A charitable remainder trust (“CRT”) is an irrevocable trust that pays the settlor, the settlor’s spouse or children, an annual income for a period of years or for life. The annual income can be in the form of either an annuity, i.e., a fixed sum annually, or a unitrust amount, which is a fixed percentage of the trust assets valued annually. Thus, the two flavors of charitable remainder trust are the charitable remainder annuity trust (“CRAT”) and the charitable remainder unitrust (“CRUT”). The remaining property goes to the charity of the settlor’s choice at the end of the trust term and the settlor receives a charitable deduction.
The advantages of the CRT are as follows:
- Appreciated assets can be sold by the trust, reinvesting the proceeds, while avoiding capital gains tax.
- The settlor receives an income stream for a term of years or for life.
- The settlor claims a charitable deduction on his/her income tax return.
- The contributed assets are removed from the settlor’s estate, so there is no estate tax liability on such assets; lifetime unified estate/gift tax exemption is not reduced.
A CRUT can also be used to provide for the settlor’s retirement needs. Because a CRUT may be structured to pay the lesser of the fixed percentage of the trust assets valued annually or the annual income of the trust, a choice of investments can add to its usefulness. In its initial years – the settlor’s preretirement years – the trust invests in high-growth, low-income assets. On the settlor’s retirement, the trustee can convert the trust assets to high-income investments to provide the settlor with income. During the early stage, the trust presumably earns little or no income and there is little or no required payout. At retirement, a “make-up” provision in the CRUT allows the trustee to pay out additional amounts of the trust’s income (in years when the income exceeds the fixed percentage) to “make up” for the early low-income, pre-retirement years when the fixed percentage was not distributed.
Additionally, a CRT can be combined with an ILIT to provide estate tax-free wealth replacement. That is, through a combination of income tax savings and increased cash flow from the CRT, the settlor can fund an ILIT with additional premiums. The additional premiums can purchase additional life insurance, which will partially or possibly even entirely offset the heirs’ loss of the principal given to the charity.
This article is intended to give you enough information to decide which of these estate planning tools might be appropriate, and which are definitely not. We can then discuss further how the ones in which you remain interested may be tailored to meet your goals.