Donating isn't just signing random checks. You can help create a lasting legacy by supporting causes that matter. In some cases, charitable giving can also help you manage estate or income taxes and contribute to your financial plan. A Charitable Remainder Trust (CRT) is a legal framework that is set up to manage charitable giving with tax‑efficient wealth management.1 It helps you make a meaningful charitable gift while giving yourself (or your beneficiaries) income for a period of time. While a CRT may not be the appropriate choice for everyone, understanding how such a trust works may help you determine whether it deserves a place in your financial strategy.
What Is a Charitable Remainder Trust?
A CRT is a type of irrevocable trust. You transfer assets into the trust while retaining an income stream for yourself or designated beneficiaries. After the trust's payment period is over (either after a term of years or when the income beneficiaries pass away), the remaining assets (hence the "remainder" in CRT) are distributed to qualified charities.
Because the trust is irrevocable, you can't reclaim the assets transferred into it. But this permanent commitment gives the trust financial advantages while potentially creating benefits for the donor and charitable organizations that eventually receive the assets.
How Does a Charitable Remainder Trust Work?
Although every situation needs a customized approach, the process generally follows four steps, which are: 1) Put assets into the trust; 2) Sell the assets; 3) Pay income to beneficiaries, and; 4) Distribute the remainder to charity.
Funding the Trust
First, the donor transfers assets into the trust. These assets might include appreciated holdings such as stocks, mutual funds, real estate, and business interests. Because the trust receives more favorable tax treatment than an individual, some wealthy people choose to contribute assets that have significantly increased in value over time.
Selling the Assets
Trusts are tax-exempt, so they may sell appreciated assets without having to pay immediate capital‑gains tax.
Paying Income to Beneficiaries
Once assets have been sold without triggering capital gains taxes, the trust may make regular income payments to the beneficiaries. Beneficiaries might include the donor, their spouse, and other family members. Payments could be for a fixed term of up to 20 years or for the beneficiaries' lifetimes.
Giving the Remaining Assets to Charity
After the payment period ends, any remaining assets are transferred to the charities the donor chooses. The amount the charity does ultimately receive depends on investment performance, payout rates, and the length of the trust.
Types of Charitable Remainder Trusts
CRTs come in two primary forms: Charitable Remainder Annuity Trusts (CRAT) and Charitable Remainder Unitrusts (CRUT). CRATs provide a fixed annual payment, making them a good option for donors who need useable income.
CRUTs pay a percentage of the trust's value, recalculated annually. When the trust's value increases or decreases, the income payments adjust accordingly. Unlike CRATs, CRUTs usually allow for additional contributions over time.
Potential Benefits for Wealthy Individuals
A CRT offers several potential advantages when you integrate it into a broader wealth management strategy.
It can let you manage appreciated assets tax efficiently. Many affluent investors own assets that can appreciate substantially, and selling them may create a major capital gains tax obligation. Contributing appreciated assets to a CRT could let those assets be sold inside the trust without triggering immediate capital gains taxes at the trust level. This keeps more value in the trust for reinvestment.
Depending on how the trust is structured, donors may qualify for a current charitable income tax deduction based on the present value of the charity's future interest in the trust. The size of the deduction depends on several factors, including the donor's age, the payout rate, the value of contributed assets, and applicable IRS assumptions and interest rates. These calculations are complex; consult a financial and tax professional.
Assets placed in a CRT are generally removed from the donor's taxable estate. For families with estate planning concerns, this may help manage future estate taxes while supporting charitable organizations. Although current federal estate tax exemptions remain historically high, it's possible that future legislative changes could alter rules and requirements that impact estate planning opportunities.
Important Considerations
Despite their advantages, CRTs involve some tradeoffs. Since the trust is irrevocable, assets transferred into it can't be recovered. Carefully consider your future cash flow needs before making a permanent commitment.
CRTs also require ongoing administration, annual tax reporting, and investment management. Establishing and maintaining the trust typically involves a team of professionals working together.
Finally, the income beneficiaries receive as distributions is subject to complex IRS tax rules. Depending on the trust's investment activity, payments may include varying combinations of ordinary income, capital gains, tax-exempt income, or return of principal. These complexities make professional guidance especially valuable.
Integrating a CRT Into Your Overall Wealth Plan
Charitable remainder trusts seldom work in isolation; they are more likely to be a part of a comprehensive wealth‑management strategy.
Some individuals also pair a CRT with life insurance held in an irrevocable life insurance trust to help replace the wealth taken as distributions that ultimately passes to charity. This lets heirs receive assets outside of the CRT while preserving your charitable goals. The appropriate strategy depends on your financial goals, family circumstances, tax situation, and charitable priorities.
Final Thoughts
A CRT is potentially a powerful planning tool for affluent investors. But like any advanced planning strategy, a CRT requires careful analysis.
If charitable giving is an important part of your financial plan, working with a qualified financial professional, tax specialist, and estate planning attorney could help determine whether a CRT fits into your broader wealth management strategy.
You can also access our charitable giving checklist to learn more about how a CRT works and whether it might be a useful addition to your financial strategy.
Important Disclosures:
This information is general and educational in nature and should not be considered tax and/or legal advice.
Neither LPL Financial nor its financial professionals provide tax and/or legal advice. We recommend you consult a tax and/or legal advisor about your individual situation.
The information provided here should not be considered an individualized recommendation. The strategies mentioned here may not be suitable for everyone.
This article was prepared by WriterAccess.
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Footnotes
1 Charitable remainder trusts
https://www.irs.gov/charities-non-profits/charitable-remainder-trusts
