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How do Charitable Remainder Trusts Work?

How do Charitable Remainder Trusts Work?

December 20, 2022

Chances are that you want to create generational wealth for your children in the years following your death. If you have high-value assets now, you might consider selling them to contribute the proceeds to an account for this purpose. However, you might be subject to high taxes on these sales that can eat into what the asset is truly worth. 

What can you do to protect your assets and pass on as much value as possible to yourself or to the next generation?

A charitable remainder trust could be the solution that you have been searching for. All of your highly appreciated assets that are exposed to taxes can be designated into this type of account. Learn more about CRTs here to help you decide if this financial move is the right choice for you. 

What is a Charitable Remainder Trust?

There are two types of charitable trusts that you might choose to open: an annuity trust (CRAT) or a Uni-Trust (CRUT). To give you a better idea of which one is the right fit for you, here is a short breakdown of what you can expect.

Charitable Remainder Annuity Trust (CRAT)

Of the two types of trust, the CRAT is the simplest to understand because of its easy pay structure. In this arrangement, you may donate assets to a trust and then choose to donate to a specific charity or multiple charities. Additionally, an annuity will be granted to a beneficiary apart from the charitable donations.

It will pay out a specific dollar amount each year, which never changes even when the principal of the trust increases or decreases. The annuity paid out to non-charitable beneficiaries is based on a percentage of the initial value of the assets. Usually, it comes in between 5% and 50% of the initial value of the account.

These accounts can remain open for life or a term of up to 20 years. After this point, any remaining assets are donated to the charity or charities of your choosing.

The only downside to the CRAT is that you must fund it all upfront. Once the CRAT is established, you will not be able to add more assets to it. If you think that you would like to continue making contributions to an account, then you may be better suited with a CRUT.

Charitable Remainder Uni-Trust

The CRUT is a little different than the CRAT, mainly in how the payouts are made to beneficiaries. With this type of account, the payout percentage is fixed but the annual payment may be higher or lower depending on the overall principal of the account. This means that it is a given that the amount paid to non-charitable beneficiaries is going to change from year to year.

One of the benefits of a CRUT is that it can continue to gather assets over the years. Every subsequent donation yields the tax benefits, no matter when the account is made.

Ways to Fund a CRT

The good news is that there are many different ways that you can fund your CRT. Contributions to a CRT run the gamut, but they are usually highly appreciated assets with exposure to taxes and include only those assets where you have a clear title. 

That means that you can contribute any number of real assets, including:

  • Antique or vintage cars
  • Stock
  • High-value fine art
  • Residential real estate, commercial real estate, or raw land
  • Coins and stamps
  • Antiques and other rare instruments 

Keep in mind that you can only fund a CRAT once, so you will need to donate everything you are considering at the outset.

How You Can Use CRT Payments

CRT payments can be used for whatever your heart desires – or whatever your beneficiary may want to do with them. The assets that are contributed to a CRT must be liquid since payments often start immediately. However, they are sheltered from taxes though the beneficiary may be subject to taxes on the amount received.

You can name anyone as a beneficiary of your CRT, including a spouse or children. That person will receive payments each year and will be subject to a four-tiered tax system. This means that you and your beneficiaries will want to work with experienced tax professionals to ensure that they are taking advantage of all the tax benefits of a charitable remainder trust.

Of course, there are some illegal uses of CRT funds that you will want to keep in mind in the next section.

Illegal Uses of CRTs

The IRS has several rules for how funds cannot be used when it comes to CRTs. It isn’t hard to comply with their regulations and rules, but it helps to be abreast of them to make the best use of your trust. 

For example, here are a few of the things you cannot do with a charitable remainder trust:

  • Inflate the basis of an asset to market value to minimize or eliminate capital gains or ordinary income
  • Fail to account for the sale of assets in the trust
  • Characterize distributions of ordinary income as distributions of the principal
  • Administer payments to non-charitable beneficiaries outside of the trust language
  • Transfer funds to organizations that are not tax-exempt
  • Make cash payments instead of remainder interest

Donors and beneficiaries face a few additional restrictions, including an inability to pay personal expenses with the trust and an inability to borrow from it. You cannot change the nature of payments from ordinary income or capital gains, and you cannot use loans or forward sales of the assets to hide capital gains and income from the trust. 

Get Started Today

Navigating the setup for your charitable remainder trust requires the assistance of an experienced partner. Magellan is the natural choice to help you set up your CRAT or CRUT. We are perfectly positioned to assist you with the legal aspect of setting up your trust as well as the taxes required. As fiduciaries, we always operate in your best interest. 

Give us a call to learn more about how we can help you set up your charitable remainder trust annuity today!