understanding charitable remainder trusts

Is a Charitable Remainder Trust Right for You?

by Kevin Woods

Proper estate planning involves striking a balance between providing for current and future financial needs, ensuring that heirs are taken care of and, in many cases, contributing to charitable causes. It is this last consideration that can present unique challenges: While you may strongly desire to support charities that for you hold a deep meaning, you may also be concerned about depleting needed retirement funds. 

One option is a charitable remainder trust that allows you to bequeath funds to the charity of your choice while also providing you with an income while you are still living. When constructed correctly, these trusts have the ability to help ensure a comfortable retirement while also giving you the satisfaction of donating your money to worthy causes.

Trusts in Financial and Retirement Planning

Many people use trusts in their investment, retirement and estate plans as a way of protecting assets, enjoying tax benefits and ensuring that their last wishes are carried out after they die or become incapacitated. Trusts can be broadly categorized as either revocable or irrevocable. A revocable trust can be modified or even cancelled by the person who creates the trust (known as a “trustor”) at any time. The downside to revocable trusts is that the trustor is responsible for paying capital gains taxes on the assets held in the trust. In addition, revocable trusts are vulnerable to garnishment or attachment by creditors, including plaintiffs in lawsuits. 

An irrevocable trust, on the other hand, cannot be cancelled or even modified by the trustor unless all beneficiaries of the trust agree to these changes. On a practical level, this means that a trustor won’t have access to the funds in the irrevocable trust unless the trust was set up to provide the trustor with funds during the life of the trust. In addition, the trustor won’t be able to make changes to the trust, even if the changes make good sense, unless all beneficiaries are willing to cooperate and agree to them.

There are advantages, however, to irrevocable trusts. Funds placed in irrevocable trusts are no longer potential tax liabilities for the trustor. Instead, the trust itself usually has its own tax identification number and tax returns are filed by the trustee on behalf of the trust. If the trust owes taxes, they are paid from the trust itself. In addition, these funds are not subject to garnishment or seizure by creditors. Individuals who are in professions where there is a high risk of lawsuits, such as physicians, often use irrevocable trusts to protect their assets and ensure that they are able to pass on their wealth to their children and grandchildren, as well as to charitable institutions.

Advantages of Charitable Remainder Trusts

Charitable remainder trusts are always irrevocable. They allow individuals and couples to place money into a trust that will allow these trustors to draw an income during their lifetimes. Trustors will enjoy some tax advantages and can create their trust to provide income to beneficiaries for a period of time before the balance of the trust is cashed out by the charitable beneficiary. Because the trust is irrevocable, the trustor is not responsible for paying taxes on the trust’s income and can enjoy retirement while also knowing that a valued charity will receive assets after the trust is eventually dissolved.

Special Considerations Surrounding Charitable Remainder Trusts

While a charitable remainder trust may seem like an ideal option for retirement and estate planners, it also has its drawbacks. The irrevocable nature of these trusts means that the trustors give up control over their assets once the trusts are established. Trustors have to make several critical decisions when setting up a trust, including:

  • The charitable organization that will control and ultimately receive the balance of the trust once the beneficiaries are no longer alive or no longer receive an income from the trust.
  • Which assets to place in the trust. An accurate appraisal of the value of these assets is critical to the success of the trust.
  • The beneficiaries of the trust, the amount of income that they may receive from the trust, as well as how long they can receive this income. For example, a trustor may decide that a beneficiary is to receive an income for life or for a more limited period of time.

An independent wealth advisor, as well as other legal and financial professionals, could be extremely helpful at the time of starting a trust. This is particularly true if the trustor plans to rely on income from the trust during his or her lifetime.  Leaders of a charitable organization might be reluctant to agree to a modification later on, so it is critical to properly calculate a trustor’s financial needs in retirement before committing funds to an irrevocable trust.

There are also federal tax laws that can limit the amount of income that trustors can receive during their lifetimes from charitable remainder trusts. Depending on how well the funds in the trust are managed, trustors may find that their income from the trust is uneven from year to year as the value of the trusts assets fluctuate. For example, publicly traded stock can be included in a charitable remainder trust: As the stock’s value fluctuates, so might any income from the trust.

Charitable organizations that benefit from these trusts can also face risks. In some cases, trusts run out of money before a trustor dies, which can, in some cases, require the charity to continue making payments to the trustor out of the charity’s own funds. In addition, poorly appraised assets, such as income property or other real estate, that are used to fund the trust can, in some cases, create IRS problems for trustors later on. One couple learned about this the hard way when their claimed tax deductions property donations, made through a charitable remainder trust, were rejected by the IRS due to a failure to appropriately document the appraised value of the properties.

Getting Help with Your Retirement and Estate Plan

Still, charitable remainder trusts remain a popular option with many individuals and couples, particularly those who have strong ties to charitable institutions. Because of some of the drawbacks and risks of these trusts, it’s important to seek out impartial financial advice and not rely solely on what a charity’s representative might tell you. A wealth advisor at Gratus Capital can help assess your financial situation and help you craft a retirement and estate plan that meets your needs for funding your retirement as well as your desire to leave a legacy.

Sources:

The Charms and Dangers of the Charitable Remainder Trust

Worried about Passing Down a Big IRA? Consider a CRT

Charitable Lead Annuity Trusts: Planning Opportunities in Today’s Low-Interest-Rate Environment

A harsh lesson on charitable contributions