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Family First with a Charitable Trust

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by Bill Hurd ’61

Your family comes first! Why would you want to establish a Charitable Remainder Trust (CRT)? My answer is that this is a great way to take care of you and your family. When all of the family beneficiaries are gone, Clarkson will get the remainder, but I like to think of this as a secondary benefit. The important thing is that a CRT can provide secure lifetime income for you, your spouse and your children. CRTs are also very tax-efficient. They can provide an immediate charitable tax deduction, defer capital gains taxes, and provide distributions that are partially tax free or taxed at capital gains rates.

When providing for your family comes first, why would you want to give any share of your capital to Clarkson? Well, the benefits of a CRT are usually worth considerably more to the family than the donated amount.  Besides the tax benefits, the donor can diversify investments, gain professional portfolio management, provide lifetime security, protect spendthrift heirs, and “much, much more”. Each year, the trust will pay the beneficiaries a generous distribution. Finally, Clarkson’s share comes at the end, after you and your family have had full lifetime benefit of the trust.

Annuities, non-charitable trusts and rollover IRAs can also be used to provide for you and your family. CRTs have different characteristics from all of these. It takes some serious thought to decide what is best for your situation. Also, there are two types of CRTs. Charitable Remainder Annuity Trusts (CRATs) pay a fixed dollar amount to the beneficiaries. Charitable Remainder Unitrusts (CRUTs) pay out a fixed percentage of the trust value, thus giving a chance for the distributions to grow over time. The rest of this article talks only about CRUTs.

CRUT Overview and Key Rules
A CRUT is a trust wherein the income beneficiaries get regular distributions for the term of the trust, and then the remaining trust assets go to a qualified charity. The IRS requires that the present value of the remainder that goes to charity is at least ten percent of the initial value of the trust. The present value is also the amount of the charitable tax deduction allowed to the donor.

Two IRS rules assure that the charity gets its share in a reasonable number of years. First, the annual payout stated in the trust document must be at least five percent. Second, although there can be any number of beneficiaries, they must all be living when the trust is funded, and the joint life expectancies of all beneficiaries must not be so long that the ten percent rule is violated. I recently ran calculations to determine some example minimum ages.  I found that the ten percent rule is barely met with a single beneficiary age 27 or with two beneficiaries both age 39. A younger beneficiary can be included by limiting the number of years that this person can receive distributions, as necessary.  You could run other cases on the Clarkson Gift-With-Income Calculator . Alternately, Sal Cania, at Clarkson, or I will be glad to run any calculations for you, including more complicated cases.

The final value of most CRUTs is much higher than the present value calculated according to IRS rules. This is because the IRS assumes that the investment return will be the same as the discount rate. In other words, the IRS assumes that the investment return barely keeps up with inflation, whereas the actual average return is likely to be a few percentage points higher. This is good for both the income beneficiaries and the charity.

CRUTs have additional tax benefits besides the initial tax deduction to the donor. One is that the distributions are usually taxed partially as capital gains or untaxed as return of capital, rather than being taxed entirely as regular income. Second, the trust is not subject to taxes, so capital gains realized by the trust are not taxed until they are distributed. Third, appreciated property contributed to the trust can be sold without paying capital gains tax; instead the beneficiaries pay capital gains tax when the gains are distributed.

Although some of the rules for CRUTs have been discussed here, there are other conditions that must be satisfied in the trust document, so a donor should have a good lawyer write the document. If you choose Clarkson as trustee of your trust, it will provide a draft trust document for review by you and your counsel.

Some Valuable CRUT Scenarios
Before we talk about specific scenarios, let’s discuss the beneficiaries. There can be any number of beneficiaries, and they can share the distributions, collect the distributions sequentially, or a combination. The problem with having a lot of beneficiaries is that the joint life expectancy is likely to be so long that the ten percent rule cannot be satisfied. One way around this is the write the trust for a fixed number of years, not to exceed twenty, or for a combination of lives and years. For example, the sequence of beneficiaries might be first to a couple for their lives, then to a child of the couple for life, and finally to a group of grandchildren, for a limited term of years or their lives, whichever comes first. The term of years is selected to meet the ten percent rule. A second way to handle a lot of beneficiaries is to break the donation into two or more trusts, such as one for each child. There are many possible scenarios, and I will be glad to help you find the best strategy for you.

Lifetime-funded CRUTs
Lifetime funded CRUTs are a good way to provide lifetime income for you, your spouse and your children. Typically the annual distributions go to you and your spouse as long as one of you lives, and then to your children. Often grandchildren can be included, for a limited term of years.

Scenario 1. Suppose you have cash that earns little, and you would like to convert this to a professionally managed portfolio with an income stream. You donate the funds to a CRUT, and get an immediate tax deduction for the present value of the amount that eventually goes to Clarkson. You name Clarkson or a qualified trust company to be the trustee. The trustee can invest for maximum total return at a risk level that is comfortable to you. The trust does not have to generate income, because the distributions are a fixed percentage, regardless of whether the trust invests for income or for asset appreciation. If the trust has no income and no realized capital gains, your annual distributions will be tax free. (Distributions are taxed first on trust income, then on capital gains, then on other income types, and then untaxed as return of capital.)

