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charitable remainder trust

While most estate plans focus on leaving wealth to your heirs, some people also wish to provide for a charitable cause with their estate. A charitable remainder trust allows you to do both. This type of trust lets you set up an income stream for you and your beneficiaries and then give the remainder to a charity. Charitable remainder trusts come with many benefits, especially when it comes to taxes. But they also come with some rules and restrictions you should know before setting one up.

What Is a Charitable Remainder Trust?

A charitable remainder trust (CRT) is an irrevocable trust that fills a few different roles. You contribute assets to a CRT that you, or a chosen beneficiary, can use as a stream of income. The remainder of the funds then go to charity or charities of your choice. Placing assets in a charitable remainder trust reduces your individual taxable income. Many people with appreciated assets choose to make a CRT part of their estate planning strategy.

You can fund a CRT with cash, publicly traded securities, real estate and some types of closely held stock. If you’re unsure how to fund your CRT, you can consult a financial advisor who can help you construct an optimized trust.

There are two different kinds of charitable remainder trusts. The first type is a charitable remainder annuity trust (CRAT). With a CRAT, you make one contribution to the trust and receive a fixed annuity amount each year. You cannot make any more contributions after your first one. The other type of CRT is a charitable remainder unitrust (CRUT) where you can make multiple contributions to the account. Then you receive a fixed percentage based on the assets within the account which is revalued each year.

How Does a Charitable Remainder Trust Work?

charitable remainder trust

A charitable remainder trust is designed to generate income for either you or a beneficiary and contribute to a charitable cause. That way, you can provide for your own income and that of a beneficiary while also eventually helping out a good cause.

When you open a CRT, you choose whether you want the trust to pay you or a beneficiary. A CRT pays out annuities to you or your beneficiary for either a set term length not to exceed 20 years, or for the life of the beneficiaries. You can decide whether the annuities will be paid out annually, semi-annually, quarterly or monthly. However, the total payout for each year must be at least 5% of the account’s assets, but no more than 50%.

When the beneficiary’s term ends, the remainder of the trust’s assets are donated to the charity or charities of your choice. These charities must be IRS-approved to qualify for your CRT donation.

It’s important to know that the contributions you make to a CRT are irrevocable. This means you cannot reclaim what you contribute until you receive your annuities. However, don’t forget that the portion of the contribution that will go to the charity is tax-deductible.

As a trust, your CRT must have a trustee to manage the account’s assets. You can be your own account’s trustee, but that means you have to manage the account responsibly and constantly. If you don’t know how to do so, you could lose a lot in assets or see a heavy tax bill through mismanagement. In that case, you’ll want to name a corporate trustee like a bank or trust company. The charity you choose may also serve as your CRT’s trustee. A trustee ensures your account is well taken care of while you still call the shots.

Pros and Cons of a Charitable Remainder Trust

A huge advantage of a CRT is that you can re-purpose your assets into a steady stream of income. Depending on your situation, you can receive these payouts yourself or you can set up a beneficiary for life. Not only that, but you can contribute to a charity with the remainder of your assets. This provides a productive outlet for you to place your assets. It also protects the trust’s remainder from falling into the hands of creditors or even irresponsible family members.

One thing to keep in mind should you open a CRT is that most of your choices and actions are set in stone once you make them. That means you cannot make changes once you set your annuity amounts. For example, let’s say you establish your CRT with annual annuities of $20,000. A couple years down the road, you decide you would like $25,000 per year instead. However, you won’t be able to adjust the terms of your CRT to reflect your new needs. If it’s a CRAT, your contributions are also limited – you can only make a single contribution to the trust.

Tax Implications of a Charitable Remainder Trust

charitable remainder trust

Placing highly valued assets into a CRT also comes with tax benefits. For starters, those contributions that go toward the charity are tax-deductible. You can spread out this deduction over five years, too, instead of the year you make the contribution. The exact deduction you can file reflects the remainder amount the charity can expect to receive. You cannot deduct your whole contribution.

As a future tax benefit, placing assets in a CRT means those assets do not count toward your estate. So once you pass away and the charity receives the remainder, those assets won’t determine your estate tax, if you don’t avoid the tax altogether. You can also avoid capital gains taxes by turning your appreciated property into cash through a CRT.

Charitable Lead Trusts and Qualified Charitable Distributions

Charitable remainder trusts aren’t the only vehicles for retirees to give to charity.

One options is to create a charitable lead trust (CLT), which in a sense is the reverse or a CRT. Rather than paying set amounts to a beneficiary and then donating the rest to charity, a CLT donates set amounts to charity for a period of time and then transfers the remainder to a beneficiary.

Charitable lead trusts have several tax benefits for both the donor and the beneficiary. The donor will have a smaller taxable income as a result of the donation. The beneficiary will also face lower gift taxes and estate taxes as well as receive a tax deduction of the amount that was donated to charity.

You can also use your retirement savings to donate to charity. This is done by placing your money in an IRA and making qualified charitable distributions. Like CRTs, these come with their own rules, so you’ll want to know the regulations before you commit to this route.

Bottom Line

Before you commit to a CRT, you’ll need to decide whether it truly makes sense for you and your financial situation. For one, will you have enough leftover in the account to even give to a charity? Will you need to pay a financial advisor to help you with your assets? Asking and answering these kinds of questions will ensure you, your beneficiaries and your charities can reap the maximum benefit from a charitable remainder trust.

Tips on Saving for Retirement

  • If you’re concerned with the impact of taxes on your retirement income, you may want to consider where you spend your golden years. Check out our rundown of the most tax-friendly states for retirees.
  • Planning out income streams for you and your heirs can get complicated quickly. That’s why it’s essential to work with a financial professional who understands how to grow wealth, create a financial plan and navigate tax rules. Find a local advisor today with our financial advisor matching tool.

Photo credit: ©iStock.com/AlexD75, ©iStock.com/Eva-Katalin, ©iStock.com/PeopleImages

Lauren Perez, CEPF® Lauren Perez writes on a variety of personal finance topics for SmartAsset, with a special expertise in savings, banking and credit cards. She is a Certified Educator in Personal Finance® (CEPF®) and a member of the Society for Advancing Business Editing and Writing. Lauren has a degree in English from the University of Rochester where she focused on Language, Media and Communications. She is originally from Los Angeles. While prone to the occasional shopping spree, Lauren has been aware of the importance of money management and savings since she was young. Lauren loves being able to make credit card and retirement account recommendations to friends and family based on the hours of research she completes at SmartAsset.
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