If charitable giving is a significant part of your estate plan, it’s essential to choose a donation structure that fits your resources and goals. Trusts can be effective ways to provide for yourself or your family and help potentially reduce taxes while maximizing support for the causes you care about.
What Is a Charitable Trust?
A trust is a legal structure into which one party (the grantor) places assets to be managed by another party (the trustee) to benefit one or more beneficiaries. In a charitable trust, one or more beneficiaries are charitable organizations, and donating to these organizations is a significant purpose of the trust.
Charitable trusts are split-interest trusts. In other words, they offer a way to donate to charity over time while providing income for you or your heirs.
How does a charitable trust work? You choose the assets you want to place into the trust, select a trustee or trustees to manage it, and set up guidelines for how you want the trust assets invested and distributed. The trustee can be any responsible party you choose, from a financial professional to a family friend or even yourself
Charitable trusts can be structured in various ways to meet the donor’s specific needs and goals. Using a trust can help ensure your goals and wishes for these assets are met, even after you are gone. It is important, however, to understand that these trusts are irrevocable; in other words, you can’t simply decide you want the money back and disband the trust.
Tax Benefits of Charitable Trusts
Charitable trusts have become a popular charitable giving strategy for the tax benefits they can offer. Depending on how they are set up, they may help you minimize taxes on your capital gains, income, and estate.
If you own long-term appreciated non-cash assets like stocks or real estate and decide to sell them, you are immediately responsible for capital gains taxes on the amount they have appreciated since you acquired them. However, if you transfer these assets to a charitable trust, you don’t pay the capital gains. And depending on the trust’s structure, you may get a charitable tax deduction for the donation.
Currently, the IRS does not require charities to pay capital gains taxes, so the trust doesn’t pay capital gains tax on the sale of the appreciated assets as long as it holds those assets for at least a year. This may allow asset in these trusts to potentially grow faster.
In addition, the assets in the trust are not considered part of your estate and may, therefore, reduce the estate taxes owed by your heirs.
The income (non-charitable) beneficiaries may, of course, owe taxes when they receive distributions from the trust.
Types of Charitable Trusts
There are two main types of charitable trusts, plus variations on those themes. Your financial advisor can help you understand which kind of trust suits your goals best.
The two main types of charitable trusts are charitable remainder trusts (CRTs) and charitable lead trusts (CLTs). Both types are designed to generate income and divide the benefits between charitable and non-charitable beneficiaries. The difference lies in which beneficiary receives income payments during the life of the trust and which receives the remaining assets when the trust is concluded.
What Is a Charitable Remainder Trust (CRT)?
Charitable remainder trusts are the most common type of charitable trust. If you set up a charitable remainder trust, you are eligible for an immediate tax deduction, and your non-charitable beneficiary receives scheduled income payments from the trust during their lifetime. You can designate yourself or some other individual as the non-charitable beneficiary. You might, for example, select your spouse, children under 18, or a child with a disability as the beneficiary.
Your non-charitable beneficiary’s income stream may be a fixed dollar amount, be tied to a percentage of the initial or current fair market value of the trust’s assets, or be a percentage of the trust’s income.
Once the non-charitable beneficiary dies, the charitable beneficiary receives the total of the trust’s remaining assets, and the trust is terminated.
You may want to consider a CRT if you have a large estate and would like to receive a steady, substantial income for the remainder of your life. Of course, these assets will not be available to pass to your heirs, but they will also reduce your estate and the amount of estate taxes your beneficiaries may have to pay. You can also use a CRT to provide lifelong financial security for someone you care about, such as your spouse or a child with disabilities.
You can establish a CRT during your lifetime or through your will to provide for heirs.
What Is a Charitable Lead Trust (CLT)?
Charitable lead trusts are essentially the opposite of charitable remainder trusts. With a CLT, your chosen charity receives regular payments for a specified period, after which the trust’s remaining assets pass back to you or go to your designated beneficiaries.
Depending on how your trust is set up, you may be able to take an immediate partial tax deduction. There also may be a gift or estate tax deduction based on the value of the charity’s interest, which could allow you to pass assets on to the next generation at a reduced tax cost.
You might consider a charitable lead trust if you wish to make a sizeable charitable donation during your lifetime and don’t mind giving up any current income from those assets. If you have a high current income and a significant concern is reducing your heirs’ gift and estate assets, this type of trust may be beneficial.
Charitable Trusts vs. Other Philanthropic Giving Strategies
There are, of course, other ways to structure your charitable donations, many of them more straightforward to establish and manage than a trust. The right structure for you depends on your resources and goals.
The simplest options are one-time and annual recurring donations. Recurring donations can be in the form of cash, stocks, or other assets and may provide you with a tax deduction for the year(s) you make them.
A donor advised fund (DAF) can also give you immediate tax advantages, but with time to make strategic decisions about your giving. You set up a designated charitable account and receive an immediate tax deduction on the full fair market value of your funding, but you can take as much time as you want to distribute donations. DAFs are simple and inexpensive. Plus, assets can grow tax-free in the account.
Neither of these strategies, however, offers the personal income opportunity of a charitable trust.
Choosing the Right Charitable Trust Strategy
There is much to consider when deciding on a charitable giving strategy, including your philanthropic vision, income goals, estate planning goals, and tax implications. Trusts can be very effective instruments for income generation and charitable giving, but they can also be complex to set up and manage legally and effectively. Your financial advisor can help ensure you’re using the right strategy and correctly setting your trust up to provide the desired benefits.
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