Grace B. Ghezzi, a self-employed Financial Consultant, focuses her practice on financial planning, estate and retirement planning, income tax planning and fraud examination. She has been in the tax and financial planning areas for over 40 years.

If I told you there was an estate planning strategy that could lower your income tax and increase your annual income for the rest of your life, would you be interested in hearing more? The answer is most likely yes. If the circumstances are right, a charitable remainder trust (CRT) can be a strategy that not only achieves those benefits, but can be an overall great addition to your financial toolkit.

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Before diving into the details that make a CRT a useful strategy, let’s go back a step to the basics. A CRT is an irrevocable trust, meaning it’s a trust where the terms cannot be changed and are typically created to support beneficiaries during one’s life in a tax-efficient manner. Once created, assets such as property or investments are transferred into the trust, which then generate income for the donor (or other beneficiaries). The remainder of donated assets are gifted to a charity of choice.

There are two types of CRTs: a charitable remainder annuity trust (CRAT) or a charitable remainder unitrust (CRUT), with each having their own stipulations and variations.

To decide which type of CRT makes sense for you, it’s worthwhile to have a conversation with your estate planning attorney and financial advisor to ensure the strategy supports your overall financial and estate planning goals.

Who is involved?

In addition to your team of professionals, there are additional parties involved with the CRT. The grantor (you) creates and funds the trust. The non-charitable income beneficiary receives income for up to twenty years or life. A trustee is responsible for the trust management. The trustee has an important job. They must invest the trust assets to generate both growth and income, file the tax return, make payments to the income beneficiary, pay trust expenses, prepare an annual accounting, and manage the trust to accomplish these objectives. Finally, the charity receives the remaining assets at the end of the trust term.

Keys to success

Setting the right term is a critical aspect – especially since irrevocable trusts cannot be amended. The general rule of thumb is that the term can be up to 20 years or the life of one or more beneficiaries. Here are some considerations:

• If you want a guaranteed payout, then 20 years may be your preference.
• If you choose lifetime income and unfortunately pass away soon thereafter, the income will end earlier than expected.
• If lifetime income is more important, then a lifetime payout may be better for you.
• If you are married, the trust document can specify that the full payment continues for both spouses' lifetimes.
• If you plan to leave the rest of your estate to children and their descendants, they will likely receive less.

Of course, the tax benefits and additional lifetime income you have received must be factored into this financial analysis.

You may be of the Warren Buffet mindset: that you would like your children to receive enough of an inheritance so that they can do anything, but not so much that they could do nothing. If you want your children to be made whole, consider buying life insurance with a portion of your annual income. It can be purchased by an irrevocable life insurance trust that, if properly structured and managed, can avoid probate, income tax, and estate tax.

When the trust term ends, the assets are transferred to, or for the use of, an organization. This can include organizations or Private Non-Operating Foundations. It can also be a church or convention of churches, an educational institution, or medical research or medical care/education.

A trust is not complete until it’s funded. One approach you may want to consider if you were funding a CRT with property or a closely held business, is selling a portion of your assets in your name, and a portion in the CRT. In that way, you would have some of your proceeds available in a lump sum, and some in the CRT providing income. The tax savings on the CRT can offset the taxable portion of your transaction. Get creative!

After the trust is funded, income in the range of 5%–50% must be paid at least annually, and typically quarterly, to the non-charitable beneficiary, such as you, or you and your spouse.

One of the benefits of a CRT is the ability to reduce your income tax. A charitable income tax deduction is received in the year the trust is funded, equal to the net present value of the remainder interest that the charity receives at the end of the period. The CRT must be funded with long-term capital gain property to generate a charitable deduction for the full fair market value on the date the assets are contributed. In addition to the charitable deduction, if you fund the trust with appreciated assets that are sold after they are titled into the CRT, the sale of the property does not create an immediate taxable event. These two tax benefits can save you a substantial amount of money in the current year.

When income distributions take place, it is taxable to the income beneficiary based on the character of the income in the trust, worst case first – ordinary income, then capital gains, then tax-exempt income, and lastly, return of principal (which is not taxable). The trust files an income tax return IRS Form 5227. A K-1 form is generated, which shows the amount and character (e.g., ordinary income, long-term capital gain, short-term capital gain, etc.) of reportable taxable income each year. If the income earned by the CRT is less than your distribution amount, principal is invaded, so that you still get paid in full.

How to Prepare to Create a Trust

Trusts are a common tool used in estate plans to detail out your wishes and legacy making it a powerful document for loved ones handling your estate. Creating a trust can seem overwhelming, but our simple checklist will break down the process for you.

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Who does a CRT make sense for?

Well, there are two situations that merit consideration for this type of trust. The first is if you are about to incur a large taxable event. This could be the result of a sale of a closely held business, performing a substantial Roth IRA conversion, planning for the sale of a highly appreciated asset such as real estate or investments, or contemplating diversification of your holdings. A charitable remainder trust pays no income tax, which allows the trustee to reinvest the full amount of the proceeds and generate larger payments to you.

The second is if you currently have a bequest under your Will would lower your taxable estate, but it would not reduce your income tax. A charitable remainder trust will generate both benefits.

There are many more details and rules that are beyond the scope of this article. Don’t let that dissuade you from exploring this opportunity. The article is focused on the planning techniques that are available so that you can discuss this with your financial and estate planning professionals.

A CRT can be a great strategy to provide ongoing income and save income tax. Perhaps it can be structured to fund the CRT with sufficient appreciated assets, along with social security, to create a desired income stream. Your attorney, CPA, CFP, and investment and insurance advisors can be of utmost importance in quantifying these calculations. Your charities can indicate if this is a strategy they would accept.

It is important to pass your assets in the manner you desire. Look at this from both a lifetime and dispositive perspective. If it accomplishes your goals both during your lifetime and at your death, then you owe it to yourself to run the numbers and determine whether it is worth considering.

Manning & Napier is not affiliated with Grace B. Ghezzi Consulting, LLC.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP® and CERTIFIED FINANCIAL PLANNERTM in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.

Please consult with an attorney or a tax or financial advisor regarding your specific legal, tax, estate planning, or financial situation. The information in this article is not intended as legal or tax advice.

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