Charitable Trust

Implementing charitable planning strategies can result in tax savings and benefits to a charity of your choice. You can make a one-time charitable gift with your will or an even more significant difference with a charitable trust. This article explains how charitable trusts operate and the benefits of each type of charitable trust.

What Is a Charitable Trust?

A trust is a legal document that transfers the ownership and management of assets. It will transfer money to a fiduciary called a "trustee." The trustee could be a person, a bank, or a management company. A donor can set up a charitable trust during their lifetime (called inter vivos) or after death (called testamentary).

To be considered a charitable trust, at least one of the beneficiaries of the trust will be either:

• A public charity
• Nonprofit organization
• Private foundation

Depending on the type of trust, the donor and their heirs may also be other non-charitable beneficiaries.

Benefits of Charitable Trusts

Charitable giving can be part of any estate plan. The benefits of a charitable trust increase with income level. But the joys of giving are universal. Other benefits of a charitable trust include:

• Create a family legacy: A family charitable trust can foster an ethic of giving in younger generations.
• Receive an income stream: Some trusts only provide income for the tax-exempt charitable organization. Others can provide an income stream for the grantor or other loved ones and beneficiaries.
• Avoid capital gains tax: A charitable trust allows grantors to turn a property that isn't producing income into cash that can be reinvested without paying capital gains tax. For example, $200,000 in stock that has appreciated from $10 a share to $100 a share can be transferred into a charitable trust without incurring capital gains tax.
• Tax benefits: A charitable trust can be important in tax planning for your estate.

Tax Benefits of Charitable Trusts

The tax advantages of an irrevocable trust will depend on your financial situation. You may be able to take an immediate charitable income tax deduction.

You may avoid capital gains tax on the sale of appreciated assets. And property transferred into your trust is not part of the value of your estate after death. The property avoids probate. A trust can reduce estate taxes if your estate exceeds the Internal Revenue Code's exemption limit.

Types of Charitable Trusts

Charitable trusts have two beneficiaries — one charitable and one non-charitable. Such trusts are "split-interest trusts." Two types of split-interest trusts are charitable lead trusts and charitable remainder trusts.

Charitable Lead Trust (CLT)

With a charitable lead trust, the charity benefits first. The trust operates for pre-determined years (or someone's lifetime). The donor receives an immediate charitable deduction on their tax return for the value of the gift. The nonprofit receives income from the investment of assets for a specified time. The remaining assets go to the non-charity beneficiary at the end of the trust period or upon the grantor's death.

Example: A donor sets up a trust to make a direct annual payment to a favorite charity for 20 years. At the end of that time, the donor's grandchildren receive the remaining assets.

Charitable Remainder Trust (CRT)

A charitable remainder trust is the most popular form of a charitable trust. The charity (or its investment manager) serves as the trustee. The trustee is responsible for investing and managing the trust funds. The charity pays income to the beneficiary, who is the donor or someone the donor selects.

The beneficiary receives income for their lifetime or a pre-determined number of years. CRTs become increasingly popular when interest rates rise. At the end of the term, the charity receives the trust's remaining assets.

There are two different types of trusts and payment plans:

• If the trust makes regular payments of a fixed amount, it is a charitable remainder annuity trust.
• If the trust pays a percentage of the value of the trust, it is a charitable remainder unitrust.

Tax Incentives for a Charitable Remainder Trust

When you feel that you're ready to make a substantial gift to a public charity or private foundation, you may want to consider a charitable trust. Charitable trusts are a special type of trust for significant tax-free charitable giving.

Consider a charitable trust when you are ready to make a large gift to a public charity or private foundation. Making a charitable gift can provide significant federal tax savings.

A charitable trust allows for tax-free charitable giving. It can provide a benefit to your favorite charity. It also offers tax benefits to you (the grantor) as a charitable deduction and annual income to you and your heirs. This trust income can avoid the gift tax. It is a multipurpose estate planning tool.

Your estate planning attorney will consider several factors when planning for a charitable trust. These include:

• Your life expectancy
• Market forces
• Income streams
• Your current amount of income
• The expected longevity of a particular charity over a term of years

Several different types of assets can fund charitable trusts. Real estate and life insurance are popular options. Charitable trusts are irrevocable trusts. That means once you start the trust and it comes into operation, you cannot take back what you have given as trust assets.

How a Charitable Remainder Trust Works

• A charitable remainder trust (CRT) is the most common type of charitable trust. To set up a charitable remainder trust, you must first set up a trust. Then you must transfer the property you want to donate to charity to the trust. The Internal Revenue Service must approve the charity. It must be exempt from taxes under the Internal Revenue Code.

The charity will serve as the trustee of the charitable remainder trust. It will invest, protect, and manage the trust funds.

