Many people wish to leave money to charity, but a traditional last will is not always the best vehicle for accomplishing that. The deceased gets no charitable deduction on taxes, and the family members often get mad because of the amount of money that was 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 that a charitable remainder trust might be right for you, then keep reading. We will tell you everything that 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 by making income payments to the beneficiaries of the trust and then donating 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 an irrevocable trust, 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.
Remember that 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 time period for which the beneficiaries receive income payouts. After this time period expires, the remaining trust assets go to the named charity. CRT’s can be a very useful estate planning tool 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.
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. There are two types of charitable trusts recognized by the IRS. While they are quite similar, there are a few differences between the two. Here are the two types and a description of each.
Charitable Remainder Annuity Trust
The charitable remainder annuity trust, or CRAT, distributes a fixed annuity amount to the beneficiaries each year. This means that they will receive the same fixed dollar amount of an income stream each year regardless of the value of the assets remaining in the trust. No additional contributions are allowed into the trust. So, in the event that the trust assets are totally depleted before the term of years specified in the trust expires, there will be nothing left over to distribute to the charity.
Charitable Remainder Unitrust
The charitable remainder unitrust, or CRUT, will distribute income to the beneficiaries on a fixed percentage basis. This means that they will receive a payout rate of a certain percentage of the value of the trust assets. So, as the value of the assets fluctuate, the income received by the beneficiaries will also fluctuate. A CRUT does allow for additional contributions, so the grantor might decide to place additional assets into the trust in the future. This type of trust can help guard against inflation as the income to the beneficiaries usually rises with rising interest rates. In addition, with the income being distributed on a percentage basis, it would be essentially impossible for the trust to run out of money. There will always be something left over for the charitable beneficiary when the number of years specified in the trust expires.
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 time period for which the beneficiaries will receive income. This could be for your lifetime, 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 a number of years.
After creation of the trust documents, 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 getting ready to draft 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 their donation.
Charitable Remainder Trust Benefits
The biggest benefit associated with these trusts are the tax advantages. First, 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 be spread out over many years as the beneficiary receives a part of the gross income each year. Remember that the IRS can audit charitable trusts, so make sure you keep all your documentation for future reference.
In addition, the grantor can receive a charitable income tax deduction during the first year in which the trust is created. However, remember that the 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 that they receive each year. Also remember to 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.
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 important 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 – the charity. If you think one of these trusts is right for you, then you should consult your estate planning attorney right away.
Frequently Asked Questions
How much income can you take from a charitable remainder trust?
There is no limit to the amount of income you can take from a CRT. The income that goes to the beneficiaries will be specified in the trust documents. It may be either a fixed dollar amount or a fixed percentage based on the value of the trust assets. The trustee will need to follow the trust documents when distributing the income. The more assets that are in the trust, the more income the grantor is likely to give to the beneficiaries.
Are distributions from a charitable remainder trust taxable?
Yes, regular income received by the non-charitable beneficiaries of the trust are taxable. They are usually taxed as regular income. However, it is possible that some of the income may be taxed as capital gains depending on how the trust was funded.
What happens if a charitable remainder trust runs out of money?
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. With a CRAT, however, no additional contributions are allowed. Once the trust is out of money, then it essentially ceases to exist.
How long do you have to use a charitable remainder trust?
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 choose to set up the trust for a specified number of years. If they take this route, they cannot specify a term longer than 20 years.
What is the difference between a charitable remainder trust and a charitable lead trust?
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 beneficiaries of the trust.