Charitable Remainder Trust Guide

A Charitable Remainder Trust is a tax-advantaged account that allows you to exit your winning positions but put off the associated income tax, thereby growing your money faster with the magic of compounding. For example, an investor with a $1 million capital gain could earn an extra $3.5 million over their lifetime with a Charitable Remainder Trust! You can estimate your potential returns with our easy to use calculator.

Let’s say you own an asset that has done well over the years, and you’re preparing to sell. You have spent years of your life investing money into these assets. But unfortunately, you will have to send a significant portion of your earnings to the government. So you might be reluctant to sell because you don’t want to trigger a taxable event. What if a Charitable Remainder Trust could save you?

This guide will explain how Charitable Remainder Trusts work. However, before diving into the mechanics, here is an explanation of why these trusts are valuable.

What Is A Charitable Remainder Trust?

A Charitable Remainder Trust is a tax-exempt account that reduces taxable capital gains income. In exchange for a promise to donate some of the trust’s assets to charity at the end of the trust’s term, you receive a considerable tax benefit: You may defer the taxes you would otherwise pay when selling your assets.

In the meantime, the Charitable Remainder Trusts distribute income to you annually for a specified period. When that period is over, donate the remainder — everything that hasn’t been distributed yet — to your chosen charity.

Charitable Remainder Trust: Benefits

By deferring your taxes and reinvesting the savings, you can increase your returns by 50% or more. Let’s dive into the specific benefits:

1. Tax Deferral And Tax-Free Compounding (Also Known As “More Money”)

Charitable Remainder Trusts protect your gains from taxes when you sell, and the money you save is reinvested and continues to grow. For example, if you are a California resident and you have capital gains of $1 million, you would typically pay about $360,000, or 36%, in taxes, and you would be left with about $640,000 to invest (or spend!) in the future. If your shares were in a Charitable Remainder Trust, the trust would keep the whole $1 million to reinvest.

In the meantime, you get to reinvest those savings. That’s an extra $360,000 reinvested, assuming your average historical returns; that additional investment could turn into more than $7 million over 40 years! That’s the key benefits of a charitable remainder trust and the power of the one-two punch of federal-tax-advantaged trusts and compounding.

2. Lower Effective Tax Rates

Another benefit of Charitable Remainder Trusts is that you can keep more of the proceeds from your sacrutle through “tax smoothing” or spreading out your income over time to lower the effective tax rate you pay on your significant gain. So instead of realizing all of the revenue from your sale in one year, you can use them to spread that income out over many years and effectively smooth out your income and, therefore, your tax rate.

3. An Up-Front Tax Deduction

In addition, in exchange for the charitable gift you’ll make at the end of your trust, you get an immediate tax deduction during the year you fund your trust, usually equal to around 10% of the value of your assets.

How Does A Charitable Remainder Trust Work?

Setting up a Charitable Remainder Trust is easy.

• Asset Choice. You, the individual setting up the trust, choose an appreciated asset(s) that you would like to contribute to a trust.
• Designate who benefits. You choose the person(s) who will receive distributions from the trust every year, they are also known as an income beneficiary.
• Asset transfer & charitable deduction. After you transfer your chosen assets to the trust, you get an immediate charitable deduction equal to ~10% of the asset(s) you put in.
• Tax-free sales. You sell your asset and are able to pay no taxes on that sale as the trust is tax exempt.
• Reinvest the savings. You’ve just saved as much as 50% on your taxes, and you can reinvest those savings and diversify your portfolio simultaneously.
• Take your annual withdrawal. You are entitled to at least yearly distributions; the amount and control you have on the distribution size depends on the type and length of Charitable Remainder Trust you choose (more on these choices below).
• Leave the remainder to charity. The remainder —whatever remains in the trust at the end of the trust’s term — is donated to a charitable organization that you can choose.
• Profit. Charitable Remainder Trusts typically result in 50% to 100% greater returns or more when used with appreciated assets, even after the charitable donation.

What Are The Tradeoffs of Charitable Remainder Trusts?

There are a few tradeoffs associated with the CRT strategy. First, there is a liquidity tradeoff: CRTs allow you to withdraw a certain amount of trust assets each year, so in the early years of the trust, you are giving up upfront liquidity for greater future wealth.

Most importantly, a Charitable Remainder Trust is an irrevocable trust, so you can’t reverse your decision after you’ve funded your trust — though there is some flexibility to make changes or even back out before you’ve placed your assets in the trust.

Different Types Of Charitable Remainder Trusts

Charitable Remainder Trusts come in a variety of flavors. For example, you can choose between a Charitable Remainder Unitrust (CRUT) and a Charitable Remainder Annuity Trust (CRAT); between a Term trust and a Lifetime trust (or even one that runs longer than your lifetime). We address each of these choices in a separate series of articles, but here’s how we think about the tradeoffs at a high level.

