Tax and Estate Planning with Charitable Trusts

Investment assets have two primary benefits: the income they produce, and their hopefully increasing value. With charitable trusts, charitably inclined investors can support their chosen charity or foundation by donating one of these two components (principal or income), while retaining the other for themselves or their heirs. Once assets are placed in a charitable trust the gift is irrevocable, but if you decide you’re not happy with your original choice of charity or heirs/beneficiaries, you can change that.

One attraction of charitable trusts is that they allow you to liquidate and redeploy assets that make you feel stuck due to large capital gains and a big tax bill if you sell the assets. A charitable trust eliminates that problem; it can sell donated assets with no capital gains tax whatsoever. A charitable trust can be established with cash or stocks, but also with non-publicly traded assets such as real estate, private business interests and private company stock. A common strategy is to donate highly appreciated stock that pays low or no dividends to a charitable trust, which then sells that stock (free of capital gains tax) and diversifies the proceeds among other securities.

Another main attraction of charitable trusts is that when you transfer assets to one of these trusts, you receive a partial income tax deduction. You don’t get a full deduction because the charity doesn’t get all of the money; you’re retaining the future rights to either income or principal, so it’s only a partial gift. Factors that determine how much you can deduct include the type of trust, the term of the trust, projected income payments and IRS interest rates, which assume a certain growth rate for trust assets.

Keep the Goose or the Eggs?

Charitable Lead Trust

Let’s say that you feel strongly about a particular charity. You want to make ongoing donations to it, but it’s important to you that your heirs get all of your assets when you die. You could establish a charitable lead trust (CLT). Once established, the charity would receive an annual payout of a given amount/rate as long as you live (or for a specified number of years). At the end of that period, the CLT would distribute all remaining principal to your heirs.

Charitable Remainder Trust

On the other hand, you might want/need income, and that’s where the more popular type of trust comes in — a charitable remainder trust (CRT). A CRT pays you income — either for a specific number of years (up to 20) or as long as you or your spouse live — and at that point, the principal (remainder) passes to the charity. A CRT is useful if you aren’t worried about all of your assets going to heirs, but you could really use more income during your lifetime. If you are willing to make an irrevocable donation to a CRT, you can receive annual income and a partial income tax deduction.

Types of CRTs

There are two types of CRTs: the charitable remainder annuity trust (CRAT) and the charitable remainder unit trust (CRUT). In either case, the income you receive is taxable, but the difference is in how your income is calculated. With an annuity trust, the amount of the payments is fixed over the term of the trust. With a unit trust, the income is a percentage of the trust value and is recalculated annually. If the assets in the trust are expected to appreciate significantly over time, a CRUT will generally result in higher income payments.

For them to make sense, you must be truly charitably inclined and want to help a cause (religion, education, conservation, etc.) about which you feel strongly. That’s because you must irrevocably give either income or principal of such trusts to charity. If that idea appeals to you, a charitable trust can get you unstuck from highly appreciated assets, provide you with a partial current tax deduction, allow either you to receive income or your heirs to inherit the principal, and enable you to help a charity as well.

While charitable trusts aren’t for everyone, in the right circumstances, they can be a compelling tool to consider.

Published in partnership with Viridian Advisors. Disclosure/Caveat: Viridian provides both tax and financial planning services. This summary is meant to serve as general information, and we encourage you to seek advice from your tax and financial advisors regarding if/how charitable trusts might help you reach your financial goals. Everyone’s situation is unique, and your complete financial picture should be considered before making such decisions.

About the Authors

Bruce Yates has been a financial advisor for almost four decades. He is passionate about helping clients build, maintain and pass on wealth so they can spend their time on family, philanthropy and other interests, instead of worrying about their money. Read more about Bruce Connect with Bruce

For more than 25 years, Doug Custer has helped many families and organizations with their financial planning and investment management needs. Much of his practice includes working with professional practitioners and business owners. Read more about Doug Connect with Doug