A Charitable Remainder Trust is set up by you and managed by the trustee. The trust will provide income to someone during their life and the remainder of the assets to the charity of your choice. The charity you pick to receive the assets must be approved by the IRS which means the charity is tax exempt organization.
Once you determine how much income you want to receive (income could be for someone else in your family) and for how long (could be your whole life or a shorter period) then you transfer the assets into the name of the trust. A word of caution here – this trust is irrevocable, meaning you can’t changes the terms of the trust once it is set up and you are giving up legal rights to the assets you transfer to the trust, meaning you can’t take the assets back at a later date. Before you transfer your assets be certain on the terms of the trust and that you want to give up the legal rights to those assets.
After you transfer the assets, the charity or some other professional organization – whoever you name, will serve as the trustee and manage the assets that are placed in the trust. You could be the trustee but there needs to be special language in the trust so that you do not lose the benefits. Many times the issue are very complex so it is better to have a professional trustee manage the assets. The trustee will manage the assets and determine how to best invest those assets so that you will continue to receive the income required by the terms of the trust.
The best assets to transfer to the trust will be assets that are appreciated assets with a low return and held for more than 12 months. This is because the income tax deduction is based on the higher fair market value instead of the initial cost of the assets. The trust is considered a tax-exempt entity so the trust is able to sell the asset without having to pay capital gains and keep the full value of the asset. This means the trust has more money to invest allowing you to get the income you need. Sometimes the trust can reinvestment the assets and even make more income then you need!
There are two types of Charitable Remainder Trust, an annuity trust and a unitrust. An annuity trust does not allow for any additional assets to be contributed to the trust. This means that the distribution will not change throughout the life of the trust. An unitrust allows for you to contribute additional assets as time goes on which can help if you need addition income because the distribution can fluctuate. In most cases the payout or income must be at least 5%. There are special calculations used to determine the payout and tax deductions. The calculations take into account the time limit of the trust, the funding amount of the trust, and the applicable federal tax rate. The income tax deduction is based on the present value of the assets that have been contributed to the charity at the end of the term of the trust.
If you’re concerned that you are giving up your children’s inheritance, you could take the income you receive and purchase an irrevocable life insurance trust. The trustee of the life insurance trust could purchase enough life insurance to replace the value of the assets that you have given away to the Charitable Remainder Trust. The trustee of the life insurance trust could control the proceeds in the trust for your children and grandchildren. This would also be a good idea if you have any beneficiaries that have spending problems or have special needs.
One side note, many individuals often start look at gifting of assets to family or charities later in life, as a reminder this is considered a gift and a divestment which has a 5-year look back period under the Medicaid laws. Also, the income is still counted as your income for Medicaid purposes.
It’s great that you are looking head and thinking about charities as one of your beneficiaries and a Charitable Remainder Trust is a great way to do that. A Charitable Remainder Trust has many advantages like income for life, providing for a charity that supports your values, and reducing your estate taxes; but always be cautious of the terms of the trust because you can’t change the terms and you’re giving up your legal rights to the assets.