How to Receive Lifetime Income, Reduce Taxes, Help Charity and Pass Your Entire Estate to Your Heirs.
Introducing the
Charitable Remainder Trust-PLUS
If you own a highly appreciated asset (such as stocks, real estate or a business) – and you’d like to sell the asset, I recommend that you consider a Charitable Remainder Trust (CRT).
A Charitable Remainder Trust allows you to donate your property to charity – lower your income and estate taxes – and help a charity that is important to you. Plus, with the money you save, you can buy a life insurance policy that replaces the asset you transferred from your estate so your children don’t lose any of their inheritance.
Here are answers to your questions:
“What is a Charitable Remainder Trust?”
A Charitable Remainder Trust is simply an Irrevocable Trust into which you transfer your highly appreciated asset. The trustee (Trust manager) sells the asset at full market value and pays no capital gains tax on the sale. Then the trustee invests the proceeds in other assets. The CRT pays you and your spouse an income for the rest of your lives. After you and your spouse die, the remaining Trust assets go to the charity you selected. (When you set up the Trust, you can name one or several charities to receive your assets, as long as they are charities that qualify with the IRS. You can also retain the right to change the charitable beneficiaries, as long as they are also qualified charities.)
Since you are donating the asset to charity, you reduce your income taxes now. And since you transferred the asset out of your estate, when you die, your heirs pay no estate taxes on that asset.
“What types of assets are best suited to a Charitable Remainder Trust?”
You benefit the most when you donate assets that have greatly increased in value while you have owned them. These include real estate, stocks, other securities, and businesses. In most cases, you cannot donate real estate that has a mortgage against it. You may benefit enough from this arrangement to justify paying off the loan in full.
“Who should we name as trustee?
You must make sure the Trust is managed correctly. Otherwise, you could lose the tax benefits and suffer penalties.
The best trustee is a person or corporation experienced with investments and accounting. You can serve as trustee. You can select a corporate trustee, such as a Trust Company or Bank. Or you can name the charity to manage the Trust, if they agree to provide this service. You should interview several potential trustees and look at their experience managing investments before you decide. Since you are relying on the trustee to make sure you have income the rest of your life, your decision is important.
“Can’t we just sell the asset and invest the money ourselves?”
Yes, but you’ll have to pay a significant tax bill, so you’ll receive less income. Here’s an example:
John and Mary Smith (ages 65 and 62) are planning to retire next year. Fifteen years ago they bought 20 acres of real estate for $200,000. Today, a city has grown to within one-half mile of the property, which is now worth $2,000,000. The Smith’s would like to sell the land so they can retire and use the money during their senior years.
If they sell the acreage, they would have a gain of $1,800,000 (its current value less what they paid for it). They would have to pay $270,000 in federal capital gains tax (15% of $1,800,000), which would leave them with $1,730,000.
If they invest the money and earn a 5% return, they would have a yearly income of $86,500. If their joint life expectancy is 22 years, they would receive a total lifetime income of $1,903,000 before taxes. Of course, they receive no tax deduction if they sell the real estate.
“How does a Charitable Remainder Trust make a difference?”
If they transfer title to the real estate to a CRT, the trustee will sell it for $2,000,000. But because the Trust does not pay any capital gains tax, the trustee can reinvest the full $2,000,000. The trustee invests the proceeds in assets that produce income. Now, the 5% return will generate a yearly income of $100,000. Before taxes, this will give them a total lifetime income of $2,200,000. That’s $297,000 more income than if they had sold the stock themselves. Plus, they can take a charitable income tax deduction when the property is contributed to the Trust. This will result in additional income savings.
“How much money do we receive as income?”
You can choose to receive money in two ways:
Fixed Percentage: You can choose to receive a fixed percentage of the Trust assets every year. Under this method, the amount of your yearly income will vary based on how well the Trust’s investments perform. At the beginning of each year, the Trust will be revalued to determine the amount of income you will receive. Since the Trust assets grow tax-free, the Trust can quickly increase in value if the Trust is well managed and if the investment market is sound.
Fixed Amount: You can choose to receive a fixed amount of income every year. This means you get the same amount of income, regardless of how much money the Trust earns. As people grow older, they often like to know exactly how much money they will receive.
If the assets donated to the Trust are not readily marketable, the Trust may have trouble paying your income. Your lawyer can set up the Trust so it pays you a fixed percentage of the Trust’s assets – or the actual income earned by the Trust – whichever is less. Your Trust can also include a provision that says during years when the income is higher, the Trust can pay you added income to make up for your losses during bad times. The IRS requires that the money paid to you must be at least 5% – and not more than 50% – of the initial fair market value of the Trust’s assets.
“Who can receive income from our Charitable Remainder Trust?”
You can receive income from the Trust for your lifetime. If you are married, the income goes to you or your spouse, as long as either of you lives.
In addition, the income can go to your children for their lifetimes – or to any person or entity you wish, as long as the Trust meets certain legal requirements. Only the remainder interest goes to charity. If someone other than you or your spouse receives the income, you should realize that you are making a potentially taxable gift upon funding the Trust which will use a portion of your lifetime gift tax exemption. The Trust does not need to last for a person’s lifetime, but may, instead, be set up for a specific number of years, up to 20.
