Charitable Remainder Trusts (CRTs): A Money-Smart Way to Give

Just about all of us are either going to spend (or already have spent) several decades accumulating assets and growing our net worth. The plan, of course, is that we'll spend the next few decades drawing those assets down in retirement.

But some of us will get to a point where we'll realize it's highly unlikely we'll outlive our wealth, and we'll be ready to start making decisions about what will happen to those remaining financial assets once we're gone.

Let's discuss one of the better such decisions you can make.

Charitable Remainder Trusts

Today's topic is a term that most people won't come across unless they're preparing for (or even in) retirement … or just really love to read about finances.

I'm talking about the charitable remainder trust (CRT)—a legal arrangement that can provide a stream of income over time to yourself and others, as well as give an eventual boost to your favorite charities … not to mention deliver an immediate tax benefit.

Here's how it works:

If you are the donor of a charitable remainder trust, you transfer cash, property, or other assets into an irrevocable trust—thus, you generally can't take out any of the assets you put in.

The trust uses those assets to provide income to one or more living noncharitable beneficiaries. (You can even name yourself as a beneficiary if you want!) These payments last for a predetermined term of either a.) up to 20 years or b.) the life of one or more noncharitable beneficiaries.

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When that term is complete, the remainder of the trust is given to one or more qualified U.S. charitable organizations, which generally must be 501(c)(3) organizations. And importantly, the present value of what the charity is projected to receive has to be at least 10% of the initial net fair market value of everything placed in the trust.

And contributing to these trusts provides you with an immediate, though partial, tax deduction. 

So, to recap: These trusts let you take a big pile of money and turn it into payments over time, while providing you with a decent tax break now, and while providing for charitable works in the future.

CRT Deductions, Pros/Cons, And More

You'll be shocked to learn that something termed a "charitable remainder trust" isn't as straightforward as my simple recap.

The benefits can still more than make up for the headache, and CRTs are also a particularly good solution for a not-too-uncommon portfolio issue.

But to make any use of these, you'll need to dig into the details. So …

What to Know About That Tax Deduction

Since the tax deduction is the very first benefit anyone will enjoy from a CRT, let's go over some of the specifics:

• The deduction is based on the present value of the expected charitable remainder.
• The deduction is subject to adjusted gross income (AGI) limits based on how the CRT is funded—60% for cash, 30% for long-term appreciated property.
• Starting in 2026, you can only claim charitable deductions on donations that exceed 0.5% of your annual AGI. (So, if your AGI is $100,000, you can only deduct amounts over $500.)
• Unused charitable deductions can carry forward for up to five consecutive years before expiring.
• If you're in the top (37%) tax bracket, the tax benefit of your deduction is capped at 35%.

There Are 2 Types of CRTs

CRTs come in two flavors, both of which can be created either while the donor is still living or upon their death (through a last will and testament). They're largely similar, but their few differences are significant:

1. A charitable remainder unitrust (CRUT) …

• Pays a fixed percentage of the value of the trust every year to noncharitable beneficiaries. 
• Must pay at least 5%, but no more than 50%, of the fair market value of the assets, valued annually.
• Does allow you to make additional contributions. 

Because CRUT payouts are based on a percentage of the trust's value, the amount of income provided can vary depending on investment performance. Check out our primer on charitable remainder unitrusts (CRUTs) for an example of how they work and what the tax deduction might look like.

2. A charitable remainder annuity trust (CRAT) …

• Pays a specific dollar amount every year to noncharitable beneficiaries.
• Must pay at least 5%, but no more than 50%, of the fair market value of the trust's property when the trust is established. 
• Does not allow for additional contributions.

Thus, unlike CRUTs, the amount of income paid out by a CRAT isn't affected by the trust's investment performance (because it's a fixed dollar amount, not percentage) nor future contributions (because you can't make them). Check out our primer on charitable remainder annuity trusts (CRATs) for an example of how they work and what the tax deduction might look like.

Young and the Invested Tip: Still don't understand the differences between a CRUT and a CRAT? Here's a deeper look.