The charity will pay you, or someone you have named, a portion of the trust fund's income. These payments will last for a set number of years, or the remainder of your life, depending on the terms of the trust. The trust will end at the time of your death, and the appreciated assets held in the trust will go to the charity.

Another option is a split-interest trust. The charitable trust provides a payout to a non-charitable beneficiary, such as a donor's family member. The remainder goes to the charity.

Three Tax Advantages for a Charitable Trust

In addition to assisting the charity, a charitable remainder trust provides tax benefits, including the following:

• Taxpayers can take a charitable income tax deduction spread over five years. The IRS calculates the allowable deduction as the fair market value of the assets in the trust minus what the income beneficiaries expect to receive as a payout over their lifetime. For example, if you give $200,000 but expect to get back $100,000 in interest throughout your life, your total tax deduction would be $100,000.
• The property you gave to the trust will go to the charity outright upon your death. Thus, the property is excluded from your estate to determine your estate tax.
• A charitable trust allows you to turn assets not functioning as income-producing assets into cash. This can occur without paying capital gains tax on any profits.

For example, Lee held appreciated property that he wanted to donate. Lee has 5,000 shares of stock that had appreciated from $10 per share to $100 per share. That is an increase of $450,000. If Lee sold his shares, he would pay capital gains tax on $450,000. If Lee donates the stock to a charitable trust, the trust can sell the stock and avoid the tax.

The charity can then take the cash they received from the sale to invest in a mutual fund. Their interest income from that investment allows them to pay Lee a yearly distribution for the rest of his life.

Two Types of Income From a Charitable Trust

When you first set up a charitable trust, you will have a choice between two different ways of receiving income from the trust fund.

Charitable Remainder Annuity Trust (CRAT)

Under this option, you receive a fixed dollar amount from the trust each year. This amount stays the same regardless of how interest rates change or how much the trust gains or loses in a year.

How do you determine how much the fixed annuity payments should be? You will need a trust attorney to help set up a trust and provide legal advice. Considerations include:

• If you set it too low, you will never receive the full benefit of setting up a charitable trust. Your income tax deduction will be more significant.
• If you set the annuity too high, you may end up depleting the principal of the trust, thus leaving the charity with nothing at your death. Also, your income tax deduction decreases as annuity distributions increase.
• A charity is less likely to agree to be the trustee of a trust if annuity payments are too high. In such a case, the charity may end up with nothing at the trust's termination.

Charitable Remainder Unitrust (CRUT)

A more common option is to set your payout rate as a percentage of the current value of the trust fund. This is called a "charitable remainder unitrust." You will receive the same percentage of the value of the trust each year. The IRS has ruled that a trust beneficiary must receive at least 5% of the value of the trust each year. At the end of the year, the trust will be re-appraised to find its current value and will pay 5% of that value.

This payment option is better suited for changing market conditions such as inflation. If the value of the dollar increases, your annual payments will reflect this change by also increasing.

Example of a Charitable Remainder Unitrust

Suppose Rita is trying to figure out what to do with stock she bought 10 years ago for $200,000. The stock is currently worth $4 million, but the dividends are small. One option for Rita would be to sell the stock and invest in something that would pay more interest. However, if Rita sold, she would owe $570,000 in capital gains tax.

Another option Rita has is to set up a charitable trust with her favorite museum. She would donate the stock to the trust, which would be able to sell the stock for a $3.8 million profit because of its tax-exempt status. The charity would be in charge of investing and managing the $3.8 million. Rita could claim an income tax deduction for her charitable donation over five years.

In addition, the trust document requires the trust to pay Rita 7% of the value of the trust annually for the remainder of Rita's life. During the first year, Rita would receive $266,000. This amount will change depending on how well the trust invests and manages the money. If the trust does well, Rita will receive more each year.

Life Insurance for Charitable Donations

For those without a large estate, life insurance can be one way to maximize charitable giving. A life insurance policy can fund the creation of a charitable trust.

A charitable giving rider on an insurance policy will pay a percentage of the policy's face value to a charity. Or a person can set up their entire life insurance policy to be donated for charitable purposes upon the donor's death.

Getting Started on Your Charitable Trust

Your first decision in setting up a charitable trust is to select the type of trust that best matches your goals. Talking to a financial advisor or an estate planning attorney to discuss your options is critical at this stage.

Next, consider your finances and decide how to fund the trust. You can fund the trust from various types of assets, including the following:

• Cash
• Stocks and bonds
• Real estate
• Business interests
• Art
• Any other valuable asset

The next step is drafting the legal document that establishes the terms of the trust. You will provide detailed instructions on how to calculate payments and the frequency of the payments. At this point, you will designate the charity or causes you would like to benefit from the trust. Make sure the charity is IRS-approved.

Next, you will set up the trust with a financial institution unless you invest in an already existing charitable remainder trust. The last step is transferring assets into the trust. Once transferred to the trust, the assets become trust assets.

