Charitable Trusts: CRTs and CLTs
Trusts that pass a 10% deductibility test qualify as charitable entities.
There are two main types of Charitable Trusts: Charitable Remainder Trusts (CRTs) and Charitable Living Trusts (CLTs). In both types, assets are transferred to the Trust as principal. In the CRT, interest on the principal is distributed periodically to the donor as income, with the principal ultimately passing to charity. In the CLT, interest on the principal is distributed periodically to the charity, with the principal ultimately passing ultimately to the donor (or their heirs). In both cases, a substantial tax benefit provides financial incentive in addition to the obvious charitable one.
Charitable Remainder Trusts: CRAT and CRUT
Most people want to have steady, dependable income from their wealth to sustain their standard of living during their lifetime, and would rather give money to charity than to the IRS at their deaths. This goal is best realized with the Charitable Remainder Trusts (CRTs). The CRTs can be subdivided into two types, CRAT and CRUT, standing for Charitable Remainder Annuity Trust and Charitable Remainder Unitrust, respectively.
The Charitable Remainder Unitrust (CRUT) is a vehicle for reducing tax load while assuring steady income and an ultimate gift to charity. It works like this:
- Assets are placed in the Trust.
- Interest earned on the principal is distributed to the donor periodically.
- At the death of the donor, the principal goes to charity.
A schematic of the CRUT is shown below:
The CRUT has been sanctioned by the IRS under Code Section 664, which requires that the donor keep at least 5% of the principal, with the charity keeping at least 10%.
In addition to the obvious benefit to the charity involved, the CRUT is attractive for the following reasons:
- Stock placed into the CRUT typically will not have performed at the 5% level, translating to increased income.
- Substantial income, estate and capital gains tax reductions can be realized.
- The trust affords a decent level of credit protection.
The main difference between the two types is that the Annuity Trust (CRAT) pays a specific amount at regular intervals, while the Unitrust (CRUT) pays a percentage (and is revalued periodically to update this percentage).
The Wealth Replacement Trust
A common adjunct to the CRUT is the Wealth Replacement Trust (WRT), also shown on the schematic above. This is a vehicle to pass wealth to one's heirs to "replace" the assets given to charity in the CRUT, which they would otherwise have received. Typically, a couple will gift regular amounts to the WRT, which then purchases a second-to-die insurance policy. After both their deaths, their heirs receive the insurance benefit.
To finance the insurance premiums, one can use the income generated by the CRUT, as well as the income tax savings from contributions thereto. The insurance benefit is not taxable under the Federal Estate Tax.
Charitable Living Trusts: CLAT and CLUT
The Charitable Living Trusts, CLAT and CLUT, are basically mirror images of the Remainder Trusts: interest is disbursed periodically to charity during the term of the trust, with the principal passing to the donor at its termination. Because of this, the CLUT lacks the ability to provide steady income to the donor in the same manner as the CRUT, since interest is distributed to the charity during the term of the trust.
A schematic of the CLUT is shown below:
In addition to the obvious benefit to the charity involved, the CLUT is attractive for the following reasons:
- A regular charitable deduction with associated income, estate and capital gains tax savings.
- Donor retains ultimate ownership of principal.
- Credit protection.