“When do we start receiving income from the Trust?”
You can start receiving income now – or you can choose to wait until a future date. Either way, you take the income tax deduction now, when you set up the Trust. The longer you wait to receive income, the more your Trust will likely be worth, which will increase the income you receive.
“How much of an income tax deduction do we receive?”
Your deduction is based on the amount of income you receive, the type and value of the asset, your ages (or the ages of the people receiving the income), and the Applicable Federal Rate (AFR), which varies. A final factor is whether the charity chosen is a public charity or a private foundation. Some clients choose to create a private foundation to be the ultimate charitable beneficiary. (Our example is based on a 6.0% AFR.) As a rule, the higher the payout rate, the lower your deduction.
Your tax deduction is usually limited to 30% of your adjusted gross income. Still, it can vary from 20% to 50%, depending on how IRS defines the charity and the type of asset. If you cannot use the full deduction the first year, you can carry it forward for up to five years.
“How much control do we have over the Trust?”
When you set up the Trust, you put instructions into the Trust that the trustee must follow. Then, for as long as you live, your trustee controls the Trust assets. If you are not satisfied with your trustee, you can retain the right to change trustees. And, of course, you can also choose to act as trustee yourself. In addition, you may be able to change the charity that receives your assets, without losing your tax advantages.
Even so, the reason you receive so many benefits from the Trust is because after you set it up, you cannot change your mind. The Trust is irrevocable. That’s why it’s important that you understand the Trust – and decide, with the help of a Trust attorney, that this decision is right for you.
“If we donate the asset to charity, what do we leave to our children?”
If you have a large estate, the asset you place into your Charitable Remainder Trust may be only a small part of your assets. On the other hand, if you want to replace the value of the asset for your children’s benefit, you can do this quite easily.
You use the money you saved on income taxes – and part of the income you receive from the Trust – to fund an Irrevocable Life Insurance Trust. The trustee of your Life Insurance Trust buys enough life insurance to replace the full value of the asset for your children and other heirs. Life insurance is often a low cost way to replace the asset for your children because one premium dollar buys several dollars of insurance. Plus, the life insurance proceeds avoid probate and income taxes.
“Why do we need an Irrevocable Life Insurance Trust?”
When you die, the Life Insurance Trust keeps the insurance proceeds out of your estate so you do not pay estate taxes on the life insurance. The Trust also lets you control when your children receive the money, such as at different times or all at once.
“What do we lose by setting up a Charitable Remainder Trust?”
To gain the benefits of the Trust, you give up two things: You give up the asset you put into the Trust (in exchange for many benefits, such as lifetime income). And you give up the ability to revoke the Trust. Still, if the trustee is not performing to your satisfaction, you can change trustees. And you can also change the charity that receives your asset. But you cannot cancel or revoke the Trust because a Charitable Remainder Trust is, by definition, irrevocable.
That’s why it’s important that you understand the Trust and – with the help of a skilled, experienced attorney – make sure this decision is right for you. Thousands of people set up Charitable Remainder Trusts each year because they want future lifetime income and the many tax benefits. The decision to set up a Charitable Remainder Trust should not frighten you, but you should realize it’s an important decision that will affect you and your family.
Summary
Here’s how the Charitable Remainder Trust and the Irrevocable Life Insurance Trust work together.
You start with a highly appreciated asset. Your lawyer creates a Charitable Remainder Trust – PLUS the Irrevocable Life Insurance Trust. You name a trustee to manage the Trust. Then you transfer the asset into the Trust – and the trustee sells the asset at fair market value. The trustee then invests the proceeds from the sale, generating income for the Trust, from which you receive income for life.
Tax Benefits: You receive a charitable income tax deduction beginning the year you transfer the asset to the Trust. This reduces your current income taxes. Since your asset is going to charity, the trustee pays no capital gains tax on the sale. And since you have transferred the asset out of your estate, when you die, your heirs pay no estate taxes on this asset.
From the money you save in taxes, you fund the Life Insurance Trust. The trustee buys life insurance that will replace the full value of the asset in your children’s inheritance. In this way, your children actually receive more money because capital gains and estate taxes do not have to be paid on the asset. Plus, the life insurance proceeds avoid probate, as well as income and estate taxes.
Also, the charity benefits now because it knows it will receive your gift in the future. As a result, it can lay the groundwork for how it intends to use the money, so everything is in place when your gift goes to the charity.
The Charitable Remainder Trust benefits you, your children and your favorite charity. If you own highly appreciated property and would like to convert it to future income, I invite you to call me.
You’re Invited to Call or E-mail.
“If you have questions or concerns about asset protection, estate planning, probate, business planning or charitable giving, please don’t hesitate to call.
You’re welcome to contact me at any time, without cost or obligation.
I’ll be happy to help you in every way.” — Celeste
M. Celeste Luce
Asset Protection & Estate Planning Attorney