Pooled Income Fund: A Charitable Trust That Brings Multiple Returns

A pooled income fund is a charitable trust created by a private foundation or qualified charitable organization.

Trusts are a diverse and versatile class of property management and estate planning tools. All trusts involve an arrangement in which a grantor (also known as a settlor or trustor) transfers assets to a trustee on behalf of the beneficiary.

The trustee owns the assets. The trustee does so, subject to a strict fiduciary duty. A grantor can set up a trust for the benefit of family members. Pooled income funds are a particular type of trust.

Pooled income funds offer a variety of benefits to fund donors, such as:

• An income stream for the remainder of the donor's life
• An immediate partial tax deduction
• Avoidance of capital gains tax
• Avoidance of probate
• A charitable donation to a nonprofit organization the donor cares about

Pooled Trust Accounts: How They Work

A qualified nonprofit organization, or its investment company, sets up a pooled income trust. It is structured as a mutual fund and seeks donations. The fund is called a "pooled trust" because the funding organization pools the donations of several charitable donors.

In addition to cash contributions, donors (also called grantors) can donate stocks and bonds as long as they are not tax-exempt. Some funds allow grantors to donate:

• Life insurance policies
• Tax-exempt securities
• Cars
• Real estate
• Personal property
• Cryptocurrency like bitcoin

The value of these assets is invested. A pooled charitable trust is a type of trust known as an irrevocable trust. The terms of the trust would require the donor to relinquish donor control of the assets contributed to the charitable beneficiary. This explains why the donor receives some tax benefits for their charitable giving.

The grantor receives scheduled income distributions. The charitable organization receives the remaining funds when the grantor and other fund beneficiaries die.

Who Chooses a Pooled Trust Account?

Many people use pooled charitable trusts as a supplemental source of income during their retirement. This option is great for people with little cash or those without an extensive investment portfolio. Once the donor meets the charity's minimum donation amount, the grantor can continue to donate even small amounts into the trust over the years.

A grantor can join a pooled charitable trust at any age and may receive an income distribution anytime. Many people only receive a distribution once they reach 65 or 70 to have additional income during retirement.

The income distribution the grantor receives will be taxed just like normal income. Many retirees have a lower income than their working years, so their tax rate would be lower.

Why Invest in a Pooled Charitable Trust?

Below are a few reasons why you might want to invest in a pooled charitable trust.

Earn Income

The charity must pay income distributions to the grantor or their named beneficiaries. These payments are made quarterly or annually from the trust's assets. Some trusts allow the grantor to choose the payment frequency.

There is no minimum payout rate. Income distribution amounts are determined by:

• The fair market value of the donor's contributed assets at the time of the transfer
• The fund's performance in the market
• The life expectancy of the donor (from IRS life expectancy tables)

The donor will be receiving an income until they die, so the fund must consider how many years of payments it will be making.

Income Tax Deduction

Every time a grantor donates to a pooled charitable trust, they can take an income tax deduction on their tax return. However, they can't deduct the full amount because they will receive income from the trust. The amount that the grantor is allowed to deduct depends on:

• The gift's fair market value
• How long the trust's beneficiary is expected to receive income
• The yield of the fund

Reduced Estate Tax

As an irrevocable trust, assets placed in the pooled income fund are no longer accessible to the donor. The trust funds are no longer considered part of the donor's estate. A pooled charitable trust can be used as part of an estate plan strategy to reduce federal estate taxes.

Exemption From the Capital Gains Tax

Grantors can donate appreciated securities to the pooled income fund. This enables the grantor to earn income from their appreciated securities without paying capital gains tax.

A charitable trust can also be used to avoid the capital gains tax on donated property. This is the case if the donor has held that property for at least a year. For this reason, well-performing securities held for over a year are the preferred gift to a pooled charitable trust.

The charity can sell them at present-day market value and pay no capital gains tax. This adds up to a larger investment into the trust by the donor and more income over time.

Example of Exemption From the Capital Gains Tax

Amy has held 1,000 shares of stock for 10 years. The stock has increased in value from $1 a share to $20 a share. Despite the increase in the stocks' value, Amy is disappointed that they do not produce much income for her. If she sells the stocks, she would have to pay a hefty capital gains tax on the gain.

Instead, Amy donates the total amount of stock to a pooled charitable trust. When the public charity takes possession of the stock, the charity sells the stock. Because the gift is for charitable purposes, there is no capital gains tax. Amy held the stock for more than one year.

The initial tax deduction Amy can take would be calculated as follows:

• Taking the market value of the donated stock— $20,000
• Subtracting the value of the payments that Amy can expect to receive during her lifetime

This estimate is derived from looking at the recent performance of the trust. Amy will never pay a capital gains tax on the $19 share gain she saw.

