tax benefits associated with the trust or could cause the charity not to receive the donation.
TIP
Beneficiaries of a charitable remainder trust will receive taxable income and be subject to income taxes on the annual distribution amount.
Charitable Remainder Trust Benefits
The most significant benefit associated with these trusts is the tax advantages.
- They allow you to reduce or avoid estate taxes. Once the assets are placed into the trust, they are no longer considered part of your taxable estate. In some cases, you might even be able to avoid the probate process altogether.
- These trusts also allow you to defer capital gains taxes until that amount is distributed to the income beneficiary. The grantor may place a highly appreciated asset like real estate into the trust. When the trustee sells this asset at fair market value, the capital gains associated with the sale could spread over many years as the beneficiary receives a part of the gross income each year.
- The grantor can receive a charitable income tax deduction during the first year the trust is created.
Additional items to beware of.
- Income from the trust is not received tax-free. Even though the charity receiving the remainder of the trust might be tax-exempt, the income beneficiaries will pay income taxes on the amounts they receive each year.
- Watch out for gift taxes. If the grantor names someone other than himself or a spouse to receive income, then that beneficiary may be subject to a gift tax based on the fair market value of the assets at the time of the trust funding. You can refer to the Internal Revenue Code for specifics on any gift tax that might be due.
Remember that the IRS can audit charitable trusts, so keep all your documentation for future reference.
The Bottom Line
A charitable remainder trust can be a great way of providing retirement income while leaving a remainder interest for your favorite charity.
These trusts can also be essential tax planning tools. Remember that the trust term can last for as long as your lifetime, so you might be able to have an income interest in the trust for life before the remainder is passed on to the remainder beneficiary of the charity.
If one of these trusts suits you, consult your estate planning attorney.
Frequently Asked Questions
The amount of income you can take from a CRT is unlimited. The trust documents will specify the income that goes to the beneficiaries.
It may be either a fixed dollar amount or a fixed percentage based on the value of the trust assets. The trustee must follow the trust documents when distributing the income.
The more assets in the trust, the more income the grantor will likely give the beneficiaries.
Yes, regular income received by the trust’s non-charitable beneficiaries is taxable. It is usually taxed as regular income.
However, depending on how the trust was funded, some of the income may be taxed as capital gains.
If a charitable remainder trust runs out of money, then there will be nothing left over for the charity to receive at the expiration of the trust term.
If the trust is a CRUT, then the grantor might choose to place additional assets into the trust.
However, with a CRAT, no additional contributions are allowed. Once the trust runs out of money, it essentially ceases to exist.
The grantor may choose to receive income for his or her lifetime, which could be many years, depending on the grantor’s age.
Otherwise, the grantor can set up the trust for a specific amount of years. Remember, you cannot specify a term longer than 20 years.
A charitable lead trust is essentially the flipped version of a charitable remainder trust.
With a lead trust, the charity is paid first. This means that they receive the specified income from the trust. The remaining trust assets are then distributed to the non-charitable trust beneficiaries.
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