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Estate planning with heart
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September 10, 1999: 6:41 a.m. ET
Charitable remainder trusts let you do good -- without slighting your heirs
By Staff Writer Nicole Jacoby
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NEW YORK - Benevolence and self-indulgence rarely go hand in hand. But when it comes to estate planning, they can be a winning combination.
Charitable remainder trusts, or CRTs, can benefit you and your favorite cause by linking generous tax incentives to charitable donations at the end of your life - without slighting your heirs.
"Charitable remainder trusts are the estate planning tool that let you have your cake and eat it, too," said Marcee Yager, a San Mateo-based certified financial planner.
Setting up a charitable remainder trust is no simple task, however, as it can involve a wide array of choices and legal processes along the way. So those with a low threshold for consternation -- or less than charitable motives -- may want to think twice before climbing aboard.
How it works
Charitable remainder trusts have two sets of beneficiaries: income beneficiaries, who receive a set percentage or fixed amount of income from the trust during the course of their lifetime, and a designated charity, which receives the bulk of the estate after the income beneficiaries pass away.
Most people establish themselves - and their spouses -- as the trust's income beneficiaries. Under certain conditions, the person setting up the trust can act as its trustee, maintaining full investment control of the assets inside the CRT.
CRTs are irrevocable, so once you have committed, there is no turning back. You can, however, change the charity beneficiary during the course of the trust. Almost any type of asset -- from real estate to stocks and bonds -- can be placed in a charitable remainder trust.
The greatest benefit of CRTs is that they allow the income beneficiaries to escape capital gains taxes. Because CRTs are exempt from these types of taxes, they are ideal for investors whose assets have a low cost basis but a high appreciated value.
An individual who scored big in the Internet free-for-all of recent years, for instance, might consider using a CRT as a tax-free way of cashing on these highly-appreciated shares.
Because of their tax perks, CRTs are often used as retirement planning tools or to diversify a portfolio with highly-appreciated assets, since the savings rendered by the avoidance of capital gains tax can be reinvested in higher-yielding assets. And unlike 401(k)s or IRAs, there are no limits to how much you can contribute.
Aside from capital gains breaks, CRTs also offer tax deductions.
CRTS are not subject to the usual annual gift limits, so trustees can deduct the present value of the remainder interest to the trust. That figure is calculated by the Internal Revenue Service based on the grantor's life expectancy or term of the trust, current interest rates and the rate used to calculate annual payments for the income beneficiaries.
Deductions cannot exceed 50 percent of your gross adjusted income, but any deductions not used in the year of contribution may be carried forward for the next five years.
A final advantage of CRTs is the control these trusts give individuals over so-called "social capital."
The concept of social capital dictates that everyone gives back to society in one way or another, usually through taxes, which Uncle Sam spends as he sees appropriate. A CRT permits individuals to redirect those funds as they see fit, its proponents argue.
"This way you have a say where that money is going. It's not just indiscriminate," said Rochester-N.Y.-based certified financial planner Jack Best. "You may get more personal satisfaction by giving a charity that means something to you."
Narrowing your options
CRTs can be set up in various ways.
"A trust is just a contract, so you can write it any way you want," said Yager. "It's quite a large field. You've got a lot of breadth in how you want to use this tool."
The two primary types are charitable remainder annuity trusts, or CRATs, and charitable remainder unitrusts, or CRUTs.
CRATs provide a fixed payment regardless of how the assets in the trust behave, while CRUTs pay a fixed percentage of the fair market value of the trust's assets.
The CRUT has the advantage of protecting against inflation. But some elderly trustees, whose inflation concerns may be less urgent, may choose CRATs.
CRUTs also allow continued contributions, so you can build up your assets in the trust over time. CRATs, on the other hand, are a one-shot deal and may be well-suited for individuals who receive a windfall that they want to invest or protect.
Charitable lead trusts are another option. Like CRTs, these trusts offer income tax deductions and lower capital gains liabilities. But they are set up in reverse, with the charities acting as the income beneficiaries, receiving a stream of income during the owner's lifetime. At the owner's death, the bulk of the CLT's assets go to a named beneficiary.
These are far less common than CRTs, but can be advantageous under certain circumstances. For example, CLTs may help individuals who want to leave their estates to their children, for instance, but are in dire need of a tax break because they exercised a heavy number of stock options or sold several properties. Contributions to a CLT can vastly lower their tax liability without greatly impacting their estate in the long run.
Win-win
CRTs often work best when combined with other strategies, especially if you want to provide for your heirs while helping your favorite cause.
And CRTs don't necessarily have to reduce the amount originally intended for your heirs if you play your cards right. That's because the money saved through a CRT -- through tax deductions and capital gains breaks - can be applied to your heir's inheritance through other means, such as life insurance.
For instance, the trustee places into a charitable remainder trust a rental property whose current fair market value is $1 million with a cost basis of $50,000. The trust then sells the property, saving in excess of $250,000 in capital gains taxes, leaving more proceeds available to generate the income necessary to pay the income beneficiary.
This "added" income can be used to purchase a life insurance policy or -- better yet -- to set up an irrevocable life insurance trust for your heirs. This "wealth replacement trust" has the added benefit of being sheltered from estate taxes.
There is one caveat, however.
"If the parents aren't healthy and can't pass a life insurance exam, then this strategy might not be that useful," Best said.
Proceed with caution
Despite potential benefits, CRTs are not for everyone.
For one, there are conditions. Annual payments must be at least 5 percent of the value of the trust's assets, but cannot exceed 50 percent. And the present value of the amount going to the charity must be at least 10 percent of the amount contributed.
Because of these and other complex conditions, individuals in their 20s and 30s are usually limited to CRTs with fixed terms of up to 20 years -- rather than lifetime terms, meaning they will outlive their the income stream provided by the trust.
Younger individuals are less likely to benefit from the tax deductions resulting from CRTs since those are figured from IRS tables based on age. The older the donor, the larger the deduction.
Finally, CRTs involve a lot of paperwork, requiring legal documents and approvals of all sorts. So individuals who aren't committed to helping a charity may get frustrated.
"This is a pretty complicated process and there is this mixed motive," Yager said. "People really need to work out why they want to give money in the first place."
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