How to Secure a Lifetime Income, Save Taxes & Benefit a Charity
1.
What does a CRT do?
2. How does a CRT work?
3. Why not sell the asset myself and re-invest?
4. What happens if they use a CRT?
5. What are my income choices?
6. Can I receive a fixed income instead?
7. Who can receive income from the trust?
8. Do I have to take the income now?
9. How is the income tax deduction determined?
10. What kinds of assets are suitable?
11. Who should be the trustee?
12. Do I still have some control?
13. Can I make any other changes?
14. Sounds great for me. But if I give away the asset, what
about my children?
15. Why use a life insurance trust?
16. So what's the catch?
17. Benefits of a Charitable Remainder Trust
18. Should I seek professional assistance?
1. What does a CRT do?
A CRT lets you convert a highly appreciated asset (stock, real estate,
etc.) into lifetime income without paying capital gains tax when the asset
is sold. It reduces your income taxes now and reduces estate taxes when
you die. And it lets you help charities that have special meaning to you.
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2. How does a CRT work?
You transfer an appreciated asset into an irrevocable trust. This removes
it from your estate so that when you die, no estate taxes will be due
on the value of the asset.
The
trustee then sells the asset at full market value, paying no capital gains
tax, and re-invests the proceeds in income-producing assets. For the rest
of your life, the trust pays you an income. When you die, the remaining
trust assets go to the charity(ies) you have chosen. That's why it’s
called a charitable remainder trust.
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3. Why not sell the asset myself and re-invest?
You could, but you would pay more in taxes and there would be less income
for you. Let’s look at an example.
Years ago, Max and
Jane Brody (ages 65 and 63) purchased some stock for $100,000. It is now
worth $500,000. They would like to sell it and generate some retirement
income.
If they sell the stock,
they would have a gain of $400,000 (current value less cost) and would
have to pay $60,000 in federal capital gains tax (15% of $400,000). That
would leave them with $440,000.
If they re-invest
and earn a 6% return, that would provide them with $26,400 in annual income.
Multiplied by their life expectancy of 26 years, this would give them
a total lifetime income (before taxes) of $686,400. Because they still
own the assets, there is no protection from creditors and no charitable
income tax deduction is available.
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4. What happens if they
use a CRT?
If they transfer the stock to a CRT instead, the trustee will sell it
for the same $500,000. But because the trust is exempt from capital gains
tax, the full $500,000 (instead of $420,000) is available to reinvest.
The
trustee invests the proceeds in income-producing assets. The same 7% return
will produce $35,000 in annual income which, before taxes, will total
$910,000 over their lifetimes. That's $145,600 – almost 20% –
more in income than if the Brodys had sold the stock themselves.
Plus,
they can take a charitable income tax deduction of about $117,070. Since
they are in a 36% tax bracket, this will reduce their current federal
income taxes by $42,145.
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5. What are my income
choices?
You can receive a fixed percentage of the trust assets (like Max and Jane),
in which case your trust would be called a charitable remainder unitrust.
With this option, the amount of your annual income will fluctuate, depending
on investment performance and the annual value of the trust.
The
trust will be re-valued at the beginning of each year to determine the
dollar amount of income you will receive. If the trust is well managed,
it can grow quickly because the trust assets grow tax-free. The amount
of your income will increase as the value of the trust grows.
Sometimes
the assets contributed to the trust (like real estate or a closely-held
corporation) are not readily marketable, so income is difficult to pay.
In that case, the trust can be designed to pay the lesser of the fixed
percentage of the trust’s assets or the actual income earned by
the trust. A provision is usually included so that if the trust has an
off year it can "make up" any loss of income in a better year.
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6. Can I receive a fixed
income instead?
Yes. You can elect instead to receive a fixed income, in which case the
trust would be called a charitable remainder annuity trust. This means
that, regardless of the trust's performance, your income will not change.
This
option is usually a good choice at older ages. It doesn't provide protection
against inflation like the unitrust does, but some people like the security
of being able to count on a definite amount of income each year. It's
best to use cash or readily marketable assets to fund an annuity trust.
In
either (unitrust or annuity trust), the IRS requires that the payout rate
stated in the trust cannot be less than 5% or more than 50% of the initial
fair market value of the trust's assets.
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7. Who can receive income
from the trust?
Trust income, which is generally taxable in the year it is received, can
be paid to you for your lifetime. If you are married, it can be paid for
as long as either of you lives.
The
income can also be paid to your children for their lifetimes or to any
person or entity you wish, providing the trust meets certain requirements.
In addition, there are gift and estate tax considerations if someone other
than you receives it. Instead of lasting for someone's lifetime, the trust
can also exist for a set number of years (up to 20).
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8. Do I have to take
the income now?
No. You can set up the trust and take the income tax deduction now, but
postpone taking the income until later. By then, with good management,
the trust assets will have appreciated considerably in value, resulting
in more income for you.
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9. How is the income tax deduction determined?
The deduction is based on the amount of income received, the type and
value of the asset, the ages of the people receiving the income, and the
applicable federal rate (AFR), which fluctuates. (Our example is based
on a 6.0% AFR.) Generally, the higher the payout rate, the lower the deduction.
