Americans are some of the most generous people in the world. Although one might have expected charitable giving to have decreased in uncertain times during a global pandemic, Americans donated a record $471 billion dollars to charity in 2020, according to a recent report in Giving USA.
One wealth management strategy for a substantial gift is known as the Charitable Remainder Trust. Consider this hypothetical simplified example:
No trust planning: Jordan is a solo-ager about to retire at age 70, and has a prized Stradivarius violin worth approximately $5 million which he acquired for $50 thousand 35 years ago. He wants to use the sale of the violin to fund his retirement, but also believes he won’t consume the entire financial resource and wants to leave whatever he doesn’t use to his preferred charity. Jordan could sell the violin, pay a capital gains tax on the appreciation, and have approximately $3.5 million left to fund his retirement. He lives for another 20 years, with his fund returning an approximate 5% each year. He only spends the income of his fund ($175 thousand each year), so he ends up bequeathing the charity $3.5 million 20 years later even though he’s spent $3.5 million during those 20 years.
Using a charitable remainder annuity trust (CRAT): Jordan funds a CRAT with the violin, and relinquishes any rights to the violin in the future. The trust sells the violin, and is funded with $5 million, but because it is a charitable trust it avoids all capital gains tax. Jordan sets up the trust with himself as the beneficiary, to receive a fixed amount of $250,000 each year for 20 years because there was no tax on the sale of the violin. This trust also returns an approximate 5% each year, and so it pays him $250 thousand each year (the approximate earnings of the trust). At the end of the 20 years, Jordan has received $5 million from the trust and the $5 million remainder flows to the charity.
In this scenario, both Jordan and the designated charity receive more, but Jordan doesn’t have the safety net of drawing on the additional funds if an extraordinary need arises.
Generally, the income tax deductible value of a charitable remainder interest ranges from 20% to 50% of the value of the assets that are placed in trust. The exact amount is determined by actuarial tables, the nature and duration of the income interest, and prevailing interest rates when the trust is funded.
Deductions (as opposed to tax credits) have the greatest benefit when you are in the highest tax bracket, so a large gift might be best timed with an anticipated high-income year. Should Jordan have highly appreciated assets in a retirement account that would be taxed as ordinary income, this large charitable gift could reduce the tax burden on those sales.
Types of Charitable Trusts
Charitable Remainder Trusts fall into the category of being either Charitable Remainder Unitrusts (CRUTs) or Charitable Remainder Annuity Trusts (CRATs) as described above. The primary difference is that the Unitrust payments are a fixed percentage of its assets determined each year instead of a fixed dollar amount. If the unitrust grows in value by more than enough to fund the income, the future income payments go up. This can help protect the income against inflation, but also runs the risk of having reduced income payments in times of economic difficulty.
If there is no need for the income, but instead a wish for an inheritance to be preserved and to be able to witness the good that comes from the donations, the same strategy can be done in reverse. This would be a charitable lead annuity trust, which provides the annuity payments to the charity and then has the remainder flow to the beneficiary.
These strategies to employ trusts are meant to provide steps that link philanthropic intentions with reducing potential conflicts with other wealth management goals.
Those in a position to have larger philanthropic efforts they wish to be directly involved in may want to consider the bigger step of creating a private foundation.
What can a private foundation do?
Setting up a private foundation during your lifetime lets you play an active role in managing your philanthropy as well as observe the results of your generosity. A foundation lets you make gifts privately and anonymously and can act as a shelter from a barrage of solicitations.
There also may be financial and emotional rewards for yourself and your family. For instance, members of your family may be appointed to the foundation’s board of directors. A foundation funded with a major donation may be large enough to provide compensation for family members who carry out administrative functions or serve on the board of directors. Parents, children, brothers and sisters may become closer as they work together in their charitable endeavors to improve the world.
At Garden State Trust Company, we are familiar with the philanthropic efforts of many clients, and take pride in our part of helping facilitate them. If you are planning any major gifts, we’d be pleased to meet and share our experience of what options may be available and appropriate given your situation.