Scenario 2. Suppose you have appreciated stock in one company, perhaps a former employer. You would like to diversify, but you don’t want to pay the capital gains tax, and you want to retain control of your investments. You set up a CRUT, and fund it by donating the stock to it. You name yourself as the trustee, and provide for a successor trustee (like Clarkson). As trustee, you sell the stock. There is no capital gains tax, because the CRUT is not taxed. You get a tax deduction for the net present value of Clarkson’s share. The trust invests the proceeds from selling the stock. You get the annual distributions, which will be taxed partially as capital gains. Without a CRUT, if you sold the stock you would pay capital gains tax, and you would not get a tax deduction, so you would have less money to invest than in a CRUT. There is likely to be considerably more income for you and the successor recipients with a CRUT.

Scenario 3. Suppose you have some unencumbered real estate that you are tired of managing and would like to sell, but you don’t want to pay the capital gains tax. You establish a CRUT and name yourself as the initial trustee. You can donate the real estate to the CRUT, and then sell it. When you no longer want to manage the trust, you resign as trustee and a successor trustee (like Clarkson) takes over. The tax and other benefits are similar to Scenario 2. There are also cases where, with some careful planning, you can benefit from donating a business to a CRUT and then selling it.

At this point, some caution is in order. You have to be careful when you donate property and then sell it. The sale must actually occur after the property is in the trust. It would be great to have an interested buyer, but you can’t have a pre-arranged agreement or contract for the sale.

Testamentary CRUTs
Testamentary CRUTs are a great way to provide for your heirs. Personally, I would like to leave my children some immediate gifts, and some lifetime income. Lifetime income is a great way to protect your children from blowing all of their inheritance quickly. It can also protect them against lawsuits and divorce. You may think that your children would not blow the money, but studies have shown that a large percentage of heirs spend everything within two or three years. They think of inheritance as found money, like winning a lottery. So I plan to leave part of my estate in CRUTs for my children.

Scenario 4. Suppose you would like to provide for your children, and perhaps your grandchildren. You would like to fund a CRUT out of assets other than IRAs or similar qualified retirement assets. It is pretty simple. You write a CRUT document, and fund the CRUT out of your estate, as directed by your will or family trust. Your grandchildren may well be in their thirties when the trust is funded, so a trust might meet the CRUT requirements with a child and one or more grandchildren as lifetime beneficiaries. Sometimes, if the grandchildren are young, you may have to limit their income to a term of years. A good attorney should be able to write the appropriate documents. Your estate will get tax benefits.

Scenario 5. In this scenario, you have significant assets in IRAs or similar qualified retirement accounts. You would like to provide lifetime income for your children, and you know about stretch IRAs. Stretch IRAs cannot guarantee lifetime income, because they require withdrawals over the heir’s life expectancy, not the actual lifetime. And you would like your children to outlive their life expectancies and continue to have income. Also, someone who inherits an IRA can withdraw all of the funds at any time. You may be concerned that one of your children might do this and take a long vacation and return to lifetime unemployment. You are also concerned that your spouse may outlive you by so long that the IRA is depleted by the minimum required distributions. A CRUT can be a solution to these IRA problems. You name the CRUT as the primary beneficiary of the IRA. In the CRUT, you name your spouse as the first distribution beneficiary, so he or she gets lifetime income. You name your child as the first successor beneficiary. You can name your child’s spouse and/or your grandchildren as second successor beneficiaries, limited to a term of years if necessary. Other scenarios are also possible. I’ll be glad to help you work out a good strategy for your family.

Trust Expenses and Trustees
Of course you are concerned about the expenses of a trust. The lawyer’s fee to write a CRUT should be pretty low. Professional trustees charge fees that usually include managing the assets and doing the legalities, including tax returns. These fees are reasonable for larger trusts, but can be significant for small trusts. The good news here is that Clarkson can often act as trustee at a reasonable cost, using a bank trust company to do much of the actual work.

Final Remarks
Please consider using a CRUT to further your family’s financial situation. It’s a great way to provide for you and your heirs, and to leave a legacy to Clarkson. Sal Cania will be glad to help you in any way he can. We care about you and your family, and we appreciate your caring for Clarkson.

Read Bill's article, "Trust Your Children or Trust a Trust"                       

Read Bill's article, "Take Care of Yourself First"                                        
Read Bill's article, "Retirement Income for Financial Conservatives"     
Read Bill's article, "A Charitable Trust Might be for You"
Read Bill's article, "Charitable Giving May Be Easier Than You Think"
Read Bill's article, "Do You Have a Tax Problem?"
Read Bill's article, "Why and How We Give to Clarkson"

Footnote: Bill Hurd passed away in 2016.  This article is published in thanks and admiration to a loyal Clarkson alumnus.

(rev. 12/2016)