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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.
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.
By deferring your taxes and reinvesting the savings, you can increase your returns by 50% or more. Let’s dive into the specific benefits:
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.
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.
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.
Setting up a Charitable Remainder Trust is easy.
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.
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
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. |
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):
Standard CRUT: (More on the different CRUT structures)
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.
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.
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).
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.
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.
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.
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.