Many clients are interested in Philanthropic Planning. One of the tax efficient ways to make gifts to charities, but also still receive some of the assets back, is through the use of a charitable trust. A charitable trust where you or loved ones benefit is also known as a split-interest trust. It is called a split-interest trust because the interest in the trust is always split between at least one charitable beneficiary and one non-charitable beneficiary.
By using advanced estate planning techniques, you can get more out of the charitable gifting you wish to do because by committing to a charitable trust now, you can create additional value for your charities and secure tax benefits for yourself.
There are basically three types of Split Interest Charitable Trusts
- a Charitable Lead Trust (CLT); and
- a Charitable Remainder Trust (CRT); and
- a Pooled Income Fund.
CHARITABLE LEAD TRUST (CLT)
The most common Charitable Lead Trusts are Charitable Lead Annuity Trusts (CLATs) and Charitable Lead UniTrusts (CLUTs). A CLAT pays out a fixed amount every year to the charitable beneficiary for the term of the trust, and at the end of the term, the non-charitable beneficiary (typically the children or grandchildren of the Donor) receives whatever remains. A CLUT differs in that the money it pays out to the charity during the term is not fixed dollar amount, but a fixed percentage of the value of the trust.
When money is placed into a Charitable Lead Trust, a calculation must be made to determine what part of the transfer is a non-taxable gift (because it goes to charity) and what part of the transfer is a taxable gift because it is expected to go to non-charitable beneficiaries. The longer the charity gets the money in the lead term, and the higher the payout, the less the taxable gift.
The primary benefits of CLTs are (1) the donor can receive a large income tax deduction upon making the gift, and (2) the potential to pass on property to the Donor’s family with minimal gift and estate tax liability. Charitable Lead Trusts are most frequently used in a year in which the Donor has an income windfall such as winning the lottery, receiving a large bonus, withdrawing a significant amount from a retirement account, or the sale of a business.
CHARITABLE REMAINDER TRUST (CRT)
The most common Charitable Remainder Trusts are Charitable Remainder Annuity Trusts (CRATs) and Charitable Remainder UniTrusts (CRUTs). A CRAT is the opposite of a CLAT in that it pays out a fixed amount every year to the non-charitable beneficiary (typically the children or grandchildren of the Donor) for the term of the trust, and at the end of the term, the charity receives whatever remains. A CRUT is also a unitrust like the CLUT, so the payouts to the lifetime beneficiary are not fixed dollar amounts, but a fixed percentage of the value of the trust.
When money is placed into a Charitable Remainder Trust, a calculation must be made to determine what part of the transfer is a non-taxable gift (because it goes to charity) and what part of the transfer is a taxable gift because it is expected to go to non-charitable beneficiaries. The longer the non-charitable beneficiary receives money in the lead term and the higher the payout, the higher the taxable gift.
The primary benefits of CRTs are (1) the donor can fund a CRT with retirement funds upon death, allowing for tax deferred growth over a longer period than if beneficiaries were named outright, and (2) the ability to diversify the investments inside the trust without incurring capital gains tax on the sale of the contributed property. The benefits of a CRT do not stem from the gift and estate tax consequences.
POOLED INCOME FUND
Under a Pooled Income Fund, the charity is BOTH the trustee AND the remainder beneficiary. In other words, these are often run by charities. The donor will donate property specifying that the income from the property will go to one or more individual beneficiaries (usually the donor) and upon such lifetime beneficiary’s death, the remainder will be distributed to the charity. This is similar to a CRT.
Pooled income funds received its name from the fact that the charity will “pool” the donations from a number of different donors into one fund. The purpose of pooling the funds is to avoid the expenses of maintaining different trusts, as the charity is usually the trust creator.
Pooled income funds are different from CRTs in that the pooled income fund must distribute ALL of the income currently, not just a set amount or set percentage. If it does not distribute all of its income then the excess will be taxed at the regular trust tax rates. Accordingly, the amount that passes to the individual beneficiaries can fluctuate based upon the income generated.
Pooled income funds are most beneficial when a person dies and wants to leave some money to a loved one in the form of an income stream and then the rest to charity after the loved one dies. Note that many Pooled income funds require the beneficiaries to be alive and of a certain age. So it may be tough to use this to name younger beneficiaries.
