Charitable remainder trusts are an excellent way to provide for your beneficiaries well into the future, removing assets from your taxable estate and accompanied by tax benefits. But what are the charitable remainder trust distribution rules that govern how much you or a loved one can pull from the trust?
This guide will walk you through the seven rules everyone should know before they set up the legal framework for one of these trusts. Preparation is key, so know the ins and outs of how these trusts are set up and how they function.
1. Your Payout Calculation Depends on the Type of CRT
Did you know that charitable remainder trusts aren’t all the same? The two broad categories arecharitable remainder annuity trusts (CRATs) and charitable remainder unitrusts (CRUTs). Each has advantages, but the major difference lies in how payouts are structured.
CRATs give beneficiaries a set payout based on a fixed percentage of the initial value of the trust. This allows them to know exactly what they will receive each year, making it easier to plan for the financial future. Payments will continue until the end of the trust.
CRUTs are a little different. They pay a fixed percentage of the value, as determined annually. This means that some years may see payments that are greater than others, depending on the overall performance of the assets within the trust.
2. You Must Meet Payout Requirements
When it comes to the payout, there are rules governing both the minimum and maximum amount you can pull from a charitable remainder trust. CRATs and CRUTs have minimum distributions of five percent, calculated either upon the establishment of the trust (CRATs) or the annual value (CRUTs).
However, maximum distribution limits also exist. This prevents someone from pulling all of the funds out of the trust in one fell swoop. The IRS caps all distributions at 50 percent of the trust’s assets. In general practice, however, payouts are usually in the 5-8 percent range.
3. You Must Donate at Least 10%
The benefits of a charitable remainder trust are many, but you negate all of them if you do not follow through on its primary purpose: to benefit a charity or charities of your choosing. The remainder interest allocated to charity is calculated at the creation of the trust, and must be at least 10 percent of the value of the trust at inception. The actual remainder interest that’s paid out to charity will almost certainly be more or less.
4. Distributions May Be Subject to Taxes
The distributions that are taken out of a charitable remainder trust may also be subject to taxes. While you can take a tax deduction for donating assets to a CRT, the payments stemming from those assets are paid in distributions, part of which may be taxable as ordinary income or capital gains. This means that beneficiaries will be responsible for filing a Schedule K-1. The trustee issues a K-1 to each beneficiary annually spelling out their tax liability, if any.
Most frequently, the income stemming from the trust will be taxed as “worst out, first out,” which means ordinary income will come out first as long as the trust had ordinary income and undistributed ordinary income in previous years. If all ordinary income has been depleted, then capital gains may play a role in distributions. Once all ordinary income and taxable gains have been paid out, then principal may be paid out, which is nontaxable.
5. Trust Funds Cannot Be Used Before Distributions
When you know that the trust has the funds to pay for a major expense, beneficiaries or even the trust owner might think about dipping into those assets. However, donors and beneficiaries may not pay any personal expenses with trust funds. Furthermore, they cannot borrow any funds from the trust for any reason.
All funds must be distributed before you can treat them as your personal income
6. Self-Dealing is Strictly Prohibited
Self-dealing is a tricky aspect of charitable remainder trusts that you should think about when naming an executor and your beneficiaries. Self-dealing takes place when an executor wants to buy something out of the estate after your passing. This could cloud their judgment, allowing their personal interest in the estate to conflict with the interests of beneficiaries.
Why is self-dealing such a big deal in estate planning?
Suppose that you had an antique automobile in your trust. Your executor, your son, wants to keep the car in the family and wishes to purchase it from the estate. It is in his best interest to pay the lowest price possible, while your beneficiaries want top dollar.
The two are at odds, which is why self-dealing is prohibited. Think about a situation like this before setting up your trust to ensure that everyone receives what you want them to have. Remember, there are at least two other interested parties involved in your trust: the charity and the IRS.
7. The Trust Cannot Be Altered
Establishing an irrevocable trust means you have to think about future-proofing it from the outset. A charitable remainder trust is an irrevocable trust, meaning that you cannot make changes to it once the ink has dried on your paperwork. Make certain the terms are how you want them before you sign.
Work with a professional like Magellan who can write some flexibility into the terms during the creation process. We have seen almost everything that could go wrong, and we know how to avoid it – or at least plan for it. This will give you a little bit of wiggle room down the road for events like death, disability, divorce, or disappearance. That’s right; if you disappear on your Amazon cruise, we have a provision for that.
Consult with Magellan
Are you ready to set up your charitable remainder trust so your beneficiaries can benefit after your passing? Work with Magellan because we are experienced in all aspects of trust creation. Our skilled team offers estate, financial, legal, and tax planning all under one roof for convenience and comprehensive planning.
Reach out to us today to book a consultation and see if charitable remainder trusts are right for you!
For a comprehensive review of your personal situation, always consult with a legal or tax advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.
This material provided by Kevin Meaders was written by Axle Eight, a non-affiliate of Magellan Planning Group and Cetera Advisor Networks LLC.