Today, it’s common for families to use charitable remainder trusts (CRTs) to boost income, reduce taxes, and make meaningful contributions to charitable organizations. But what exactly are CRTs, how do they work, and how do you know if establishing one is right for your client? In this article, we’ll explore CRTs from all angles and answer some commonly asked questions.
Essentially, a CRT is a mechanism for converting highly appreciated assets such as real estate and investments into lifelong income.
CRTs involve transferring an appreciated asset into an irrevocable trust, effectively removing the asset from your client’s estate. This means there’ll be no estate taxes payable on it when they pass away, and allows for an immediate charitable income tax deduction for your client’s estate.
The trust can then sell the asset at its full market value without incurring capital gains tax, and the proceeds can be reinvested into income-producing assets. The trust provides an income stream to the client for the remainder of their life.
Upon your client’s death, what’s left of the trust (the “remainder”) goes to their chosen charity or charities.
Establishing a CRT can offer a few advantages over simply selling the asset and reinvesting it. For one, it helps minimize the tax burden (including federal capital gains tax) allowing your clients to retain more of their wealth. Here are some other benefits:
Clients with significantly appreciated assets can contribute these to a CRT, preserving the asset’s full fair market value. This strategy avoids the reduction of the asset’s value due to capital gain taxes, ensuring more funds are available for income and for charitable beneficiaries.
Setting up a CRT allows clients to take partial income tax charitable deductions based on the value of the remainder distribution to the charitable beneficiary.
Clients can also delay taking income from the CRT, potentially allowing the trust’s assets to appreciate further, which can increase future income.
Additional benefits include:
A wide range of asset types can be used to fund a charitable remainder trust, including:
Ideal assets to use to fund CRTs are ones that have appreciated significantly in value since they were acquired, such as real estate, publicly traded securities, and stock in certain closely held corporations.
Note: Any real estate with an outstanding mortgage typically won’t qualify unless the loan is paid off first.
There are two primary CRT types: a charitable remainder unitrust (CRUT) and a charitable remainder annuity trust (CRAT).
A CRUT provides a fixed percentage of the trust's assets as income. This amount will fluctuate depending on the investment’s performance and the trust's annual value.
At the start of every year, the trust will be revalued to establish the income received. In the case of a well-managed, high-performing investment, the trust will grow rapidly because its assets are appreciating tax-free. So, the income will increase as the value of the trust increases.
A charitable remainder annuity trust (CRAT), by contrast, offers a fixed income regardless of the trust’s performance and provides a predictable annual income.
This option is often favored by older clients who want the security of being able to count on a guaranteed amount of annual income. The downside to CRATs is that they don’t provide protection against inflation in the way a CRUT does.
Trust income can be paid to your client and their spouse for their lifetime. Subject to certain requirements, the income from the CRT can also be distributed to children or other chosen beneficiaries.
Clients can act as the trustee of their own CRTs, but it’s crucial they’re capable of managing the trust correctly to maintain tax advantages and avoid penalties. Often, clients who name themselves as trustee of their CRT work with an experienced, qualified third-party administrator to ensure all the relevant paperwork is correctly drafted and processed.
Another option is to appoint a corporate trustee, such as a bank or trust company specializing in managing trust assets, as the trustee of the CRT. Certain charities may also be willing to act as trustees. If this is the selected route, clients should select a partner with care. Remember:
These are important considerations because once an irrevocable CRT is signed, no further changes can be made. The terms and conditions of every document must be scrutinized before they are signed.
For clients with sizable estates, the assets they place in a CRT may only represent a small percentage of their entire asset base. If they choose to bequeath one asset to a charity via a CRT, they can still replace its value for their children by setting up a life insurance trust.
Here’s how this works:
The income tax savings and some of the income received from the CRT are used to fund an irrevocable life insurance trust. The trustee of the insurance trust then purchases sufficient life insurance to replace the full value of the asset for children or other beneficiaries.
This approach comes with the following benefits:
When advising clients on the pros and cons of establishing a charitable remainder trust, consulting with an estate planning attorney experienced in CRTs is essential. This ensures clients are fully aware of all the potential tax consequences of this course of action and that the trust is managed responsibly.
For estate planning and trust professionals, Estateably is the perfect tool for streamlining operational efficiencies and automating repetitive tasks involved in CRT administration. Our digital platform enables better collaboration between internal and external parties, embeds workflows, and tracks activities via a tamper-proof audit log.
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