A charitable remainder trust or (CRT) is a type of irrevocable trust that allows the person who creates it (called the “Grantor”) to receive income from the trust and even split the income with other beneficiaries for a period of time. After the period expires, the assets that remain in the trust are gifted to the Grantor’s favorite charity or charities.
The Grantor and non-charitable beneficiaries who receive income before the remainder passes to charitable beneficiaries are referred to as “Lead Beneficiaries.”
A CRT is referred to as a “split-interest” trust because it allows the Grantor to donate to charity and save on taxes while gifting money to other beneficiaries. The Grantor receives a partial tax deduction based on the remaining trust assets received by the charitable beneficiaries.
How Long is the Period of Time that the Grantor and/or Beneficiaries Receive an Income Stream?
A Grantor can arrange for himself and/or other beneficiaries to receive a potential income stream from the CRT for a period of time not to exceed 20 years or the life of one or more non-charitable beneficiaries. The remaining assets then pass to the named charitable beneficiaries.
There is also an actuarial value component. The remainder that passes to the charitable beneficiaries must be at least 10% of the initial CRT value established at the time of funding. The 10% test creates a minimum amount or floor that must remain in trust for the benefit of the charitable beneficiary.
If the Lead Beneficiary very young, the CRT may fail the 10% test. The 10% test depends on three elements:
- The term of the CRT or for lifetime CRTs, the life expectancy of the Lead Beneficiary.
- The amount of the annual payment.
- The Internal Revenue Code 7520 rate that is defined as 120% of the federal midterm interest rate (which in November 2022 is 4.80%).
In a high interest rate environment, a CRT strategy becomes more favorable because higher rates can reduce the actuarial value of the taxable gift. If the trust does not meet these requirements, it can be reformed to meet legal requirements.
What are the Two Types of CRTs?
There are two types of CRTs.
- A Charitable Remainder Annuity Trust (“CRAT”) is a type of CRT where a fixed annuity payment is distributed annually and no additional contributions to the trust are allowed.
- A Charitable Remainder Unitrust (“CRUT”) is a type of CRT that distributes a fixed percentage of the assets to the beneficiaries based on the trust balance, which is updated or “revalued” each year. With a CRUT, the Grantor can make additional contributions.
For both the CRAT and the CRUT:
- The Grantor contributes an irrevocable transfer of money or property.
- The Grantor and/or his named non-charitable beneficiaries then receive a portion of the income.
- The amount of the trust assets that must be distributed whether as fixed payment (CRAT) or fixed percentage (CRUT), must be not less than five percent of the value of the trust assets and must not exceed 50 percent of the value.
- The payments must be made at least annually (more frequently is allowed).
- When the CRT expires, the remaining assets pass to charitable beneficiaries.
How Does a CRT Work?
A Grantor transfers a highly appreciated asset to a CRT. When the CRT sells the asset, the CRT is not subject to capital gains tax, which preserves the full value of the asset within the trust. The proceeds of the highly appreciated asset sale may then be invested in a diversified portfolio. The capital gains taxes are eventually paid but are spread out and payable when the Lead Beneficiaries receive income from the CRT. As mentioned above, the Grantor also receives an immediate tax deduction.
Where Can I Get More Information?
To create a charitable remainder trust, you should consult with a qualified California estate planning attorney. Call the Law Office of Jonathan Alexander at (949) 334-7823 to set up your CRT today.
To learn more about Mr. Alexander, his practice, and his estate planning philosophy click on the link to his bio here.
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