What is a charitable trust?
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A charitable trust allows you to donate assets to a chosen tax-exempt charitable organization or nonprofit and comes with certain tax benefits to help you minimize what you might owe to the government. Charitable trusts can also be structured to provide a reliable income stream to you and your beneficiaries for a set period of time.
Establishing a charitable trust can be an important part of your estate plan and a rewarding way to make an impact for a cause you care deeply about.
Types of charitable trusts
There are a few types of charitable trusts to consider based on your situation and what you may be looking to accomplish.
Charitable lead trust
A charitable lead trust is an irrevocable trust that is established to distribute an income stream to a designated charity or nonprofit organization for a set number of years. The trust can be established with a gift of cash or securities made to the trust. Depending on the structure, the donor can benefit from a stream of income during the life of the trust, deductions for gift and estate taxes and current year income tax deductions when the assets are donated to the trust.
If the charitable lead trust is funded with a donation of cash, the donor can claim a deduction of up to 30 percent of their adjusted gross income (AGI) in any single year. Any unused deductions can generally be carried over into the subsequent five tax years. The deduction limit for appreciated securities or other assets is also generally limited to no more than 30 percent of AGI in the year of the donation.
Upon the expiration of the charitable lead trust, the assets that remain in the trust revert back to the donor, their heirs or designated beneficiaries. The assets do not revert to the charity.
Charitable remainder trust
A charitable remainder trust (CRT) works a bit differently than a charitable lead trust. A CRT is an irrevocable trust that is funded with cash or securities. The CRT provides the donor or other beneficiaries with a stream of income with the remaining assets in the trust reverting to the charity upon your death or the expiration of the trust period.
There are two types of CRTs: A charitable remainder annuity trust or CRAT distributes a fixed amount as an annuity each year; no additional contributions can be made to a CRAT. Meanwhile, a charitable remainder unitrust or CRUT distributes a fixed percentage of the value of the trust, which is recalculated annually. Additional contributions can be made to a CRUT.
The steps when using a CRT are:
- Make a partially tax-deductible donation of cash, stocks, ETFs, mutual funds or non-publicly traded assets such as real estate to the trust. The amount of the tax deduction received is a function of the type of CRT, the term of the trust, the projected annual payments (usually stated as a percentage) and the IRS interest rates that determine the projected growth in the asset that’s in effect at the time.
- Receive an income stream for you or your stated beneficiaries based on how the trust is set up. The minimum percentage is 5 percent based on current IRS rules; payments can be made monthly, quarterly or annually.
- After a designated time frame, or after the death of the last remaining income beneficiary, the remaining assets in the CRT revert to the designated charity or charities.
Benefits of a charitable trust
There are several benefits of a charitable trust that make them attractive for estate planning and other purposes.
- A charitable trust is a tax-efficient way to donate to the charities or nonprofit organizations of your choosing. The charitable trust provides benefits to both the charity and the donor.
- The trust provides upfront income tax benefits to the donor when the contribution to the trust is made.
- Donating highly appreciated assets, such as stocks, ETFs and mutual funds, to the charitable trust can help you avoid paying capital gains taxes that would be due if these assets were sold outright. Additionally, the market value of the assets donated is used to determine the value of the donation when calculating the amount that can be deducted for tax purposes.
- A charitable trust can provide income to the donor or their heirs, and in the case of a charitable lead trust, the remaining balance in the trust reverts to the donor or their heirs at the end of a set period of time.
- Donations to a charitable trust can help reduce the value of your estate and reduce estate taxes on larger estates.
Disadvantages of a charitable trust
For all their benefits, charitable trusts do have some disadvantages as well.
- These trusts are generally irrevocable, meaning that you cannot undo the trust if your situation changes and you were to need the money or assets donated to the trust. Once you make the decision to establish and fund the trust, the money is no longer under your control, and the trust cannot be revoked.
- Any income you derive from the trust could reduce the amount that ultimately goes to the charity or nonprofit organization. If your goal is to give the maximum amount directly to the charity upfront, a charitable trust might not be the best vehicle to accomplish this.
- You need to make a large enough contribution to the trust to accomplish the dual goals of providing a significant donation to the charity and providing income to yourself and your heirs.
Is a charitable trust right for you?
A charitable trust may be a good option if you have a desire to create a legacy with some of your assets. If you have appreciated securities or other assets and want to donate them in a tax-efficient way that also generates income for you or designated beneficiaries over a specified period, establishing a charitable trust could make sense.
It might not be the best vehicle for you, however, if you don’t want to give up control of these assets or go through the process (and cost) of working with an attorney to establish the trust. You’ll also have to perform the annual work to maintain it. A less-costly alternative to consider setting up — that comes with many of the same benefits — is a donor-advised fund.
It’s best to consult with a financial and tax advisor if you are thinking about establishing a charitable trust or other tax-efficient ways of making donations to nonprofit organizations.