A Potentially Tax Efficient, Income Producing Tool for People with $1+ Million Portfolios
It’s no question that planning for the future at a time when you’re no longer around is hard. If you’re like most people, the most important thing is being able to continue to protect the people you love. And for many that have made charitable giving as part of their mission, leaving a legacy ranks high as well. According to a recent survey, the top reasons for creating an estate plan are: 1. to provide for family financially (76.3%), 2. to streamline the inheritance process (65.5%), and 3. to leave a lasting legacy (36.8%).
Good news is that there’s an estate planning tool that may be able to accomplish all three objectives while also providing tax advantages. Charitable remainder trusts (CRTs) can help transfer appreciated assets in a tax-efficient way with the potential to provide income to beneficiaries all while giving to a charitable cause.
The Structure and the Advantages
A CRT is a tax-exempt trust that allows you to donate to the charity of your choice, while provisioning (creating potential income) for a noncharitable beneficiary, such as the creator of the trust or any named individual or group.
Federal estate taxes can be avoided with CRTs because the appreciated property is essentially removed from the estate. Because it is donated to a tax-exempt charity, the sale of the assets is not subject to capital gains taxes. For assets that have appreciated substantially, this can be a way to monetize the asset to the maximum extent and then create a possible long term income stream with the proceeds, leaving behind the remainder to work toward funding a legacy for the charity.
It is important to remember that CRTs are irrevocable, meaning that once tax relief is granted for the sale of an asset, the relief can’t be revoked. The asset is also protected from claims by creditors since the asset is no longer in the donor’s books.
Two Options for Creating a Possible Income Stream
Once a CRT is created, the property is transferred to the trust and its value is determined. The annual income stream (if any) paid out to the beneficiary of the trust can be either a fixed percentage of the value or a fixed dollar amount.
A Charitable Remainder Unitrust (CRUT), calculates the annual payment as a fixed percentage of the initial value of the assets in the trust. The trust is revalued annually, and the payout is recalculated based on the value of the principal assets. The percentage remains the same, but the amount of the annual payout can move up or down, tied to increases or decreases in the value of the principal assets. This means the amount of any income stream is variable.
A Charitable Remainder Annuity Trust (CRAT) also provides an annual payment to the beneficiary, but it’s a fixed dollar amount, based on the initial fair market value of the assets in the trust. This amount remains the same regardless of subsequent valuations.
Remember, in both the CRAT and CRUT, the IRS specifies that distributions to an appointed beneficiary be no less than 5% and no more than 50% annually. Furthermore, the charitable organization must receive at least 10% of the initial donation you made to the trust.
The terms of termination of the trust are determined by the trust document, and the remainder of the trust’s assets are then transferred to charity.
Conclusion
As with most estate planning tools, there is a level of complexity. When it comes to passing down wealth, it’s important to ensure your goals are considered. If desired, assets can be more appropriately and efficiently transferred while incorporating charitable intent which may help high-net worth and accredited investors in a variety of ways.
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