Retirement Saving and Charitable Remainder Trusts

Leveraging a Charitable Remainder Trust may improve your financial plan. Use it to fine-tune the variables, including how much to give, how it changes your tax picture, how your cashflows are impacted, and how much is left to heirs.
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By Clint Camua, CFP

Given the rise in asset prices both in stocks and real estate, the prospect of paying exorbitant taxes on capital gains is becoming an increasing concern. In addition, with legislation targeting to increase the taxes on these gains to pay for government spending, having a strategy to minimize and/or avoid these taxes is gaining popularity. For those who are charitably inclined, there are even more opportunities to combine different charitable strategies to satisfy both the desire to potentially reduce taxes and the desire to give to worthwhile charities. This is where using the Charitable Remainder Trust (CRT) can be helpful. 

Clint Camua, CFP

Clint Camua, CFP

This article will discuss the following:

· Two types of CRTs

· Tax benefits of CRTs

· Income benefits of CRTs

· Benefits of a Donor Advised Fund (DAF) as the remainder beneficiary

· How a CRT may fit into your overall financial plan

As with any strategy that may involve tax and/or estate ramifications, it is important to review all recommendations with your tax and estate attorney. Let us begin.

Two Types of Charitable Remainder Trusts

The CRT can be broken down into two different types: The Charitable Remainder UniTrust (CRUT) and the Charitable Remainder Annuity Trust (CRAT). Both trusts have the charity as the “remainder” or the beneficiary of the principal once the income interest ends. This means that before the charity is paid out, income from the trust is paid to a non-charity beneficiary for a period of time or the rest of the life of the income beneficiary.

A CRUT differs from a CRAT in the way the income payout is calculated. For example, in a CRUT with a 5% payout, the 5% is calculated based on the value of the CRUT each year. That payment will fluctuate based on the performance of the CRUT’s assets. In a CRAT, the payments are fixed based on the initial amount of the contribution. Thus, the payments do not fluctuate regardless of the performance of the CRAT. 

Tax Treatment of Charitable Remainder Trusts


Capital gains

The CRT can be funded with highly appreciated assets because selling within the CRT results in no capital gains tax to the donor. This is sometimes why some may refer to the CRT as the “Capital Gains Bypass Trust.” From there, the proceeds can be reinvested in a manner that is suitable to distribute the needed income while also potentially growing to have remainder assets for the charity. An administrator is hired to evaluate the trust to ensure compliance. The administrator can advise the trustee on the amount of the distribution each year to comply with guidelines.

Where this can be helpful is for someone who has highly appreciated assets or concentrated positions but has been hesitant to sell because of the capital gains. There could be several reasons to sell a highly appreciated asset:

Concentrated positions

Liquidity

Low or inadequate income from the appreciated asset

Reduction of overall portfolio risk

The assets donated can be liquid securities or other assets such as real estate or shares in a private company.

Tax treatment of a contribution

Since the charity is a “remainder” beneficiary, you will not be able to deduct the entire amount of the contribution to the CRT. The income payments you choose, and the term of the CRT, will determine the percentage of the deduction. Typically, planners who advise in this area have software that will help calculate the approximate deduction based on the inputs. Generally, the higher the income payment, the lower the deduction. Also, it is possible that the longer the term, the lower the deduction. It is always recommended that you consult your tax professional before implementing and determining which strategy to employ.

One thing to note is that if you are giving highly appreciated long-term capital gains assets, you can only give up to 30% of adjusted gross income. The rest can be carried forward for five years. This may influence the amount of assets you contribute to the CRT.

Income of Charitable Remainder Trusts

As mentioned earlier, whether you choose the UniTrust or Annuity Trust option, you can design an income stream from the trust. Depending on the type of assets in the CRT, the taxability will vary. CRTs follow a tiered system. Per IRC Sec. 664(b), “the character of this income is categorized into four tiers that must be distributed in the following order” — ordinary income, including current year and accumulated income, and qualified dividends; capital gains; other tax-exempt income; and return of principal.

As is noted on CalCPA, “With both CRATs and CRUTs, the IRS requires that the payout rate each year cannot be less than 5 percent or greater than 50 percent of the initial fair market value of the trust’s assets.” Here’s why this is important. If the asset donated pays little or no income, you can potentially turn that asset into one that can provide cash flow.

A Donor Advised Fund as the Remainder Beneficiary

As described above, the charity is the “remainder” beneficiary. For many, this is a tough choice, as you may have multiple charities you want to benefit. In addition, there is the underlying concern that the charity may not be in existence when the time comes to receive the funds.

One solution that may make sense is to use a Donor Advised Fund (DAF) as the beneficiary of the CRT. A DAF, from a tax perspective, can be treated like a charity. Many custodians offer these accounts to gift to charity in a simple way. With a DAF, you can control not only how you fund it, but you also control the speed at which you distribute the assets to the charities you may support. In addition, you do not have to name the charities at the time you set up the CRT. You can name specific charities and/or the DAF as the remainder beneficiaries.

In some cases, a DAF is used as a way to educate the younger generation on how to gift to charities and understand the importance of giving. They can even serve as the DAF successor to make the gifting decisions to charities that are important to their families.

How a Charitable Remainder Trust Fits into Your Overall Financial Plan

Perhaps the single biggest point to underscore when it comes to using the CRT strategy is that the principal of the donated asset will go to the charity as opposed to any family beneficiary. Therefore, it is important before considering this strategy that one has the proclivity to donate to charity.

There are some strategies that you can incorporate to “replace” part of the donated asset. To the extent you qualify, incorporating life insurance may make sense because part of the income from the CRT can be used to pay premiums.

As with any strategy, it is important to use the CRT within the context of your overall financial plan. Sometimes, something that looks good on its own may not look as good within the context of other inputs, and thus, tying it back to the plan is important. Confirming that leveraging a CRT will improve your financial plan can help increase your confidence in the decision. Also, within the plan, you can fine-tune the variables, including how much to give, how it changes your tax picture, how your cashflows are impacted, how much is left to heirs with or without life insurance, etc.

Conclusion

In summary, a CRT can be a useful strategy under the appropriate circumstances. The ideal candidate should be willing to donate to charity and have highly appreciated securities to donate that would benefit from avoiding capital gains tax. Potential secondary benefits include additional cash flow, tax deduction, and diversification from concentrated positions or overallocation to a particular asset class. If you may benefit from the above, consider reaching out to your advisor and discussing the details.

About the author: Clint Camua, CFP®

Clint Camua, CFP®, MBA, is Regional Director and Partner at EP Wealth Advisors. He is based in the firm’s West Los Angeles and Westlake Village, California, offices. Clint has almost 30 years of experience in the investment industry. His background spans brokerage and wealth management. Clint promotes sound decision-making among clients, and encourages them to understand their behavioral tendencies. The information provided is not intended to be viewed as individualized investment advice nor is it intended to supersede it. Neither Clint Camua nor EP Wealth Advisors are in the business of providing tax or legal advice. Always consult a tax and legal professional before employing a sophisticated CRT strategy or any other referenced here.


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