Charitable Remainder Trusts: Life Insurance Ownership Explained

A charitable remainder trust (CRT) is a tax-efficient way to provide an income stream for beneficiaries and leave a remainder to a charity of your choice. It is a popular option for those who want to benefit their heirs and donate to a good cause. While CRTs can be funded with a range of assets, permanent life insurance policies are one of the more common sources of funding. This is how it works: the CRT purchases the life insurance policy using donated money. When the insured dies, the CRT pays out benefits to the beneficiary for a set number of years or until their death. The remaining funds are then given to a charity of choice.

Irrevocable life insurance trusts (ILITs)

ILITs are set up between three legal parties: the grantor, the trustee, and the beneficiary/beneficiaries. The grantor creates and funds the trust, the trustee manages it, and the beneficiaries receive the assets upon the grantor's death. The trustee can be a friend, relative, or independent professional.

The benefits of an ILIT include tax advantages, asset protection, and government benefit protection. By removing taxable assets from the grantor's portfolio, an ILIT can lower their current tax burden and provide a tax-efficient way to transfer wealth to beneficiaries.

ILITs also protect legacy assets from potential creditors and can be used to set aside assets for a family member with special needs without interfering with their eligibility for government benefits. The trustee can manage how distributions from the trust are used, ensuring that the beneficiary's eligibility for benefits is maintained.

The main downside of an ILIT is that it is irrevocable. Once the trust is finalised, no changes can be made, and the grantor relinquishes control of the assets. Therefore, careful consideration and planning are necessary before setting up an ILIT.

How charitable remainder trusts work

A charitable remainder trust (CRT) is an irrevocable trust that allows you to donate assets to charity while also providing an income stream for yourself or other non-charitable beneficiaries. Here is how charitable remainder trusts work:

Establishing the Trust:

A CRT is established by transferring assets, such as cash, securities, real estate, or other property, into the trust during your lifetime. This transfer of assets provides an annual stream of payments to the non-charitable beneficiaries for a term of up to 20 years or for the lifetime of the beneficiaries.

Types of Charitable Remainder Trusts:

There are two main types of charitable remainder trusts: the charitable remainder annuity trust (CRAT) and the charitable remainder unitrust (CRUT). In both types, the value of the charitable remainder must be at least 10% of the net value of the property transferred to the trust, and the payout must be between 5% and 50% annually.

The CRAT pays a fixed annuity amount each year, and additional contributions are not allowed. The CRUT, on the other hand, distributes a variable percentage based on the balance of the trust assets, which are revalued annually. Additional contributions can be made to the CRUT.

Tax Benefits:

One of the key advantages of CRTs is the potential for tax savings. Donors may be eligible for a partial income tax deduction when they fund the trust, based on the expected distribution to the charitable beneficiaries. Additionally, the CRT's investment income is tax-exempt, providing an opportunity for asset diversification.

Flexibility and Control:

CRTs offer flexibility and control over your charitable giving. You can choose to name yourself or someone else as the income beneficiary, and you can select the payout rate, which must be at least 5%. You can also designate one or more charities to receive the remainder of the donated assets after the specified timeframe or the death of the last income beneficiary.

Benefits to Donors:

Donors can receive an income tax deduction for a portion of the assets contributed to the trust and avoid capital gains tax on the sale of appreciated assets used to fund the trust. CRTs can help increase current income, diversify assets, and provide a predictable income stream.

In summary, charitable remainder trusts are a powerful tool for philanthropic individuals who want to support charities while also generating income and potentially reducing their tax burden.

Types of charitable remainder trusts

There are two main types of charitable remainder trusts (CRTs): the charitable remainder annuity trust (CRAT) and the charitable remainder unitrust (CRUT). Both types of trusts can be created while the donor is alive (inter vivos) or upon death (testamentary).

A CRAT pays the beneficiary a fixed annuity benefit for a period of time, and the remainder is donated to charity at the end of the distribution period for the beneficiary. The value of the trust is determined when the funds or assets are added and is not re-evaluated each year. Additional contributions to CRATs are not allowed. With a CRAT, the amount distributed to a non-charitable beneficiary remains constant for the duration of their distribution period, regardless of whether the value of the assets in the trust fluctuates over time. CRATs are best used if the assets placed in the trust are expected to lose value.

A CRUT, on the other hand, requires that annual distributions are made to the non-charitable beneficiary(ies) based on a fixed percentage of the value of the assets in the trust, re-evaluated each year. Since the value of the assets in the trust generally fluctuates from year to year, so does the annual payment to the non-charitable beneficiary(ies). CRUTs are best used if the assets placed in the trust are expected to appreciate in value.

In both types of CRTs, the value of the charitable remainder must be at least 10% of the net value of the property transferred in trust on the date of contribution to the trust. Also, in both, the payout must be no less than 5% and no more than 50% annually.

Benefits of charitable remainder trusts

A charitable remainder trust (CRT) is a powerful tool for those who want to give to charity while also generating income. Here are the key benefits of CRTs:

Income Generation

CRTs allow donors to convert appreciated assets such as stocks or real estate into a steady income stream, either for themselves or other named beneficiaries. This can be particularly useful during retirement or to support loved ones after the donor's passing.

Tax Benefits

CRTs offer significant tax advantages, including the ability to reduce income taxes through charitable income tax deductions. Donors can also defer or eliminate capital gains taxes when the trust's assets are sold, as the trust itself is tax-exempt. Additionally, CRTs can help reduce or eliminate estate taxes since assets placed in the trust are removed from the donor's estate.

Charitable Giving

CRTs provide a structured way to give to charities that the donor supports. By naming a charity as the trustee, donors can ensure their contributions are well-managed and benefit a worthy cause. CRTs also allow donors to plan their charitable contributions effectively and may enable them to give more due to the tax savings.

Flexibility

CRTs offer flexibility in terms of their structure and how they can be combined with other strategies, such as donor-advised funds. Donors can choose between different types of CRTs, such as charitable remainder annuity trusts (CRATs) and charitable remainder unitrusts (CRUTs), to suit their specific needs.

Asset Preservation

By contributing highly appreciated assets to a CRT, donors can preserve their value while avoiding capital gains taxes. This allows donors to receive annual payments from the trust without incurring additional tax liability, ultimately enabling them to give more to their chosen charities.

Downsides of charitable remainder trusts

Charitable remainder trusts (CRTs) are a great way to donate your personal assets to charitable organisations while also providing you with potential relief from capital gains taxes. However, there are some downsides to CRTs that you should be aware of before setting one up.

Firstly, CRTs are irrevocable, meaning that they cannot be modified or terminated without the charitable beneficiaries' permission. This gives the trustor no access to or control over the funds in the trust and makes it difficult, if not impossible, to alter the terms of the trust. Legally, the trustor no longer has control of the assets in the trust, and any part of their estate that goes into the CRT will go to the charitable organisation of their choice, not their heirs.

Secondly, CRTs are complex constructions, and their creation and administration can be complicated and costly. It is important to run a thorough cost-benefit analysis to ensure that a CRT is the best use of the assets you are planning to put into it.

Thirdly, distributions from the CRT to the income beneficiaries might be taxable as ordinary income. While the trustor can receive an income stream from the reinvested proceeds of the CRT, this income may be subject to tax.

Finally, CRTs usually require a donation of substantial assets to make sense. This means that CRTs may not be suitable for everyone, depending on the value of their estate and the amount they wish to donate to charity.

Frequently asked questions