The Pros

Charitable remainder trusts of either type provide a few advantages that I mentioned above, but that I'll point out again here:

• Income stream that lasts years: Creating a charitable remainder trust can provide you or other beneficiaries with income for a set time period or even for life.
• Tax benefits: It can also be a tax-savvy move for donors, as you can defer capital gains on the sale of the assets transferred to the trust. Again: Contributions to these trusts are eligible for a partial charitable deduction, with certain AGI limits and other restrictions.
• Charitable vehicle: CRTs are an advantageous way to support charities you believe in.

There's also another use case that benefits people whose wealth is highly concentrated in one or a couple assets.

Let's say Mark is an Apple (AAPL) employee who has acquired company stock over a couple decades at the firm, and that stock is now worth $20 million. Mark wants to diversify his portfolio so his wealth no longer lives or dies by Apple's performance alone. If he simply sells the stock, he'll take a significant tax hit, then he'll reinvest the reduced assets that remain. 

But if Mark is charitably inclined, he can contribute the stock to a charitable remainder trust. Inside the CRT, Mark can sell all $20 million of the stock without tax consequences, then reinvest that money into whatever assets he wants. Yes, he would pay taxes each year when he took distributions, but he wouldn't be kneecapping the earnings potential of his assets with the upfront tax responsibility.

Obviously, not everyone is going to need this diversification benefit, but "Mark's" situation is a lot more common than you might think.

The Cons

You don't get something for nothing, of course. Charitable remainder trusts do have their hangups. And even if they're not enough of a hindrance to prevent you from moving forward with a CRT, it still helps to know what you'll be in for:

• UBTI: Charitable remainder trusts are not a good place to hold investments that will generate unrelated business taxable income (UBTI). Although CRTs aren't subject to federal income tax, they are still subject to UBTI. The CRT must pay a 100% excise tax equal to the full amount of the UBTI.
• State taxes: Additionally, where you live can affect the attractiveness of a CRT. While the trusts themselves generally aren't subject to federal income tax, some states do levy taxes on CRTs.
• Gift taxes: If you establish a lifetime CRT, and you name a noncharitable beneficiary other than you or your spouse, your contribution may be considered a gift for federal gift tax purposes.
• Effectively set in stone: As previously mentioned, these are irrevocable trusts. You generally can't alter the terms of the trust later.
• Costly: CRTs not only can be costly to set up initially, but they're also an ongoing obligation. While the fund may be able to pay legal fees, taxes, management costs, etc., this isn't a set-it-and-forget-it vehicle.
• Complicated: CRT setup and management can be complex, so you should carefully discuss the option with a financial advisor before deciding whether this type of trust makes sense for you. 

Beneficiary Taxes

The income that noncharitable beneficiaries (you, your spouse, etc.) receive from charitable remainder trusts is taxable and should be reported to the IRS. 

The payments are taxed as distributions of the trust's income and gains, in this order:

1. Ordinary income. Taxable at marginal tax rates, just as one's salary is. In a situation where the trust has sufficient ordinary income to cover all payments, those payments are taxed as ordinary income. The payments must be reported as ordinary income as outlined in Schedule K-1.
2. Capital gains. If the trust's ordinary income runs out, then payments are taxed as capital gains, up to the amount of any capital gains from the current year plus undistributed capital gains from previous years.
3. Other income. If ordinary income and capital gains both are fully distributed, payments are considered "other income," up to the amount of the trust's current year and accumulated other income (including tax-exempt income).
4. Corpus. Once all current-year and accumulated income and gains are completely distributed, remaining payments are considered corpus or "principal" and not subject to tax.

It's essential for beneficiaries to understand their tax obligations and be prepared to pay what they owe.

Is a CRT Right for You?

Again, CRTs can be both complex and expensive to set up and manage, so they deserve a fair bit of thought before taking the plunge. I highly recommend talking to a financial advisor about whether you're even in a position (or eventually will be) to take advantage of a CRT or other charitable vehicles … and if so, whether a CRT (and which type) is right for you.

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Thanks for reading along with us, and we'll see you again next week!

Riley, Kyle & Hannah

Young and the Invested

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