Benefits of a Charitable Remainder Trust

Even if you haven’t yet invested in estate planning, you’ve probably heard of Charitable Remainder Trusts (CRTs). When you visit your favorite non-profit’s website or receive a solicitation letter from your alma mater, you may see a pitch for the benefits of a CRT. What may not be immediately obvious is that a CRT can benefit you and your loved ones as well as your charity or charities of choice.

What is a Charitable Remainder Trust?

A charitable remainder trust is an irrevocable trust that provides income for the grantor and/or his  beneficiaries across a pre-determined period. The duration of the trust may be a fixed period of up to 20 years, or may be for the lifetime of one or more of the trust beneficiaries. When the time specified in the trust creation instrument has passed, any remaining assets in the trust are paid to the designated charity.

Why Use a Charitable Remainder Trust?

A charitable remainder trust provides immediate tax benefits for the grantor, and may be used to achieve additional tax benefits, as well. First, the grantor receives a charitable deduction for the tax year in which he or she transferred assets to the CRT. Calculation of the deduction is complicated, but a carefully-structured CRT may reduce your income tax liability by up to 30% of your adjusted gross income. Under some circumstances, the reduction may be even larger.

In addition, a CRT may be legally employed to avoid federal capital gains tax. Capital gains taxes act as a deterrent to the sale of assets that have appreciated significantly. However, when the asset is transferred to a CRT, there is no tax on the transfer. The trustee of the CRT may then sell the asset, and the trust will not incur federal tax on the income. New Jersey law treats charitable remainder trusts differently, and will tax the income to the trust. However, the tax savings versus paying both state and federal taxes is significant—increasingly so as the value of the asset and the value attributable to appreciation increase.

How Does a Charitable Remainder Trust Work?

There are two types of charitable remainder trusts: charitable remainder annuity trusts (CRATs) and charitable remainder unitrusts (CRUTs).  Most elements of the two types of trust are the same. Both are irrevocable. Both pay periodic income to beneficiaries over a specified period of time. Both transfer remaining assets to a designated charity when that time expires.

The key difference is that the CRAT pays a fixed dollar amount annually, whereas the CRUT pays a fixed percentage of the trust’s value each year. One determining factor to be considered is the value of predictable income versus the goal of protecting against inflation. Regardless of whether the payouts are fixed amounts or percentage-based, the annual distribution must be at least 5%, but not more than 50%, of the initial value of the trust assets.

Providing for Heirs with an Irrevocable Life Insurance Trust

While the charitable remainder trust provides you with immediate tax benefits, allows for the transfer of high-value appreciate assets without large federal capital gains taxes, and benefits your favorite charity, you may have concerns about tying up large assets this way. Of course, you want to ensure that you provide for your children, grandchildren, and other loved ones as well.

Depending on the structure and timeline of the trust, it may pay out significant income to your beneficiaries before the trust terminates and the remainder is transferred to the charity. And, the asset or assets placed in the trust may represent only a fraction of the estate, leaving other assets to provide for beneficiaries. However, if you are concerned about the impact on your family, an irrevocable life insurance trust (ILIT) may be the answer.

Using some or all of the income tax savings achieved through creation of the CRT and your income from the trust, you may create an irrevocable life insurance trust. The trustee will then use the funds you transferred to the ILIT to purchase life insurance with a death benefit sufficient to replace the asset transferred to the CRT. Since the life insurance will be held in an irrevocable trust, it will not be part of your estate, and so will not be considered in calculating any estate tax obligation.

An added benefit is that life insurance proceeds won’t be paid directly to heirs, but rather will be held in trust for the benefit of those you designate. Thus, you can structure payments as you wish, paying out to beneficiaries over time or for specific purposes if you prefer.

Talk to a New Jersey Estate Planning Lawyer

Charitable trusts can provide significant benefits for you and the causes you support, but choosing the right type of trust and structuring the terms of the trust require strategy. Since CRTs are irrevocable, you can’t afford to make a mistake. Count on the experience of a knowledgeable estate planning lawyer.