There are types of strategies that when executed properly, can financially support charitable organizations you are passionate about and provide you with significant tax benefits. Most of our clients are familiar with donating cash or appreciated stock directly to charity or even using a Charitable Donor Advised Fund as a conduit for their philanthropic goals. These are great strategies that allow the charities to benefit from the donations while providing tax and “feel good” benefits to the donor. Every donor’s financial situation is unique and sometimes a more complex charitable giving strategy is appropriate. Charitable Remainder Trusts (CRTs) are a good tool to consider using to address charitable goals while also taking into consideration other financial planning goals.
How do Charitable Remainder Trusts work? At a high level, appreciated stock or assets are transferred from the donor into the charitable trust. Once the stock or assets have been transferred into the trust, the donor can then sell the assets and build a diversified portfolio without incurring immediate taxation on the capital gain. On the trust’s anniversary date a pre-determined annuity payment will be made back to the donor for a specific period of time. At the end of the trust’s term, whatever amount is left in the trust then gets passed through to the ending charity(s).
This is certainly a bit more complex than just giving to charity outright, so who may this be most appropriate for?
- Investors who hold a significant portion of their net worth in an asset that is highly appreciated and they wish to diversify – the charitable remainder trust allows for an immediate reduction in the asset concentration without incurring an immediate large taxable gain.
- Investors who are charitably inclined but who either do not want to, or cannot afford to, permanently lose access to the full value of the appreciated asset they will donate.
- Investors who are interested in converting a highly appreciated asset into a tax efficient source of income.
- Investors who could benefit from a large charitable deduction in the year they fund the CRT.
As is true with most financial planning strategies, there are features to the charitable trust which should be discussed prior to implementing the strategy. While by no means inclusive, some things to consider are:
- Life expectancy – the trust will make annuity payments back to the donor over the course of their lifetime. In order for the cumulative annual payments to equal the market value of the initial donation, a break-even calculation can be run to determine how long one needs to live to recover their initial donation. Generally speaking, time is needed for the benefits to accrue. If life expectancy is short another strategy may be a better choice.
- Desire to sell the appreciated asset. The charitable remainder trust is not appropriate unless there is a desire to sell the appreciated asset for diversification purposes once it is in the trust.
- Illiquidity- gifts to a CRT are irrevocable and funds within the trust will only be available to the extent an annuity payment is due. You should be sure that your financial plan has enough liquidity in other areas to provide you with flexibility, should you need access to liquid assets.
In terms of the annual income stream this can be structured to pay out a fixed dollar amount (a CRAT) or a fixed percentage of the trust (a CRUT) each year. The level of charitable deduction generated in the year the CRT is funded will be a function of the annuity structure and the timeframe of the trust. Tax only comes into consideration as payments are made out of the trust back to the donor.
Let’s explore a hypothetical example to illustrate how could work:
Assume an investor has $1 million of stock that they initially paid $250,000 for. At the time the stock is donated into the trust and sold, the trust realizes a gain of $750,000. However, it is not taxed immediately. Let’s assume on each anniversary date the CRT makes a $100,000 payment back to the donor. The $100,000 distribution will be taxed based on how the CRT earned the income with interest, dividends, and capital gains being taxed at their respective rates. This taxable exercise happens each year until the full deferred gain is paid out and taxed, which emphasizes the importance of managing the trust as tax-efficiently as possible. Once the deferred gain has been fully paid out, the future annuity payments will be taxed as a portion of dividends, interest or capital gains generated within the trust while the remainder would be paid out tax free as a return of principal.
If you are interested in diversifying a highly appreciated concentration in your portfolio in a tax efficient way while benefiting a charity(s), please contact your wealth advisor to discuss Charitable Remainder Trusts.
Important disclosure information
Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.
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This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.
RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.