It
is usually limited to 30% of adjusted gross income, but can vary from
20% to 50%, depending on how the IRS defines the charity and the type
of asset. If you can't use the full deduction the first year, you can
carry it forward for up to five years. Depending on your tax bracket,
type of asset and type of charity, the charitable deduction can reduce
your income taxes by 10%, 20%, 30% or even more.
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10. What kinds of assets are suitable?
The best assets are those that have greatly appreciated in value since
you purchased them, specifically publicly traded securities, real estate
and closely-held corporations. Mortgaged real estate usually won't qualify
(you might consider paying off the loan). Cash can also be used.
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11. Who should be the
trustee?
You can be your own trustee. But you must be sure the trust is administered
properly – otherwise, you could lose the tax advantages and/or be
penalized. Most people who name themselves as trustee have the paperwork
handled by a qualified "third party administrator."
However,
because of the experience required with investments, accounting and government
reporting, some people select a corporate trustee (a bank or trust company
that specializes in managing trust assets) as trustee. Some charities
are also willing to be trustee.
Before
naming a trustee, it's a good idea to interview several and consider their
investment performance, services and experience with these trusts. Remember,
you are depending on the trustee to manage your trust properly and to
provide you with income.
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12. Do I still have some control?
Yes. For as long as you live, the trustee you select – not the charity
– controls the assets. Your trustee must follow the instructions
you put in your trust. You can retain the right to change the trustee
if you become dissatisfied. You may also be able to change the charity
(to another qualified charity) without losing the tax advantages.
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13. Can I make any other changes?
Generally, once an irrevocable trust is signed, you cannot make any other
changes. Be sure you understand the entire document and it is exactly
what you want before you sign.
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14. Sounds great for me. But if I give away the asset,
what about my children?
If you have a sizeable estate, the asset you place in a CRT may only be
a small percentage of your assets, so your children may be well taken
care of. However, if you are concerned about replacing the value of this
asset for your children, there is an easy way to do so.
Using the income
tax savings and part of the income you receive from the charitable remainder
trust, you can fund an irrevocable life insurance trust to replace the
asset for your children.
You
can take the income tax savings, and part of the income you receive from
the charitable remainder trust, and fund an irrevocable life insurance
trust. The trustee of the insurance trust can then purchase enough life
insurance to replace for your children or other beneficiaries the full
value of the asset you have given to charity.
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15. Why use a life insurance trust?
With an insurance trust, the insurance proceeds will not be included in
your estate, so you avoid estate taxes. It will also let you control when
your children will receive this money (for example, all at once or in
installments). This is often referred to as a wealth replacement trust.
Life
insurance can be an inexpensive way to replace the asset for your children
because every dollar you spend in premium buys several dollars of insurance.
Insurance proceeds are available immediately, even if you and your spouse
both die tomorrow. And, in addition to avoiding estate taxes, the proceeds
will be free from probate and income taxes.
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16. So what's the catch?
There really isn't one. Combining a charitable remainder trust with an
irrevocable life insurance trust is a winning situation for everyone—you,
your children and the charity. Here's why:
You
convert a highly appreciated asset into lifetime income, paying no capital
gains tax when the asset is sold. You remove the asset from your estate,
reducing estate taxes that will be paid when you die. And, you receive
a charitable income tax deduction in the year you transfer the asset to
the trust, reducing your current income taxes.
With
the life insurance trust replacing the full value of the asset, your children
receive much more than if you had sold the asset yourself, and paid capital
gains and estate taxes. Plus the proceeds are free of income and estate
taxes and probate.
Finally,
you will make a substantial gift to a favorite charity. And because the
charity knows it will receive the gift at some point in the future, it
can plan projects and programs now—benefiting even before receiving
the gift.
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17. Benefits of a Charitable
Remainder Trust
• Convert appreciated asset into lifetime income.
• Pay no capital gains tax when the asset is sold.
• Reduce or eliminate your estate taxes.
• Reduce your current income taxes with charitable income tax deduction.
• Benefit one or more charities.
• Receive more income over your lifetime than if you had sold the
asset yourself.
• Leave more to your children or others by using life insurance
trust to replace gifted asset.
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18. Should I seek professional
assistance?
Yes. If you think a charitable remainder trust would be of value to you
and your family, speak with a tax-planning attorney, insurance professional,
corporate trustee, investment adviser, CPA, and/or favorite charity. Be
sure an attorney experienced in CRTs prepares the documents.
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NOTE: This information is designed to provide a general overview with
regard to the subject matter covered and is not state-specific. The authors,
publisher and host are not providing legal, accounting or any other advice
which purports to be specific to your situation. The contents of this
website are believed to be completely reliable. Nevertheless, some material
may be affected by changes in the laws or interpretations of such changes
since the material was entered on the website. If legal advice or other
expert guidance is required, the services of a competent professional
in the field of law, accounting, insurance or investments should be sought.
Price
& Farrington, PLLC - Attorneys and Counselors
at Law
12501 Bellevue-Redmond Road, Suite 215 ....Bellevue,
Washington 98005
Phone: 425.451.3583.. Fax: 425.452.0153 ..E-mail: contact@pricefarrington.com
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