Does this sound familiar? You want to give back to the community through charitable giving, but your biggest concern is ensuring that your needs and the needs of your family will be met now and in the future. Fortunately for you (and the charitable cause of your choice), these goals can be achieved in a simple, financially sound, and tax advantageous way by utilizing a charitable remainder trust (“CRT”).
Here’s why you do it: First, a CRT allows you to convert appreciated assets, like stock or real estate, into lifetime income for yourself, your spouse, or any other chosen beneficiaries. Second, transferring assets to a CRT yields an immediate charitable tax deduction and reduces your estate for estate taxes purposes. Finally, you can meet your charitable goals without harming your retirement objectives or your family’s financial security.
Here’s how you do it: You fund the CRT by transferring assets into it. The best assets to use are appreciated assets, like stock or real estate, which have increased in value over time. After the transfer, the trustee sells the assets at full market value. Because a CRT is a tax-exempt entity, the trust is not taxed on the capital gains resulting from the sale like you would be if you personally sold the assets. The full sale amount can then be reinvested in vehicles more appropriate for achieving the income goals outlined in your trust agreement.
Upon the transfer, you receive an immediate income tax deduction. You do not receive a dollar for dollar deduction since you will be receiving payments for the term of the trust. The deduction, determined by applying a specific formula, is equal to the amount expected to be left behind after the CRT has reached maturity (the “charitable remainder” in legal jargon). The deduction can be used to offset income in the transfer year and any unused amount can be carried forward for five years. Another tax benefit is that the asset transfer to the CRT effectively removes the asset from your estate for estate tax purposes.
Trust payments, which are generally taxable in the year received, are paid to the beneficiaries of your choice for a term of years (no more than 20) or for their lifetime. There are two different types of CRTs and the payment the beneficiaries receive depends on the type you choose. The first type is called a charitable remainder annuity trust (“CRAT”) and pays out a fixed amount each year for the term of the trust, regardless of the trust balance in the future. As an example, if you funded a CRAT, with a $500,000 contribution and elected a 10% pay out, the named beneficiaries would receive $50,000 a year for the life of the trust. CRATs are a good option for older individuals who prefer the security of a fixed payment.
The second type is called a charitable remainder unitrust (“CRUT”) and pays out a fixed percentage of the trust value as redetermined each year. CRUTs are a good option for people looking to increase the income payout of the trust over time. If the value of the trust increases, the unitrust payments also increase accordingly. Ordinary growth potential is bolstered by the CRUT’s tax exempt status, which allows the trustee to make asset changes without incurring capital gains tax.
Because of the growth possibilities, CRUTs can negate the effect of inflation, which is important in situations where the grantor names a young income beneficiary (e.g. a grandchild). Grantors can also make subsequent contributions to a CRUT, which option is not available with the CRAT. Of course, there is a risk that assets will lose value, which would result in a lower unitrust amount. However, if the CRUT is well managed, there will be a distribution formula that cushions an income beneficiary from extreme changes, up or down, in the securities markets.
When the income interests of a CRT end, the assets remaining in the trust go to support the charitable cause of your choosing. You can plan projects and programs with a charity so that your gift makes the specific charitable impact you want upon receipt.
Although the process may seem a bit daunting, the use of a corporate trustee can greatly simplify matters. These entities can outline the CRT choices in more detail and assist you with the process. If you use a nonprofit corporation as the trustee, it can provide advice on how to meet your charitable goals. Community foundations, for instance, have years of CRT experience and are great places to get started.
The bottom line: you can meet your philanthropic goals and retire too. Take advantage of the charitable remainder trust to reap tax benefits, provide a steady income stream, and meet your charitable goals.
Nathaniel J. Flandreau is an associate at the Harrisburg law firm Nauman, Smith, Shissler and Hall, LLP, Harrisburg’s oldest law firm. Nat’s practice focuses on taxation, corporate matters, insurance, probate/estate planning, and municipal law. In the course of his practice, Nat regularly works with community foundations and other non-profit entities.
Spencer G. Nauman Jr., is the senior partner of the Harrisburg law firm Nauman, Smith, Shissler and Hall, LLP. Mr. Nauman has been a lawyer with the firm for more than 40 years and his primary practice areas are corporate, probate/estate planning, taxation and insurance. Mr. Nauman represents several community foundations and the state community foundation organization. He is serving or has served as Director and President of business as well as community health, educational and social service organizations.