A guide to Charitable Remainder Trusts
When executed properly, there are certain strategies that can help financially support the charitable organizations you’re passionate about while also providing you with significant tax benefits.
Many of our clients are familiar with donating cash or appreciated stock directly to charity, or even using a Charitable Donor Advised Fund to help achieve their philanthropic goals. These are great strategies that allow the charities to benefit from the donations while providing tax and “feel good” benefits to the donor.
Every donor’s financial situation is unique and sometimes a more complex charitable giving strategy is appropriate. Charitable Remainder Trusts (CRTs) can be an effective tool for addressing charitable goals while also taking into consideration other financial planning objectives.
How do Charitable Remainder Trusts work?
At a high level, appreciated stock or assets are transferred from the donor into the charitable trust. Once the stock or assets have been transferred into the trust, the donor can then sell the assets and build a diversified portfolio without incurring immediate taxation on the capital gain.
On the trust’s anniversary date, a pre-determined annuity payment will be made back to the donor for a specific period of time. At the end of the trust’s term, whatever amount is left in the trust then gets passed through to the ending charity (or charities).
CRTs are certainly more complex than giving directly to a charity outright, so who might be a good candidate for this strategy? Here are four common scenarios:
- Investors who hold a significant portion of their net worth in an asset that is highly appreciated in value, and they wish to diversify. The CRT allows for an immediate reduction in the asset concentration without incurring an immediate large taxable gain.
- Investors who are charitably inclined but who either don’t want to, or cannot afford to, permanently lose access to the full value of the appreciated asset they will donate.
- Investors who are interested in converting a highly appreciated asset into a tax-efficient source of income.
- Investors who could benefit from a large charitable deduction in the year they fund the CRT.
As is true with most financial planning strategies, there are features to the charitable trust that should be discussed prior to implementing the strategy. While by no means inclusive, some things to consider are:
- Life expectancy. The trust will make annuity payments back to the donor over the course of their lifetime. In order for the cumulative annual payments to equal the market value of the initial donation, you can run a break-even calculation to determine how long you’ll need to live to recover your initial donation. Generally speaking, time is needed for the benefits to accrue. If life expectancy is relatively short, another strategy may be better.
- Desire to sell the appreciated asset. The CRT is not appropriate unless there’s a desire to sell the appreciated asset for diversification purposes, once it is in the trust.
- Illiquidity. Gifts to a CRT are irrevocable and funds within the trust will only be available to the extent that an annuity payment is due. You should be sure that your financial plan has enough liquidity in other areas to provide you with flexibility, should you need access to liquid assets.
In terms of the annual income stream, this can be structured to pay out a fixed dollar amount (a CRAT) or a fixed percentage of the trust (a CRUT) each year.1 The level of charitable deduction generated in the year the CRT is funded will be a function of the annuity structure and the timeframe of the trust. Tax only comes into consideration as payments are made out of the trust and back to the donor.
CRT strategy in action
Let’s explore a hypothetical example to illustrate how a CRT could work:
Assume an investor has $1 million of stock for which they initially paid $250,000. At the time the stock is donated into the trust and sold, the trust realizes a gain of $750,000. However, it is not taxed immediately. Let’s assume on each anniversary date the CRT makes a $100,000 payment back to the donor. The $100,000 distribution will be taxed based on how the CRT earned the income, with interest, dividends and capital gains being taxed at their respective rates.
This taxable exercise happens each year until the full deferred gain is paid out and taxed, which emphasizes the importance of managing the trust as tax efficiently as possible. Once the deferred gain has been fully paid out, the future annuity payments will be taxed as a portion of dividends, interest or capital gains generated within the trust, while the remainder would be paid out tax free as a return of principal.
If you’re interested in benefiting one or more charities while tax efficiently diversifying a highly appreciated concentration in your portfolio, please contact your wealth advisor and tax professional to discuss Charitable Remainder Trusts.
ABOUT THE AUTHOR
Chadderdon O'Brien, CFP, FRM
Responsible for managing client relationships on all aspects of financial and tax planning and investment management. Specifically, Chad works with corporate executives to help take full advantage of their benefits, deal with employer stock concentrations and manage stock option strategies. Chad co-chairs the corporate executive specialty practice. Chad is a member of RegentAtlantic's Board of Managers and sits on CIPW's Business Development and Organic Growth committee. He serves on multiple other working committees at RegentAtlantic. He graduated with a dual concentration in Finance and Entrepreneurship & Small Business Management from Northeastern University. He was a member of the NJBIZ Forty under 40 class of 2014. He lives with his wife and their twins in Basking Ridge, NJ.
Peter O'Neill, CFP
Pete counsels and advises families and individuals on holistic financial planning. His areas of expertise are in retirement planning, income tax planning, investment management and estate planning. Pete joined RegentAtlantic in 2019, and has more than ten years of experience working with high-net-worth families and individuals. He is a member of the Financial Planning Committee and actively contributes to discuss and enhance best practices for advisors providing holistic financial planning advice.
Pete graduated from St. Joseph's University where he earned a Bachelor of Science in Finance. He is a CERTIFIED FINANCIAL PLANNERTM, having received the designation from the Fairleigh Dickinson University. Pete was born and raised in New Jersey, and today he and his wife Paige live in Bridgewater with their two boys. In his free time Pete enjoys trying new restaurants and collecting wine. As a sports enthusiast, I'm a Yankees, Giants and Knicks fan and continue to work on my golf game.
This information is for educational purposes and is not intended to provide, and should not be relied upon for, accounting, legal, tax, insurance, or investment advice. This does not constitute an offer to provide any services, nor a solicitation to purchase securities. The contents are not intended to be advice tailored to any particular person or situation. We believe the information provided is accurate and reliable, but do not warrant it as to completeness or accuracy. This information may include opinions or forecasts, including investment strategies and economic and market conditions; however, there is no guarantee that such opinions or forecasts will prove to be correct, and they also may change without notice. We encourage you to speak with a qualified professional regarding your scenario and the then-current applicable laws and rules.
Different types of investments involve degrees of risk. Future performance of any investment or wealth management strategy, including those recommended by us, may not be profitable, suitable, or prove successful. Past performance is not indicative of future results. One cannot invest directly in an index or benchmark, and those do not reflect the deduction of various fees which would diminish results. Any index or benchmark performance figures are for comparison purposes only, and client account holdings will not directly correspond to any such data.
Our clients must, in writing, advise us of personal, financial, or investment objective changes and any restrictions desired on our services so that we may re-evaluate any previous recommendations and adjust our advisory services as needed. For current clients, please advise us immediately if you are not receiving monthly account statements from your custodian. We encourage you to compare your custodial statements to any information we provide to you.