Amid the current unprecedented crises in public health and the economy, charitable organizations are under strain, asked to meet a multitude of vital needs. Many charities themselves are hurting. So now may be a perfect time to think about how to set up charitable trusts that can do good in the world, but also help your family and provide you with tax benefits.
I’m going to talk about four related types of trusts, all of which share the “split interest gift” feature. That means the income earned by the trust’s assets is directed toward one beneficiary, and the principal toward somebody else – or something else.
Now for the ugly acronyms. The four chief types of split-interest trust are called CRUT, CRAT, CLUT and CLAT. Before looking more closely at them, let’s define some terms. The initial “C” stands for “charitable.” Simple enough so far.
The second letter is either “R” for “remainder” or “L” for “lead.” Under a CRUT or CRAT, the charity of your choice gets the remainder: what’s left after the trust’s income is distributed to the other beneficiaries. Typically, that would be to members of the trust creator’s family. To approach this in reverse, with the charity taking the lead and getting the income, and the family beneficiaries eventually collecting the principle, you would want a CLUT or a CLAT. Income in this case, by the way, means primarily the interest and/or dividends from investments held in the trust. But any other form of income, such as rent on real estate, might also be included.
The next important initial will be either “U” for “unitrust” or “A” for “annuity.” A CRUT or CLUT, as a unitrust, pays a percentage of the trust’s assets each year. A CRAT or CLAT, as you would expect from the word “annuity,” pays a fixed amount every year. In both cases, how long those payments continue is dictated by the trust’s terms. It might be set up for a fixed number of years. Or it could be pegged to a specific event, or to some combination of years and events.
For example, a trust might provide income for its creator’s widowed spouse. But that spouse’s death would end the trust, triggering the distribution of the principle to the designated charity.
The final “T” is easy again: “trust.” There is one additional important option: whether to create the trust during your lifetime, or have it set up through your will. If you create it so it begins during your lifetime, you have the option of naming yourself as a beneficiary, instead of or in addition to your heirs.
So besides determining how you want to divide your assets between family and charity, you have several other decisions to make. First of those may be whether any of these trust types makes sense for you. They are complex and can be expensive to set up. So, unless your estate is in the neighborhood of $1 million or more, the administrative costs may not be worth the benefits. But million-dollar estates are quite common these days, and so this may well be worth considering.
The next choice is how to manage the split. In simple terms, who gets money first? If you want the charity to get funded for, say, twenty years after your death, but your grandchildren to collect whatever is left in the trust, then a CLAT or a CLUT is your best choice.
If, instead, you want to provide for a spouse or children first, and then let a charity collect the remainder later, then CRAT or CRUT make better sense.
Finally, consider whether to specify a fixed annual payout or a percentage. That is, choose between the “annuity” or “unitrust” approaches. A useful guideline about which to pick: If the trust’s assets are mostly safe investments, highly likely to perform well, then a unitrust approach may be best. The annual payments may vary somewhat but will still remain largely consistent or even grow. Riskier investments may dictate the annuity approach, ensuring that annual payouts don’t change even if the value of the trust’s assets fluctuate wildly.
One reason to choose a lead trust is that it can be better for the heirs during times of low interest rates. The lower return on investment will diminish the charity’s share, not the beneficiaries. Conversely, at times of high interest rates, a remainder trust will shift that greater income to the beneficiaries and leave the charity to collect whatever is left later on.
So, what about the benefits for the creator? Well, as in so much of estate planning, taxes are a major consideration. Setting up a charitable trust reduces the value of your estate, which may well spare your heirs from estate taxes, or at least reduce them. There are also large potential savings in capital gains and income taxes.
The complexities of how these trusts affect taxes gets back to my earlier point: this is a complex business, and any attempt to generalize too much is likely to be confusing. That is why expert help, focused on your unique circumstances and objectives, is absolutely necessary.
So, what can you do if your estate isn’t big enough to justify a CLUT or a CLAT, a CRUT or a CRAT?
One possibility is a charitable annuity. It’s essentially an insurance contract by which financial assets are used to buy a guaranteed flow of income. The owner directs that money toward the charity of their choice. This can be cost-effective with estates even valued at less than $100,000. It still has benefits for the giver, notably hefty income tax deductions for the charitable donations. And whatever goes into the annuity is no longer part of the estate.
A second option is charitable life insurance. How it works: you make an annual gift to a charity, which uses your money to pay the premium on an insurance policy. On your life! Your gifts are charitable deductions. Then, when you’re gone, the charity of your choice collects on the life insurance policy.
If you are thinking about finding ways to benefit your favorite causes, while not neglecting your family, it’s worth educating yourself about charitable trusts, whether remainder or lead, unitrust or annuity. The investment and estate-planning experts at Old North State Trust are knowledgeable about the pros and cons and tax implications of these useful instruments.