Looking at your portfolio, you might notice that you have some highly-appreciated assets that will cost you a small fortune in capital gains taxes if you sell. Tax shelters can help offset some of the tax debt that you will incur if you were to sell those assets outright. In particular, many people turn to charitable remainder trusts.
Are CRTs still a legal tax shelter, and how do they work? This guide will help you decide if it's time to establish a trust of your own!
What is a Charitable Remainder Trust (CRT)?
When it comes to long-term financial planning, a charitable remainder trust may be the ideal vehicle to maximize your assets and defer the tax burden for beneficiaries. CRTs are irrevocable trusts where you can contribute cash, as well as highly appreciated assets like real estate or stocks.
From here, the trust can provide a source of income for your beneficiaries while the remainder of the trust is donated to a charity of your choice, sometimes not until 50 years or more.
How CRTs Function as a Tax Shelter
Deciding whether or not charitable remainder trusts are the best move for your beneficiaries and your financial legacy is only the tip of the iceberg. You will also need to ensure that it makes the biggest impact as a tax shelter for the assets you want to contribute. There are several ways in which these irrevocable trusts serve as an efficient means of reducing tax debt.
First, the cash and assets that you contribute to the trust are removed from your taxable estate. In the year that you contribute to the CRT, you receive an income tax deduction for your gift. It also minimizes any estate taxes that your beneficiaries may have to pay upon your passing.
Second, it allows you to sell highly appreciated assets without incurring capital gains taxes. As the assets are sold, you retain the full value of the sale and can then reinvest those funds to grow the income for yourself or your beneficiaries or create a larger earmark for the charitable giving of your choice.
Is a CRT a Good Tax Shelter Fit for You?
Now that you know why charitable remainder trusts are beneficial, it is time to consider whether they are the right move for you. If you have highly appreciated assets that you would like to take out of your estate right now for an immediate tax deduction, CRTs are often a strategic move. It will defer 100 percent of capital gains from the sale of those assets.
In turn, the trust can continue to generate a diversified income stream for your beneficiaries. You decide whether to parse that income out over a set period or for their lifetime. At the end, all of the remaining funds achieve a massive philanthropic legacy by donating to the charity that you have carefully selected.
Of course, you must remember that a CRT is an irrevocable trust. The main downside of an irrevocable trust is that once assets are placed in the trust, they cannot be pulled out. This means that you must be certain about what you want to remove from your estate before signing on the dotted line of the trust formation. The remainder will also go to charity—not your kids, beneficiaries, or heirs.
If you do decide that a CRT is the right move for you, this is not something to DIY. Setting up a CRT comes with costs andrequires thorough legal and financial planning to establish it properly.
What are Some Tax Shelter Alternatives?
While charitable remainder trusts may be the most tax-advantaged, there are other options out there if they are not the right move for you. Here are three other strategies you might employ or talk to your financial planner about.
Donor-Advised Funds (DAFs)
Donor-advised funds are another great vehicle when CRTs are not the right fit. As with charitable remainder trusts, they provide an immediate tax deduction for the assets you contribute. If you have one excellent year, you can even bunch donations and make up to five years of contributions in a single calendar year.
While the assets are part of the DAF, they enjoy tax-free growth.
DAFs are a great thing to combine with CRTs, especially if you are unsure where to donate funds when the trust ends. Naming a DAF as your charitable beneficiary is a powerful strategy that lets you leverage the tax advantages now and make recommendations for grants at a later date.
Max 401(k), IRA, and HSA Contributions
These types of savings accounts aregreat ways to create a well-rounded financial plan. While they may not be tax-sheltered, they are tax-deferred. You contribute your pre-tax dollars now, allow them to continue growing, and pay the taxes later on down the road when you may be in a lower income tax bracket.
They do not allow for the capital gains tax savings, but are still a powerful part of your overall tax strategy. And because these assets have never been taxed, they make an excellent choice for charitable giving, such as the Qualified Charitable Deduction (QCD).
Tax Loss Harvesting
Tax loss harvesting is more of a strategy than a shelter. If you’re concerned with the capital gains you expect to incur, this is a straightforward strategy to helpminimize tax liability. When you have realized capital losses, you use them to offset the exorbitant capital gains that might have occurred in the same tax year. Losses can then be used to offset ordinary income (but only up to $3000 per year) and can carry over indefinitely to future years.
Navigate Your Tax Strategy with Magellan
Whether you decide on a charitable remainder trust or one of the other tax shelter alternatives, you need to ensure that you are making the right move for your estate and portfolio. Magellan can help you with comprehensive estate, tax, financial, and legal planning, all under one roof for a one-stop shop to form your estate plan.
Contact us today to set up a meeting to discuss which of these strategies and shelters are right for you!
For a comprehensive review of your personal situation, always consult with a tax or legal 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.