A charitable remainder trust (CRT) is a great way to realize a tax deduction today while providing for retirement income in your golden years. A CRT also has estate planning benefits. However, if you think a CRT might be good for you and your favorite charity, make sure you get professional help.
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CRTs allow you to transfer property to a charity, retain the right to the income generated by that property during your lifetime (or for some other period of time), and then allows for the eventual transfer of the property's ownership to a charity. By structuring the trust to pay out its income for your life and/or the life of your spouse, you can use a CRT to supplement your retirement income. In fact, if you want to incorporate charitable contributions into your retirement and estate planning, CRTs may compare favorably with direct contributions during life or after death.
A few of the benefits of a CRT:
But the most important advantage of a CRT is that it offers almost complete flexibility in the timing of distributions. As long as the payouts satisfy the minimum payout requirements -- which require only that the income beneficiary receive not less than 5% or more than 50% of either the initial fair market value or the current fair market value of the trust's assets each year -- distributions from charitable remainder trusts can be made at the trustee's discretion, and the character of the income (taxable or tax-exempt) can be selectively decided by the trustee.
Perhaps an example will help you see how all of the parts fall into place.
EXAMPLE:
Freddy Fool, age 55, intends to retire in 10 years. He wants to include a gift to his alma mater (Whassamatter U) in his estate planning. But Freddy also wants to supplement his retirement income. He can achieve both of these goals by creating a CRT that pays him income for life, with the principal eventually going to the university.
Here's what Freddy does: He transfers appreciated securities worth $100,000 to the CRT. In doing so, his immediate charitable contribution deduction is $28,000 (based on the actuarial value of the remainder interest transferred to the university). As trustee of the CRT, the university sells the stock, pays no capital gains tax, and invests the full $100,000 proceeds. Assuming a non-income-producing total return of about 12%, the $100,000 will grow to $250,000 in 10 years, when Freddy will be 65 and will need retirement income from the CRT.
At that time, the university will use the funds in the CRT to provide current income for Freddy. At that point, the CRT -- slated to pay a fixed rate, say 7% -- would call for payments of $17,500 a year to Freddy. If the university is able to realize some larger amount (say 10%), the larger amount can be paid out until the trust makes up all the distributions missed in the 10 pre-retirement years.
I think that you can see how powerful a CRT can be for Freddy. He receives an immediate tax deduction at age 55 (when his income is likely very high), and he can still receive the income generated by his charitable contribution for the remainder of his life.
So... what's the downside?
Well, one major drawback of using a CRT is that your interest in the CRT terminates at your death. The property contributed to the CRT is effectively removed from your estate because it is transferred to the charity when the trust terminates.
That being the case, using a CRT can substantially reduce the amount available for your heirs. One possible solution to this is to create a so-called "wealth replacement trust" by using a portion of the income generated by the CRT to purchase a life insurance policy, also held by a trust. There is no income tax cost to this strategy and, as long as the life insurance policy is held by a trust, there is no estate tax cost either.
On the other side of the coin, since the assets in the CRT have been effectively removed from your estate, none of the assets held in the CRT will be subject to estate taxes. So, if you're concerned about a large taxable estate with possible large estate taxes, a CRT might help you to minimize that problem.
Another major drawback to using a CRT is that contributing encumbered property (such as rental property with an underlying mortgage loan) can produce debt-financed income, which is deemed "unrelated business income," thereby causing the trust to lose its exemption. Additionally, transferring encumbered property or stock in your own corporation can create part-gift/part-sale issues and possible self-dealing taxes. For this reason, the property to be contributed to the CRT must be carefully chosen.
Get some help to set up a CRT
There are many shapes and sizes of CRTs. The most common are the charitable remainder unitrust (CRUT), the charity remainder annuity trust (CRAT), and the flip unitrust (FLIP). While they are all CRTs, they have special provisions that can be used to further customize your estate planning and retirement income needs.
But, be assured of one thing: This is not a "do-it-yourself" issue. If you're interested in incorporating a CRT into your retirement and estate plan, your best bet is to get as much information as you can on CRTs, and then engage the services of a qualified estate planning pro to walk you through the maze. Your estate planning pro will also help you with decisions about which type of CRT to use, the property to be contributed, and establishing the trust documents.
Most charitable organizations are also well-versed on the workings of CRTs, since they will ultimately be receiving the funds. So don't hesitate to ask your favorite charity about their various CRT plans.
But in the meantime, just know that this powerful vehicle is out there and available. It's certainly not for everybody, but can be a wonderful way to generate an immediate charitable contribution deduction while generating income during your golden years.
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