Benefits of The Charitable Remainder Trust

A charitable remainder trust is one of the few legal ways to achieve tax exempt investing. The term “tax exempt investing” might lead you to assume that this is about tax exempt municipal bonds. It’s not. It’s about creating a tax exempt entity to be your private investment company. It’s about being able to use highly appreciated assets to exchange on a tax deferred basis for a life income annuity for you and your spouse. What I’m describing is a charitable remainder trust or CRT. 

The key word is "remainder". With a CRT, you will receive an income from the trust for the rest of your life or the joint life or yourself and your spouse. Appreciated assets can be contributed to the trust, free of any capital gains tax. The trust can sell the appreciated assets without having to pay any capital gains tax. The trust can invest its assets to earn interest, dividends or capital gains, free of any income tax. When you and your spouse die, the remainder of the trust assets go to a charity of your choice and those assets are not included in your estate. If you are concerned about leaving something to your children or grandchildren, you can make them the beneficiary of some other assets or life insurance (if you are insurable) or you can make gifts to them of any annual income from the CRT that is in excess of your current needs. 

The only time a tax is paid is when the trust makes distributions to your or to you and your spouse. 

The residue that you leave to the charity can be as little as 10% of the amount you contribute to the trust (plus the income on that portion) or as much as the full value of your contributions to the trust. 

Let’s say that you have some stock worth $500,000 that cost you $100,000. You will have to pay $60,000 in federal capital gains taxes if you sell the stock. That would leave you with $440,000. Assuming your estate already has $1,500,000 of other assets, that $440,000 could be subject to an estate tax of at least $200,000. Your children would get $240,000 out of the $500,000. After you sell the stock, you would get an income of about $24,000 a year - at an average investment return of 6% per year - before taxes. 

If you contribute the $500,000 of stock to a charitable remainder trust in exchange for a lifetime income based on 5% of the value of the assets in the trust each year, you would get an annual income of $24,000 a year and the trust would increase in value by about 1% per year -- based on an assumed investment return of 6%.  However, when you die, a charity would get the remainder of the assets in the trust. If you are single and have no heirs, this is an ideal arrangement. This arrangement is also useful when your heirs already have a substantial estate and do not want to receive any of your estate.

Another benefit of the charitable remainder trust is that you get an income tax deduction based on your age and the rate of income you are paying to yourself. At age 60, you would get a tax deduction equal to about 40% of the value of the property. That would  amount to $200,000. Assuming that you are in the 38.6% federal tax bracket and the 11.4% state income tax bracket, you would save $100,000 in taxes from that deduction. If you are in good health, at age 60, you could buy a life insurance policy with a face value of  $500,000 for a single premium of  $100,000. (That’s just an example.) You’ve used the cash from the tax deduction to replace the assets that would have gone to your heirs, you’ve converted an appreciated asset into a life income annuity without paying a capital gains tax on the capital gain and you have left a generous endowment to a charity or church of your choice instead of leaving it to the IRS. 

And, unless you have hard to value property in the charitable trust, you can serve as the trustee and manage the investments if you wish to do that.  However, you are only permitted to invest in publicly traded securities if you are the trustee. If the trust has assets that are not publicly traded (stock in your corporation, land, an interest in a small investment partnership, etc.), you will need a "special Trustee" to make all decisions regarding the management or disposition of those assets. 

To be completely fair in this example, we should point out that there is no reason why you can’t sell the property, pay the capital gains tax, buy $500,000 worth of life insurance for your heirs and still have some money left over. In truth, a completely impartial comparison of paying the tax and investing the balance versus using the charitable trust will show that you can’t make money by giving it away. But who would you rather leave it to? The IRS or a church or other charity of your own choosing.

It’s either a charity or the IRS.