Presented by: Damon Colusci
Each year, taxpayers tally up the gifts they have made to qualified charities for the purpose of claiming an income tax deduction. But did you know that a current tax deduction isn’t the only financial benefit available for a gift to charity?
Through a Charitable Remainder Trust (CRT), it may be possible to receive a charitable deduction for your gift to your favorite charity, while also receiving lifetime income. You can also avoid paying capital gains taxes on the sale or disposition of appreciated securities or other property with effective CRT planning. In addition, a CRT can play an important role in your estate and retirement planning.
Lose Ownership, Gain an Income
You set up a CRT by establishing an irrevocable trust and transferring assets such as cash or securities into it. “Irrevocable” means that you permanently give up ownership and control of assets which will then be sold by the tax exempt trust, and re-invested to provide you with enhanced income.
A qualified attorney can write the trust document to specify the terms you want, including the term and remainder interest beneficiaries who will benefit from the trust’s assets and earnings:
- One or more income or “term” beneficiaries are chosen to receive annual payments from the trust based upon a fixed % of the value of the property transferred to the trust. The trust term can be based upon either a fixed number of years (up to 20) or a one more individual’s lifetimes. For example, you could name yourself and your spouse as joint lifetime income beneficiaries, assuring income for the rest of your lives. The trust can even be designed to defer your payments, and tax on your payments, until a future need arises (e.g. post retirement years, college funding, etc).
- One or more charitable beneficiaries are named to receive the “remainder” of trust assets at the end of the income payout or trust term. Following the trust term, typically after the death of the last lifetime income beneficiary, the remainder passes to the charitable remainder beneficiaries.
Upon funding the trust, you are entitled to receive a current charitable income tax deduction based on the projected future value of the remainder interest that will pass to charity at the end of the trust term. This deduction may be used to offset your current income, up to 30% of your adjusted gross income (AGI), and any unused deduction may be carried forward for up to the next five years.
Avoiding Capital Gains Tax On Sale of Appreciated Property
What is the best way to fund a CRT? Many tax professionals suggest that you transfer ownership of appreciated securities such as stocks and bonds. If you sold these assets outright, you would owe a capital gains tax on any appreciation, but this tax can be avoided when the assets are transferred to your CRT, and subsequently sold by the trust. Once the CRT receives the securities or other property, the trustee disposes of them and reinvests the proceeds, undiminished by capital gains tax, typically in assets with higher yield potential or more diversified investments to help provide you or other term beneficiaries with enhanced income. Since trust itself is a tax-exempt entity, it does not incur capital gains tax on the sale.
Since CRT rules are complex, you must hire a qualified attorney to draft your trust document and a professional administrator to ensure proper administration of the trust. It’s important to remember that expertise of these professionals are essential to the successful planning and operation of the trust.
Federal rules require you to choose an income payout rate that realistically can leave a remainder to charity. However, by specifying that your CRT is a “unitrust,” your future income will be calculated each year as a fixed percentage of the trust’s current fair market value. If that value increases over time with investment performance, your income also can increase.
One Gift Provides Several Rewards
Many reputable charities welcome CRT remainder gifts, and they will appreciate your generosity. In addition, any assets passing from a CRT to a qualified charity at the end of the trust term, are not subject to federal gift or estate taxes. This can simplify matters for your heirs and reduce your ultimate estate taxes.
A CRT can have one planning drawback. By itself, it isn’t designed to leave any of the remainder interest to children or grandchildren. However, this problem can be solved by using a portion of the trust income, or income tax savings generated by your trust contributions, to pay premiums on a life insurance policy that names your children or grandchildren as beneficiaries. Adding this concept to your CRT planning can “convert” assets for heirs, that otherwise would have been taxable to them, into an income tax-free and estate tax free legacy.
In summary, your financial advisor, working in coordinated effort with your attorney and tax advisor, can help you design a CRT strategy that meets your personal objectives, including steady current income, rewarding favorite charities, saving taxes, and ensuring a legacy for your loved one as well.
The information above is for educational purposes only and should not be considered specific financial or legal advice. Always, consult with a qualified advisor regarding your individual circumstances. Investing involves certain risks, including loss of value.
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Primary Care Financial Group and 21st Century Financial are independent of HTK.
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© 2016 The Penn Mutual Life Insurance Company, Philadelphia, PA 19172