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Charitable Remainder Trusts: Meeting the Challenges
Financial, personal and charitable objectives sometimes appear mutually exclusive. For example, providing inheritances to our loved ones may preclude making an estate gift to charity. Preserving enough income to sustain our lifestyle seems difficult if we make a charitable gift of investment assets. The challenge is to find a way to do both. The solution may be a charitable remainder trust, or CRT.
How a CRT Works
Q: How are charitable remainder trusts able to pay income for life and also be claimed as major tax deductions?
A: When you establish a CRT, you really create two separate and distinct interests in the same property. First, you create an income interest in the form of payments to you or other beneficiaries whom you designate. Those payments can be made either for the life of the beneficiaries or for a term of up to 20 years. A beneficiary can be anyone you choose.
Second, you create a remainder interest, which consists of the trust assets when the trust terminates. These remaining assets are distributed to one or more charities that you designate. For example, you might establish a charitable remainder trust that pays income to you for life and then distributes whatever remains to RUSH Copley Medical Center. Because the remaining trust assets are irrevocably committed to charity, you are entitled to an income-tax charitable deduction.
Barbara is a successful 50-year-old professional who establishes a 5% charitable remainder unitrust, or CRUT, and funds it with $100,000. Until she reaches the age of 65 - her anticipated retirement age - the trust will make annual distributions only out of income, and then it will flip and pay her a straight 5% of its annual value. If the trust's income averages 1% and the annual capital appreciation averages 6% over the next 15 years, it will grow to approximately $240,000. That means she will receive about $12,000 (5% of $240,000) during her first year of retirement. Up front, her $100,000 contribution will generate a charitable deduction of more than $26,900 and save her about $8,600 in her 32% federal income-tax bracket.
Q: What is a CRUT?
A: A CRUT is a tax-exempt, irrevocable trust funded by a charitable donation that pays income to one or more beneficiaries for life or a set number of years, after which the remaining trust assets are transferred to your designated charities. The percentage a unitrust pays annually is fixed, and that percentage is applied to the value of the trust principal as it changes from year to year. Because of this variable, a CRUT is a good choice if there is concern about keeping pace with inflation.
Meeting College Expenses, With a CRT
Q: Our granddaughter is starting college next year, and we plan to help with costs. We are planning to make a significant gift to RUSH Copley Medical Center as soon as she graduates. Is there any way a CRT could let us help with her education while accelerating our charitable plans?
A: Absolutely. The cost of addressing charitable and noncharitable goals together is often substantially less than the cost of addressing each separately.
Bill and Carol have been investing for several years to help with the college expenses of their granddaughter, Jennifer. Over the years, their $50,000 investment has grown to $200,000. Now that Jennifer is just a year away from college, they are considering liquidating their college fund and investing it in something safe that pays current income for the next four years. They plan to give her $30,000 each year and use whatever is left to make a gift to RUSH Copley Medical Center.
Unfortunately, a sale would generate a capital gain of $150,000 and a tax of $22,500, leaving just $177,500 to reinvest. If they invest that amount, pay tax on the earnings and give Jennifer $30,000 each year, after four years there will be only about $60,000 left to meet their charitable goals.
Charitable solution: They can transfer the college fund investments to a four-year CRT and achieve better overall results. If the CRT distributes $35,000 each year to Jennifer (the extra $5,000 accounts for any taxes she might have to pay in her low income-tax bracket) and achieves a 6% total return, there will be more than $97,000 left after four years. Under this plan, Jennifer still nets as much to help with her college costs - while Bill and Carol are able to generate $37,000 more to meet their charitable goals. What's more, they get a $74,082 charitable deduction the year they set up the CRT - saving them $25,929 in federal income tax, given their 35% tax bracket. |
