Charitable remainder trusts are a type of irrevocable trust which are for the benefit of a non-charitable entity now — such as you, your spouse, or your children — but leave what is left after that support to charity. They are called charitable remainder trusts because they pay an income stream to the beneficiaries now and whatever remains afterward is donated to charity.
Most types of testamentary gifts afford the original grantor no lifetime benefit, because the charitable gift occurs after death. However, charitable remainder trusts are part of the short list of testamentary gifts which afford a lifetime charitable deduction.
Establishing a charitable remainder trust requires the assistance of an experienced estate attorney first. With the attorney, you pick what the size and character of the beneficiary’s income stream will be when you set up the trust, but in order to be qualified for any charitable deduction the trust must meet certain requirements imposed by U.S. tax law.
Next, you need the assistance of an actuary to calculate your tax deduction. Charitable remainder trusts give you a tax deduction equal to the value of your gift minus the calculated present value of the income stream owed to the trust beneficiaries. This “annuity due” calculation relies on U.S. tax law approved assumptions to find an actuarial projection of the likely remainder. That calculated remainder is then the charitable deduction you receive now.
Even though the charity may receive more or less as reality deviates from those actuarial projections, your charitable deduction is fixed and captured now by the projection.
Charitable Remainder Trusts are used primarily to 1) pull the tax savings of charitable estate intentions forward into life or 2) try to game the system to get a tax deduction larger than the charity receives in gift. They can be costly to establish, requiring at least an estate attorney and actuary, and can be difficult to maintain, requiring annual reporting and income distribution calculations.
The more the beneficiaries receive, the less the charity receives.
If the account goes sufficiently down in value, it is possible that you would receive the entire corpus with nothing left for the charity. If the account goes sufficiently up in value, it is possible that you could have received a larger charitable deduction by donating directly to charity outside of the trust.
If the income stream is set too high, actuarial projections may calculate that you get no charitable deduction and have simply created an expensive way to give money to your beneficiaries. If your income stream is too small, you could have irrevocably separated yourself or your heirs from retirement assets, emergency funds, or long-term care funding.
In this way, even for someone who wants to leave 100% of their estate to charity, a charitable remainder trust is not a perfect tool.
While we are knowledgeable with how charitable remainder trusts function and some theoretical scenarios where they could be helpful, we have yet to meet a client whose goals are best supported by this expensive trust.
This can be contrasted with a donor advised fund. Donor advised funds are cheap to establish and easy to maintain. They are trying to support only your charitable intentions, not also your retirement or your personal giving to heirs.
If you give stock to your donor advised fund and the account value subsequently goes down, this means that you have received a larger tax deduction than you could receive now by giving the same assets. On the other hand, if the account value goes up, then your charity receives more than you originally thought they would. Both scenarios can be considered a win.
Donor advised funds are used for many purposes. Some common ones are 1) facilitate gift clumping by separating the tax deduction from the charitable grant, 2) remove the drag of annual taxable dividends and interest from your lifetime estate, 3) provide administrative support to gifting appreciated stock, 4) fulfill a recurring charitable gift or pledge, and 5) establish an easy way to change your testamentary charitable intentions.
It is helpful to know that a charitable remainder trust exists, but most charitable intentions benefit more from a donor advised fund.
Photo by Wijdan Mq on Unsplash. Image has been cropped.