What You Should Know About Charitable Remainder Trusts
1. What is a Charitable Remainder Trust?
A Charitable Remainder Trust permits someone with charitable intent to set aside funds for a future gift to charity, while reserving an annuitized payment stream for a period of up to 20 years or life. When the annuity payments end, the named charity receives the balance of funds in the trust.
For example, a woman may create a trust that pays her an annuity with a fixed dollar amount from the trust as long as she lives. Upon her death, the remainder of assets in the trust will be paid to a qualified public charity. This is referred to as a Charitable Remainder Annuity Trust (“CRAT”). Alternatively, she may create a trust that pays her an annuity with a fixed percentage amount from the trust – recalculated each year – as long as she lives. The actual distribution amount may change from year to year. This is referred to as a Charitable Remainder Unitrust (“CRUT”).
Other variations of the theme are available, including (1) the “net income” CRUT that pays out the lesser of a Unitrust percentage or actual trust accounting income, and (2) the “flip” CRUT that can change from a net income CRUT to a standard CRAT. Either variation can be used as a powerful and flexible retirement planning vehicle.
2. What are the tax benefits of a Charitable Remainder Trust?
There are several potential tax benefits of establishing a Charitable Remainder Trust:
3. Is there a limit to how small or large the annuity percentage may be?
Yes, the annuity amount may not be less than 5% of the initial contribution. In addition, the annuity may not be larger than 50% of the initial contribution or large enough to cause the present value of the charity’s remainder interest to fall below 10% of the initial contribution.
4. What if the remainder interest is nothing?
It is mathematically possible for the investments inside a Charitable Remainder Trust to perform so poorly that there would be nothing left for the charity when the initial term ends. If this happens, there is no harm to the donor. Although the charity would receive nothing, the chances of this occurring are slim. For this reason many charitable organizations heavily promote the creation of charitable remainder trusts by their major donors. From the charity’s perspective, the potential of a major gift is better than no gift at all.
5. Can the donor make changes to the trust?
A Charitable Remainder Trust is irrevocable, which means that the donor cannot reclaim assets contributed to the trust. The donor is also unable to change the annuity amount, the length of the trust, or add non-charitable beneficiaries. However, the donor may reserve a right to amend the charitable remainder beneficiary.
6. May the donor serve as trustee?
Yes, the donor may serve as trustee of a Charitable Remainder Trust. However, it is common to name a professional trustee familiar with administration of charitable trusts because of the complex tax reporting and annuity calculations.
7. What is the major drawback of establishing a Charitable Remainder Trust?
From the perspective of the donor’s children, the parent is giving away a major asset to charity instead of to the children. The typical solution is to establish an Irrevocable Life Insurance Trust and have it purchase a life insurance policy on the donor’s life. Upon the donor’s death, the children would receive the proceeds free of tax. The initial tax savings from establishing the Charitable Remainder Trust could be used to purchase the life insurance policy.
About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.
A Charitable Remainder Trust permits someone with charitable intent to set aside funds for a future gift to charity, while reserving an annuitized payment stream for a period of up to 20 years or life. When the annuity payments end, the named charity receives the balance of funds in the trust.
For example, a woman may create a trust that pays her an annuity with a fixed dollar amount from the trust as long as she lives. Upon her death, the remainder of assets in the trust will be paid to a qualified public charity. This is referred to as a Charitable Remainder Annuity Trust (“CRAT”). Alternatively, she may create a trust that pays her an annuity with a fixed percentage amount from the trust – recalculated each year – as long as she lives. The actual distribution amount may change from year to year. This is referred to as a Charitable Remainder Unitrust (“CRUT”).
Other variations of the theme are available, including (1) the “net income” CRUT that pays out the lesser of a Unitrust percentage or actual trust accounting income, and (2) the “flip” CRUT that can change from a net income CRUT to a standard CRAT. Either variation can be used as a powerful and flexible retirement planning vehicle.
2. What are the tax benefits of a Charitable Remainder Trust?
There are several potential tax benefits of establishing a Charitable Remainder Trust:
- Income Tax Charitable Deduction. The donor receives an income tax charitable deduction equal to the present value of the charitable remainder interest. The deduction amount must be greater than or equal to 10% of the initial trust value in order to qualify.
- Deferral of Capital Gains Tax. A Charitable Remainder Trust is tax exempt so it pays no income taxes. If a donor transfers a property into the trust that would otherwise be subject to capital gains tax, the trust can sell the property without having to pay the tax.
- Tax-deferred Growth. Taxable income earned by the trust is taxable to the beneficiaries when it is distributed, but not until then.
- Estate Tax Deduction. The assets in a charitable remainder trust are excluded from the donor’s taxable estate for estate tax purposes.
3. Is there a limit to how small or large the annuity percentage may be?
Yes, the annuity amount may not be less than 5% of the initial contribution. In addition, the annuity may not be larger than 50% of the initial contribution or large enough to cause the present value of the charity’s remainder interest to fall below 10% of the initial contribution.
4. What if the remainder interest is nothing?
It is mathematically possible for the investments inside a Charitable Remainder Trust to perform so poorly that there would be nothing left for the charity when the initial term ends. If this happens, there is no harm to the donor. Although the charity would receive nothing, the chances of this occurring are slim. For this reason many charitable organizations heavily promote the creation of charitable remainder trusts by their major donors. From the charity’s perspective, the potential of a major gift is better than no gift at all.
5. Can the donor make changes to the trust?
A Charitable Remainder Trust is irrevocable, which means that the donor cannot reclaim assets contributed to the trust. The donor is also unable to change the annuity amount, the length of the trust, or add non-charitable beneficiaries. However, the donor may reserve a right to amend the charitable remainder beneficiary.
6. May the donor serve as trustee?
Yes, the donor may serve as trustee of a Charitable Remainder Trust. However, it is common to name a professional trustee familiar with administration of charitable trusts because of the complex tax reporting and annuity calculations.
7. What is the major drawback of establishing a Charitable Remainder Trust?
From the perspective of the donor’s children, the parent is giving away a major asset to charity instead of to the children. The typical solution is to establish an Irrevocable Life Insurance Trust and have it purchase a life insurance policy on the donor’s life. Upon the donor’s death, the children would receive the proceeds free of tax. The initial tax savings from establishing the Charitable Remainder Trust could be used to purchase the life insurance policy.
About the Author
Thomas J. Bouman provides legal counsel in the areas of estate planning, estate settlement, and asset protection. He brings a highly systematic approach to the practice of law, which is critically important when wading through the complex, and often bizarre, legal requirements associated with estate and trust law. Mr. Bouman is author of the Arizona Estate Administration Answer Book and a prominent member of Wealth Counsel, LLC, the nation’s premiere organization of estate planning attorneys.