Suppose you would like to make a substantial donation to your favorite charity, but you worry about reducing your income once you retire? A charitable remainder trust might be the perfect answer for that dilemma. But wait, that’s only the beginning.
Benefits of a Charitable Remainder Trust
Creating a charitable remainder trust may allow you to achieve three other highly desirable goals. It actually can increase your lifetime income stream. It can give you a current charitable income tax deduction. And it can reduce the amount of your estate that is subject to estate taxes.
Several types of charitable remainder trusts are available. This article will focus on the charitable remainder unitrust (CRUT). A CRUT is a trust that pays an income stream to the trust creators (you and your spouse) for life. After the death of the second spouse, the balance (remainder interest) is paid to a designated charity or charities. The CRUT also allows you to make additional contributions. Trust Point Inc. often acts as a trustee of these types of charitable remainder trusts.
Among the ideal assets to contribute to a CRUT are low-basis, highly appreciated, publicly traded stocks. If you wanted to diversify out of a large stock concentration in your portfolio, you normally would incur a significant capital-gains tax hit. Capital-gains tax rates are lower than ordinary income tax rates but they still can result in a painful tax liability. Contributing the stock to a CRUT can meet your charitable intent, allow for diversification, and normally will increase your income stream.
Normal dividend yields on U.S. stocks are about 2 percent. The minimum required payout to the income beneficiaries (normally the trust creators) of a CRUT is 5 percent, which is why your income stream is likely to increase.
As a possible benefit to your children, however, you may include heirs as income beneficiaries of a CRUT. This typically involves a gift element and a charitable deduction element. The gift portion uses up gift tax annual exclusion and your lifetime exemption. When you create a CRUT for yourself and spouse there is no gift portion because you are making it to yourself and a spouse which qualifies for the gift tax marital deduction.
How Does It Work?
The distributions the CRUT makes to the income beneficiaries are usually taxable in the year they are received. The character of the income reported annually depends on many factors. Normally, a small portion will be subject to ordinary income tax while the larger portion would be taxed as long-term capital gain.
The starting point for the income tax deduction is the fair-market value of the stock on the date of the contribution to the CRUT. The amount of the current charitable deduction is based on the calculated value of the remainder interest. This calculation considers the ages of the donor couple, the payout percentage, and an IRS interest-rate factor called the Section 7520 rate.
Assets in the CRUT are excluded from the couple’s taxable estate. Even though the federal estate-tax exemption is currently $5.43 million, this is a good tool to reduce large estates for tax purposes. Also, depending on where you live, the use of a CRUT might shrink your state’s estate-tax bite significantly.
A charitable remainder trust offers a genuinely win-win deal: You benefit through increased cash flow, a substantial charitable income tax deduction, and no capital gains tax on the low-basis assets you contribute to the CRUT. Your family stands to benefit from decreased estate taxes. And your favored charities benefit from your generosity.
Trust Point, Inc. can help you evaluate whether this planning tool would be beneficial for your situation. Get in touch with one of our professionals to start the conversation now!