Charitable Remainder Trusts: The Giving is Good

A Charitable Remainder Trust (CRT) is an increasingly popular retirement and estate planning tool. This article provides an introduction to such arrangements.

The creator of the CRT, the grantor, contributes property to an irrevocable trust. However, the grantor retains (or directs to another individual) the right to an annual income stream for a term of years (20 or less) or for one or more lifetimes. At the end of this income period, the remaining assets in the trust will pass to charities selected in advance by the grantor. The present value of the income stream that the interim beneficiary will receive represents the retained interest. The remainder interest, then, is the present value of the sum the charitable institution is likely to receive at the end of the trust term. The remainder interest is deductible as a charitable gift in the year the trust is funded.

Often, what initially draws our clients to the Charitable Remainder Trust is its tax-exempt status. A charitable trust does not pay income taxes. Therefore, a taxpayer may contribute highly appreciated property and the trust will not owe tax on the capital gains resulting from its subsequent sale!

This is especially appealing to land-owners who find their old family farm surrounded by developments. Also, there are those investors who have ridden one particular stock to dazzling heights and realize that the risk of their position is now too great. Countless investors are slaves to such holdings, unwilling to diversify due to the taxes and so unwittingly assume too much risk. (I can think of many stocks that have lost much more in value than the capital gains tax would have cost - and that was just in the 2nd week of April!)

Here is an example of a CRT in action. This 65 year old couple has made many wise investments over the years and now has a significant percentage of their wealth ($750,000) concentrated in just three stocks. Even though the stocks they own are in large, proven companies, together they are a far cry from a well-diversified portfolio.

Because they are retiring in December, this will be their last year in the highest income tax bracket. Both have passionate feelings for a number of charities - an essential ingredient.

As retirement is around the corner, raising cash flow is becoming a pressing issue. They are naturally disinclined to draw on their retirement accounts (IRAs) for income tax reasons. Also, choosing to diversify their positions all at once would mean giving Uncle Sam a big piece of their retirement capital up front in capital gains taxes. Their only other options are either to 1) hold on to the bulk of the stock, incrementally selling shares to raise cash to meet living expenses or 2) establish a charitable remainder trust.

Selling stocks as cash needs arise is the surest way to insomnia. How will our new retirees sleep knowing that market volatility will cause them to sell stocks that are depressed? (If you think your spouse was tight before retirement, imagine deciding whether you get beans or steak depending on how the markets move each day!)

Diversifying within a charitable trust and drawing out 7.5% annually ($56,250 in the first year) for as long as either of them live is the perfect solution. This income stream should grow as the trust principal grows. Also, the income tax deduction of $165,000 could save them as much as $65,000 in taxes! (Due to IRS limitations on charitable gifts of appreciated property, the deduction may have to be carried over into later tax years.) Finally, at the second death, a charity or charities will enjoy a handsome gift.

In short, our anxious retiring couple will convert low yielding, high risk investment positions into a healthy income stream, they will save income taxes, and they will one day endow their favorite charities!

Wait - what about the children? It is true that the children will not inherit this asset. However, there are tax-efficient ways to compensate for this circumstance, including implementation of a gifting program with some of the new-found cash flow.

Note, there are a number of variables affecting which CRT plan may be best for you. A thorough review of your investment, retirement, and estate plan is essential before proceeding with this type of planning.