If you’ve never heard of a charitable remainder unitrust(CRUT), then you aren’t unlike the other 90 percent of Americans that have never heard of it either. However, a charitable remainder unitrust is a vehicle that can help clients accomplish many different things, especially for those in or nearing retirement. For example, a charitable remainder unitrust helps maximize retirement income, while giving to charitable organizations, while avoiding taxes, and leaving money to loved ones. How does a CRUT accomplish all of this? Read on to learn how.
A charitable remainder unitrust is first and foremost a trust. A trust is a legal term for an entity that allows a person to hold property or economic interest for the future use and benefit of another person/entity. In this case, the trust is formed in order to hold property until the person who formed the trust passes at which time the property transfers to a charitable organization named in the trust.
There are two basic types of trusts…revocable and irrevocable trusts. Revocable trusts are trusts that can be changed and altered after they have been created. An irrevocable trust is different in that it is a trust that cannot be altered after it has been set up. A charitable remainder trust is an irrevocable trust. Before we dive in to more details, be aware of resources such as this CRUT calculator that can help you understand how a CRUT can work.
Why A CRUT?
Now that we have that out of the way, let’s talk about why someone would want to create a CRUT. People who create CRUT’s generally have assets(stocks, businesses, real estate, etc.) that are highly appreciated above their book value. That means that when they are sold, there will be significant capital gains tax expenses that will need to be paid. In these cases, the owner of the trust will gift these highly appreciated assets to the trust at which point the capital gains tax liability goes away(except for withdrawals made from the trust).
When these assets are entered into the trust, the IRS also gives you an immediate income tax deduction that can be used against personal income until it is fully used. The IRS gives this income tax deduction because after you pass away, these assets will be transferred to the charitable organization that is named in the trust. The IRS uses actuarial tables to determine the tax deduction based on gender, age, the withdrawal percentage(more on this next), and the value of the assets gifted to the trust.
The CRUT Withdrawal
Regarding the withdrawal percentage, that is an annual amount that will be taken from the trust while the grantor is still living. It is a withdrawal percentage that is chosen when the trust is set up and cannot be changed afterwards since the trust is irrevocable. This will affect your income tax deduction from the IRS. As you might have guessed, the larger the annual withdrawal from the trust, the smaller the income tax deduction that will be received at the outset. A withdrawal percentage up to 50% may be taken but this will allow for a very small tax deduction. Most people use the CRUT in retirement to provide income or supplement retirement income. Keep in mind that income taken from the trust will have tax consequences. A professional tax consultant familiar with tax law related to CRUTs will be needed.
Leaving An Inheritance
You might be wondering, “you said that a CRUT can provide an inheritance for loved ones but how does it do that if all the money in the trust is passed on to the charitable organization?” Here’s how this can work. Sometimes, people who start a CRUT don’t need (all) the income/withdrawal provided by the CRUT and so they will use the withdrawal amount to purchase a permanent life insurance policy. This is yet another way this strategy becomes tax advantaged. As long as the total estate of the deceased is below the estate tax threshold, the life insurance death benefit can be passed on to beneficiaries tax free.
Managing the Assets
It’s also important to remember that after assets are granted to the trust, the grantor can still manage the assets inside the trust until the day they are passed on to the charitable organization. This means that assets can be bought and sold within the trust with the purpose of increasing the value of assets in the trust.
For those that might be thinking that a charitable trust is too complicated and you just want to gift assets directly to a nonprofit organization. You might rather use a charitable donation tax deduction calculator to calculate your income tax deduction and see how it compares to the deduction from a CRUT. This could be a deciding factor and you may be surprised how comparable the tax deduction from the CRUT is to a standard charitable donation. Just remember that the CRUT provides other benefits besides the income tax deduction.
So that is how a charitable remainder trust works from a high level overview. There are downsides to the CRUT and it isn’t for everyone. But when estate and financial planning become this technical, it’s always important to encourage clients to consult with a CRUT specialist. When used correctly, a CRUT can help clients pass on more of your money to loved ones and philanthropic causes while giving less money to the IRS.
This article was written by IQ Calculators, where they create smarter financial calculators.