A charitable remainder trust — commonly called a CRT — is a type of irrevocable trust that provides income to the grantor or other named beneficiaries for a period of time after which the remaining assets pass to one or more designated charities. It is a powerful estate planning tool that allows individuals to support charitable causes they care about while also receiving income and significant tax benefits during their lifetime.
Charitable remainder trusts are most commonly used by people who have highly appreciated assets such as stocks or real estate that they want to sell without paying large capital gains taxes and who also want to support charitable organizations.
How a charitable remainder trust works
When you create a charitable remainder trust you transfer assets — typically appreciated property such as stocks, real estate, or other investments — into the trust. The trust then sells the assets and reinvests the proceeds without paying capital gains tax on the sale. The trust pays income to you or other named beneficiaries for a specified period — either a fixed number of years up to 20 or for the lifetime of the beneficiaries. When the trust ends the remaining assets — called the charitable remainder — pass to the designated charity or charities.
Tax benefits of a charitable remainder trust
Charitable remainder trusts offer several significant tax benefits:
- Capital gains tax avoidance — when highly appreciated assets are transferred into a CRT and sold the trust generally does not pay capital gains tax on the sale. This allows the full value of the assets to be reinvested and used to generate income rather than being reduced by capital gains taxes.
- Charitable income tax deduction — when you create a CRT you receive a partial charitable income tax deduction in the year the trust is created. The deduction is based on the present value of the charitable remainder interest — the estimated value of what the charity will receive when the trust ends.
- Estate tax reduction — assets transferred into a CRT are generally removed from your taxable estate which can reduce estate tax liability for people with large estates.
Types of charitable remainder trusts
There are two main types of charitable remainder trusts each with a different method for calculating income payments:
- Charitable remainder annuity trust — CRAT — pays a fixed dollar amount to the income beneficiaries each year. The payment amount is set when the trust is created and does not change regardless of how the trust’s investments perform. No additional contributions can be made to a CRAT after it is created.
- Charitable remainder unitrust — CRUT — pays a fixed percentage of the trust’s assets as revalued each year to the income beneficiaries. Because the payment is based on a percentage of the current asset value it fluctuates with the performance of the trust’s investments. Additional contributions can be made to a CRUT after it is created.
The CRUT is generally more popular than the CRAT because it offers inflation protection — if the trust’s assets grow over time so do the income payments.
Who the income beneficiaries can be
The income beneficiaries of a charitable remainder trust — the people who receive income payments during the trust term — can include:
- The grantor — the person who creates the trust
- The grantor’s spouse
- Other individuals named by the grantor
- A combination of the above
The trust can pay income for the lifetime of one or more beneficiaries or for a fixed term of up to 20 years. Many grantors name themselves and their spouse as income beneficiaries for their lifetimes.
Who the charitable beneficiaries can be
The charitable remainder — the assets remaining when the trust ends — must pass to a qualified charitable organization as defined by the IRS. Qualified organizations include:
- Public charities such as hospitals, universities, and religious organizations
- Private foundations
- Donor advised funds
You can name one or more charitable organizations as the remainder beneficiary and can specify how the remainder should be divided among multiple charities.
Replacing the inheritance with life insurance
One concern some people have about a charitable remainder trust is that transferring assets into the trust means those assets will ultimately go to charity rather than to their heirs. A common strategy to address this concern is to use some of the income received from the CRT to purchase a life insurance policy in an irrevocable life insurance trust — ILIT — that will pay a death benefit to heirs when the grantor dies effectively replacing the inheritance that will go to charity.
When a charitable remainder trust makes sense
A charitable remainder trust may be worth considering for people who:
- Own highly appreciated assets such as stocks or real estate with a low cost basis that they want to sell
- Want to avoid or defer capital gains taxes on the sale of appreciated assets
- Want to receive income from their assets during their lifetime
- Have charitable intent and want to benefit one or more charitable organizations
- Want to reduce their taxable estate
- Are in a high income tax bracket and can benefit from a charitable deduction
Limitations and considerations
Charitable remainder trusts are complex and irrevocable — once created they generally cannot be changed or canceled. Important considerations include:
- The trust must pay at least five percent of its assets as income each year
- The charitable remainder must be at least ten percent of the initial value of assets transferred into the trust
- Once assets are transferred into the trust you give up ownership and control of those assets
- The trust requires ongoing administration including annual tax filings and investment management
- Professional trustee services may be required adding to the cost
Because of their complexity charitable remainder trusts should only be created with the guidance of an experienced estate planning attorney and in coordination with a financial advisor and tax professional.
Key terms to know
- Charitable remainder trust — CRT — an irrevocable trust that pays income to beneficiaries for a period of time after which remaining assets pass to charity
- Grantor — the person who creates and funds the trust
- Income beneficiary — the person or people who receive income payments from the trust during the trust term
- Charitable remainder — the assets remaining in the trust when the trust term ends that pass to the designated charity
- Charitable remainder annuity trust — CRAT — a CRT that pays a fixed dollar amount each year
- Charitable remainder unitrust — CRUT — a CRT that pays a fixed percentage of trust assets revalued annually
- Cost basis — the original value of an asset for tax purposes used to calculate capital gains when the asset is sold
- Irrevocable life insurance trust — ILIT — a trust used to hold life insurance outside of the taxable estate
Sources
- Internal Revenue Service — irs.gov
- American Bar Association — Public Resources
- National Council of Nonprofits
- USA.gov — Estate Planning
This article is for general informational purposes only and does not constitute legal or financial advice. Tax laws and trust regulations vary and are subject to change. Consult a licensed attorney and tax professional for guidance specific to your situation.