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A charitable remainder trust is a powerful solution for eliminating capital gains taxes at the point of sale and converting appreciated assets, like real estate or stock, into lifetime income. If you are charitably inclined, a charitable remainder trust helps you make a donation to your donor-advised fund or a cause you are passionate about while also providing an immediate tax deduction you can use towards other income.

Let’s look into charitable remainder trusts and why establishing one may make financial sense for you.

How Does a Charitable Remainder Trust Work?

Transferring the assets into a charitable remainder trust removes them from your estate, resulting in no estate taxes on those assets after you pass away. As mentioned earlier, you also receive an immediate tax deduction.

Once you transfer your assets into the charitable remainder trust, the trustee sells the assets at market value. The sale results in no capital gains tax at the point of sale, and the proceeds will be reinvested within the trust. This means your financial advisor can manage the assets on your behalf through the trust.

Using a charitable remainder trust can provide you with an income stream during the trust term or your lifetime. The IRS requires a minimum 5% annual distribution. When the trust terminates, a minimum of 10% of the initial trust value, as required by the IRS, must pass to your chosen charity or a donor-advised fund.

What Types of Assets can be Placed Within a Charitable Remainder Trust?

Charitable remainder trusts are typically funded with greatly appreciated assets like publicly traded securities and real estate and can also be funded with cash, C-Corp stock, and more. It is important to note that certain types of closely-held stock, such as S-Corp stock, do not qualify.

How do you Generate Income from a Charitable Remainder Trust?

Two primary trust options fall under the umbrella of CRTs. You can establish a Charitable Remainder Unitrust (CRUT) or a Charitable Remainder Annuity Trust (CRAT).

A CRUT allows you to receive a fixed percentage of the trust assets annually, while a CRAT distributes a fixed dollar amount annually. The income distributed to you will remain stable with a CRAT and fluctuate when using a CRUT because the value of the trust assets change. Therefore, no additional contributions are allowed in a CRAT, while additional contributions besides the initial investment can be added to the CRUT.

Since the CRAT distributes a fixed dollar amount of income each year, when establishing the CRAT you must ensure that you can meet the 5% minimum distribution rate annually while still leaving the 10% to charity. If the value of the assets cannot meet these standards with a fixed dollar amount, a CRUT may be a more appealing option than the CRAT.

Because the CRUT distributes a fixed percentage of the trust assets, the payout rate can be maximized to still provide the charity on an actuarial basis at least 10% of the initial value of the assets within the charitable remainder trust, and also provide you with the maximum amount of income. You can also decide to set the minimum rate of distributions for yourself in order to provide the maximum amount of income to the charity.

A Hypothetical Case Study:

Let’s look at a hypothetical case study in which a client decides to invest a portion of her assets into a charitable remainder trust.

Mary, age 54, lives in California and owns $3 million of a stock she has held for over a year with a cost basis of $500,000. This leaves her with $2.5 million, subject to taxation.

Her tax situation is as follows:

Federal Capital Gains Tax:

20% of the gain ($500,000).

Net Investment Income Tax:

3.8% of the gain ($95,000).

California State Tax:

13.3% tax ($332,500) — if your state does not have a state tax or a lower tax, you would need to use the tax in your state.

Total Tax:

37.1% ($927,500).

For our case study, we will also use the following investment assumptions:

  • Annual Income: 2%
  • Annual Appreciation: 4%
  • Assets are Sold in the First Year
  • Income Tax Bracket of Donor: 40.8%
  • Mary lives to age 89

If Mary chooses to place her assets into a Charitable Remainder Unitrust with maximized annual payments to Mary (11.4372% in this scenario), the benefits for Mary will be as follows:

Average Annual Payment (after taxes): $154,820

Charitable Deduction: $300,000

Total Benefit to Payment Recipient: $5,418,708

Total After-Tax Benefit to Payment Recipient: $3,518,497

Benefit to Chosen Charity: $423,967

As you can see, if the donor wants to optimize the benefits for themselves, they will set their distribution schedule to the maximum amount allowed while still leaving 10% for their charity. Said differently, when optimized for the donor themselves, the IRS will allow the donor to pull 90% of the value of the assets over their lifetime.

It is also important to note that donors will also have the option of choosing any distribution amount between the minimum and maximum. You can work with your financial advisor to create a plan that best meets your desires.

Learn More about Charitable Remainder Trusts with Dunham Trust Company

The primary benefits of using a charitable remainder trust include potential lifetime income for you or your beneficiary, no capital gains tax when your asset is sold, a current income tax deduction, and a gift for a donor-advised fund or a charity you are passionate about.

To learn more about the potential benefits of using a charitable remainder trust, contact Dunham at (858) 964-0500, or complete our online contact form. You can also click the button below to receive a free PDF that outlines Frequently Asked Questions about using a Charitable Remainder Trust!

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Disclosures – Charitable Remainder Trust

This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax or investment advice or an investment recommendation, or as a substitute for legal or tax counsel. Any investment products or services named herein are for illustrative purposes only, and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance.

Federal and state laws and regulations are complex and subject to change, which can materially impact your results. Charitable deductions at the federal level are available only if you itemize deductions. Rules and regulations regarding tax deductions for charitable giving vary at the state level, and laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy or completeness of the information provided. Dunham Associates & Investment Counsel, Inc. (“Dunham”) cannot guarantee that such information is accurate, complete or timely; and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.

The trust is subject to the published fee schedule at the time the trust is established.

Because the annuity payments from CRATS are fixed and must immediately begin after the creation of the trust, the underlying assets within the structure must be kept highly liquid.

Income tax consequences for the donor can be complex, depending on the individual situation. All or some of the income from the trust may be taxed at ordinary income rates, but part may be taxed at lower capital gains tax rates, or may even be tax-free, for some years.

Dunham & Associates Investment Counsel, Inc. is a Registered Investment Adviser and Broker/Dealer. Member FINRA / SIPC. Advisory services and securities offered through Dunham & Associates Investment Counsel, Inc. Trust services offered through Dunham Trust Company, an affiliated Nevada Trust Company.