Avoidance of Probate

Assets held in a trust pass directly to beneficiaries without going through probate. Let's look at an example of how one might use a pooled income trust to pass assets to a charity:

John has worked hard in his company for the past 20 years and now makes $100,000 a year. John loves relaxing in his favorite park, so he donates $10,000 to the park's pooled charitable trust. John can deduct a portion of this $10,000 from his income taxes.

John enjoyed the park for the next 15 years and regularly donated to the pooled trust. Ultimately, his contributions to the trust total $250,000. John deferred receiving any income from the trust while he was working. Now he's retiring at age 65, and he chooses to receive the payments he deferred and interest income on that amount. When John dies, the public charity that runs the fund receives the balance of the gift.

Pooled Special Needs Trust

In addition to using a pooled trust for charitable purposes, a grantor can set up a pooled special needs trust. These trusts are also known as supplemental needs trusts (SNT).

An SNT is a specialized trust, usually set aside by a family member. It sets aside funds for a beneficiary with a mental or physical disability. A special needs trust can strengthen an individual's financial security and enhance the quality of their lives.

Leaving assets to a loved one with a disability without planning may unintentionally disqualify them from these need-based benefit programs. A supplemental needs trust does not jeopardize the individual's eligibility for need-based government benefits. These needs-based benefits can include:

• Social Security
• Supplemental Security Income (SSI)
• Medicaid

Pooled trusts give people with disabilities the ability to access health care benefits and meet other needs. Any excess funds can be deposited into the trust to pay for items and services not covered by other benefits.

For example, New York residents of any age who are disabled, as defined by Social Security Law, can establish a pooled trust. Individuals can deposit excess monthly income. Those funds are excluded from assets when determining a person's eligibility for needs-based government benefits.

There are several benefits of a supplemental needs trust, including the following:

• Allows a disabled individual to maintain eligibility for Medicaid or SSI benefits
• Protects funds for supplemental needs that can increase or enhance the individual's quality of life
• Obtain care and pay expenses
• Eliminates the need to spend down funds quickly

Speaking with an experienced estate planning attorney about different types of special needs trusts is wise. You can discuss what to consider, how to avoid losing public benefits, and any other pitfalls.

Alternatives to a Pooled Income Fund

The following are four options that work as alternatives to a pooled income fund.

Charitable Remainder Trust

A charitable remainder trust (or a CRT) comes in various forms. It operates much like a pooled charitable trust. The donor can gift appreciated assets while avoiding tax. The donor can receive a lifetime income. Federal law requires that CRTs have a minimum payout rate of 5%. The donation qualifies for an immediate tax break, and estate taxes are reduced after death.

The primary difference between a pooled income fund and a CRT is that a charitable remainder trust is private. It is established with the assets of one donor or donor family. A pooled income fund, on the other hand, invests the assets of a larger number of donors to earn a return. The amount a donor would need to contribute to a charitable remainder trust to earn a similar return would be much larger.

Donor-Advised Funds

A donor-advised fund is also set up by a nonprofit and offers an immediate tax benefit and a reduction of estate taxes. With a donor-advised fund, all the donor's contributions go to the charitable organization. There is no income stream for the grantor.

Charitable Lead Trust

A charitable lead trust (or CLT) is similar to a pooled income fund. A CLT provides:

• An income
• An income tax deduction for some grantors
• A charitable gift to a nonprofit

A CLT may also distribute assets to heirs, but that would be a taxable gift. Appreciation of trust assets could be subject to capital gains tax.

Charitable Gift Annuity

A charitable gift annuity is not a trust. It is a contract between a grantor and one charitable nonprofit. The terms of the contract lock in the rate of return and the timing of the payments to the grantor. The grantor can claim a partial charitable deduction on their taxes for the year the gift annuity is established. It can reduce or eliminate capital gains tax.

One of the most significant differences between a charitable gift annuity and a pooled income fund or CRT or CLT is that payments are fixed. Charitable gift annuity payments aren't adjusted to inflation or the performance of the market.

Get Lifetime Value From Your Charitable Contributions

Many large charities, like museums, universities, and hospitals, offer pooled charitable trusts. They may also offer CRTs, CLTs, and annuity trusts. Before you invest, consider the following:

• How much money do you have to invest?
• What income stream do you need?
• What tax liability reduction goals do you want to accomplish?

Some tools may be better than others for reaching your particular goals. Many of these investment products are very similar. An estate planning attorney versed in wealth management, elder law, and estate tax avoidance strategies will be able to advise you on the best choice for you and your loved ones.

Work With an Attorney to Achieve Your Charitable Giving Goals

The rules for charitable trusts are complex. If you are considering charitable giving as part of your estate plan, an experienced estate planning attorney can help. The attorney can explain your legal options.