What Is a Charitable Remainder Trust?
A charitable remainder trust is a “split-interest” giving vehicle that enables people to pursue philanthropic goals while still generating income. Tax exempt and irrevocable, they are designed to reduce the taxable income of individuals. They are set up with a donation by the trustor (also known as “the grantor” or “the benefactor”) that provides a partial tax deduction. They then operate by dispensing income to either the trustor or one or more named noncharitable beneficiaries for a specified period of time, after which they donate the remainder of the trust to one or more designated charitable beneficiaries, which can be either a public charity or private foundation.
- A charitable remainder trust is a tax-exempt irrevocable trust designed to reduce the taxable income of individuals.
- A charitable remainder trust dispenses income to one or more noncharitable beneficiaries for a specified period and then donates the remainder to one or more charitable beneficiaries.
- Setting up a charitable remainder trust makes the trustor eligible for a partial tax deduction.
How Does a Charitable Remainder Trust Work?
A central idea of a charitable remainder trust is to reduce taxes. This is done by first donating assets into the trust and then having it pay one or more noncharitable beneficiaries for a stated period of time, which can be no longer than either 20 years or the life of one or more of the noncharitable beneficiaries. The payments can be made annually, semiannually, quarterly, or monthly. Once the time frame expires, the remainder of the estate is transferred to one or more charitable beneficiaries.
Assets that can be donated to a charitable remainder trust include cash, stocks, real estate, private business interests, and private company stock. The partial tax deduction a trustor receives for their donation is based on the trust’s type and term, the projected income payments to the charitable beneficiaries, and interest rates set by the Internal Revenue Service (IRS) that are determined by assumptions about the growth rate of trust assets. In addition to tax management, charitable remainder trusts can also offer benefits for retirement planning and estate planning.
Charitable remainder trusts are irrevocable, which means that they cannot be modified or terminated without the charitable beneficiaries’ permission. The trustor, having transferred assets into the trust, effectively removes all of their rights of ownership of the assets and the trust upon creation of its irrevocable status.
By making a trust irrevocable, the trustor is removing it from inclusion in their estate, meaning that it will not be part of the probate process, is not subject to estate taxes, and can transfer to a beneficiary immediately. In contrast, a revocable trust, which allows the trustor to make modifications to the trust over the years or end it entirely, is considered a part of the trustor’s estate and will be subject to both probate and estate taxes.
The Secure 2.0 Act, part of the Consolidated Appropriations Act of 2023, which was signed into law by President Biden on Dec. 29, 2022, includes special provisions for making a one-time qualified charitable distribution from an IRA of no more than $50,000 to a charitable remainder annuity trust (CRAT) or charitable remainder unitrust (CRUT). Read below for details on these two types of charitable remainder trusts. [This provision of the Secure Act 2.0 also applies to charitable gift annuities (CGAs)]. Special rules apply to these donations so get advice from a tax expert.
Charitable Remainder Trust Types
There are two main types of charitable remainder trusts, distinguished in part by whether they pay a fixed or fluctuating annual amount to the noncharitable beneficiaries.
Charitable Remainder Annuity Trust (CRAT)
Charitable remainder annuity trusts (CRATs) distribute a fixed annuity each year to their noncharitable beneficiaries. This amount is always the same and must be at least 5% but no more than 50% of the assets in the trust. They do not allow for additional contributions.
Charitable Remainder Unitrust (CRUT)
Charitable remainder unitrusts (CRUTs) distribute a fixed percentage based on the balance of the trust assets, which are revalued every year. The annual amount will fluctuate, but, as with CRATs, it must be at least 5% but no more than 50% of the assets in the trust. Unlike a CRAT, though, a CRUT does allow for additional contributions.
Pros and Cons of Charitable Remainder Trusts
The biggest pro of a charitable remainder trust is its tax savings. The trustor not only gets a partial tax deduction for their donation to the trust; they also can see a reduction in capital gains, gift, and estate taxes. Another advantage is that unlike with a charitable lead trust, a trustor or their designated noncharitable beneficiary can get a regular income stream from a charitable remainder trust while simultaneously donating money to charity from the trust. After death, the trust protects the money from creditors or greedy family members, passing it on instead to charity as directed by the trustor.
The greatest con of a charitable remainder trust is that it is irrevocable, giving the trustor no access to or control over the funds in the trust and making it difficult-to-impossible to alter the terms of the trust. A second disadvantage is that a charitable remainder trust is a complex construction whose creation and administration can be complicated and costly. In addition, it is important to run a thorough cost-benefit analysis to make sure that it is the best use for the assets you are planning to put in it.
What Is the Purpose of a Charitable Remainder Trust?
A charitable remainder trust allows a trustor to simultaneously contribute money to charity while providing a steady income stream for the trustor or one or more designated noncharitable beneficiaries. The income is available for a set period of time, after which the remaining funds in the trust are donated to one or more designated charitable beneficiaries.
What Are the Tax Implications of a Charitable Remainder Trust?
When a charitable remainder trust is set up, the trustor is entitled to a partial tax deduction for the money put into it, which can grow tax free inside the trust due to investments. The trust can also reduce capital gains, gift, and estate taxes.
How Long Can a Charitable Remainder Trust Last?
The term of a charitable remainder trust can be for up to 20 years or for the lifetime of one or more noncharitable beneficiaries.
The Bottom Line
Using one of the two types of charitable remainder trusts can provide you with a tax donation and designated noncharitable beneficiaries with an income stream, and then pass the remainder to a designated charitable beneficiary without its needing to go through probate. Those are notable benefits. The limitation is that both types of charitable remainder trusts are irrevocable.