For years, the CRAT was the standard approach because it was simple and easy to understand. But over time, creative minds realized CRUTs result better. What’s the difference? This Charity Remainder is a “unitrust,” which means it pays out a fixed percentage of the trust’s assets every year, and that amount can go up or down depending on how the trust grows. Instead, an “annuity” Charitable Remainder pays out a fixed amount of the trust’s assets, determined at the start of the term, and that amount cannot change over time. This might seem like an esoteric distinction, but it has real consequences: If your assets grow over time, a CRUT, by definition, will pay out more significant distributions every year, and you have more control over when you can take your distributions. Plus, per IRS rules, a CRUT can last much longer than a CRAT, and a longer trust term means more tax-free growth and more distributions for you and your family. Overall CRUTs

• Can be set it up for more extended periods such as multiple people’s lifetime (the longer the trust lasts, typically the higher the returns are)
• If set up for the same time, a Charitable Remainder Unitrust can have a higher annual payout rate than CRATs, e.g., entitling you to a higher distribution percent of the trust assets
  • This is very technical but due to the IRS’s accounting methods and their charitable remainder trust 10 percent rule (which requires that the Charitable Remainder Trusts are estimated to leave behind 10% of the present value of contributed assets to charity)
• Have a variety of distribution methods. Multiple distribution options enable you to control and defer distributions if you prefer while CRATs do not
• Assets can be added at any time to a CRUT but cannot be added to a CRAT after you’ve set it.

When Does Each Type of Charitable Remainder Trust Make Sense?

CRAT	CRUT
The primary reason to choose an annuity trust is that you want certainty with your annual payments from the trust.	Want a higher ROI from the structure — that is, more total distributions. To check out the ROI of a CRUT, check out our online model here.
You are pessimistic about your future potential investments growth rates over the length of your trust.	Want more flexibility with the timing and amount of distributions.
	You want the trust to run for a more extended period.

CRUT vs. CRAT Example

Erica is a 36-year-old New Yorker with $1m assets that have no cost basis (that is, she paid $0 for it). She wants to set up a 20-year term trust.

CRAT (Charitable Remainder Annuity Trust):

• Payout Rate: Given the trust length and the IRS’s discount rate, she will receive 5.39% of the trust’s initial value every year.
• Annual Payments: The trust was originally worth $1 million, so Erica will receive $53,900, or 5.39%, every year.
• Up-front Charitable Deduction: $100,000
• Total Payouts After Donating Charitable Remainder: $647,268

Standard CRUT: (More on the different CRUT structures)

• Payout Rate: Erica is entitled to receive 11.04% of the trust’s assets annually for 20 years.
• Annual Payments: In year 1, Erica would receive $117,742 (assuming the assets are valued at the end of the year after they’ve had a chance to grow a bit); because her payout rate of 11.04% exceeds the asset growth rate of 8%, the trust’s value and payments will decrease over time.
• Up-front Charitable Deduction: $100,000
• Total Payouts After Donating Charitable Remainder: $1,483,400

Why does a CRUT perform so much better on average?

No doubt you noticed the bottom line: The total payouts from Erica’s CRUT are significantly higher than from a CRAT. Why is that so? It’s simple: A CRUT’s annual distributions are defined as a percentage of the trust’s assets, measured that year, whereas a CRAT’s annual distributions are a fixed percentage of the trust’s starting value. Assuming that the trust grows in value over time — a fair assumption for our users, most of whom will aim to match historical market returns. Then, the distributions will be much larger if they connect to the trust’s growing value rather than how much the assets were worth on day 1.

Another benefit is adding additional assets to a CRUT whenever you’d like. Say you added $1m of stock in year one and then had another $1m in year five you wanted to defer taxes on; with a CRUT, you can continue contributing those assets. CRATs don’t offer the same benefit.

FAQs

How much of your CRTs goes to Charity?

In most cases the IRS estimates that you (or your beneficiaries) will receive ~90% of the asset value from the Charitable Remainder Trust, and the charity will receive ~10%. In exchange for giving up that 10% you get the benefits of tax-free growth and receive a deduction for 10% of the value of the trust. In most cases when using the CRT with appreciated assets it allows you to come out ahead you come out ahead in the end as the tax-free growth outweighs the charitable gift.

Why Are CRTs Allowed?

When we explain the magic of Charitable Remainder Trusts, most people ask: Why does this work? In short, the government has decided that it’s willing to allow people to get tax-free growth in exchange for a promise that they’ll give some money to charity in the future. In addition, since the assets left in a Charitable Remainder Trust at the end will go to a tax-exempt entity, the trust doesn’t pay taxes on its capital gains (and you won’t pay taxes until you withdraw your money).

How Much Does It Cost to Set Up A Charitable Remainder Trust?

With most attorneys, it would cost about $10,000-$25,000 and 6 weeks or more to set up a Charitable Remainder Trust. With Valur, you can get set up at no cost and in less than 24 hours! You can create an account and fill out your information to get started.

Charitable Remainder Trust Length

Most of our customers feel concerned about how long Charitable Remainder Trusts last. A CRT can last for a specific number of years, up to 20 years, or the lifetime of one or more people. However, it’s convenient to set up the trust for as long as possible to grow your assets faster by taking advantage of deferring taxes for longer. Also, each of these structures has benefits and costs. Therefore, we worked with our legal partners to design trusts that enhance the value and minimize the drawbacks.

Next Steps

According to Charles Schwab, Charitable Remainder Trusts are “particularly suited for appreciated assets” because they allow for tax deferral, reinvestment, diversification, and, most importantly, significantly improved returns.

If you still have any questions, please reach out to our team to schedule a meeting or you can start by creating your trust here.

About Valur

We have built a platform to give everyone access to the tax planning tools of the ultra-rich like Mark Zuckerberg (Facebook founder), Phil Knight (Nike founder), and others. Valur makes it simple and seamless for our customers to utilize the tax-advantaged structures that are otherwise expensive and inaccessible to build their wealth more efficiently. From picking the best strategy to taking care of all the setup and ongoing overhead, we take care of it and make it easy.