Charitable Remainder Trusts get a lot of attention from Estate Planning professionals. Yet, these trusts might not be the best option for many estate owners. There is the less-known charitable gift annuity to consider.
Each strategy shelters appreciated assets from capital gains taxes, reduces current income taxes, provides income for life or for a period of years, and reduces estate taxes.
In a charitable remainder trust, a property’s owner transfers property to a trust that he or she created, making him the trust grantor. The trust terms provide that it will pay income at least annually to the grantor. The payments will continue for a period of years, the former owner’s lifetime, or the joint lifetime of the grantor and a named beneficiary ? whichever the grantor selects. After the payments end, the amount remaining in the trust is transferred to the charity or charities the grantor named in the trust agreement.
The grantor also sets the formula for computing the payments. The annual payment can be a fixed amount, or it can be a percentage of the trust’s annual value. The law gives a fair amount of flexibility in deciding the amount of these payments.
The CRT is best used when the owner has appreciated property. The property can be contributed to the trust. Because the trust remainder eventually goes to charity, when long-term gains property is donated to the trust, the owner gets a charitable contribution deduction based on the property’s fair market value. The deduction is the present value of the trust’s remainder, since that is what the charity will get. The older the donor, the higher the deduction. Tables issued by the IRS and current interest rates are used to determine the deduction.
The donor does not owe any capital gains taxes on the appreciation. In addition, the trust can sell the property without paying any gains taxes and can reinvest the entire sale proceeds. The CRT is a good way to turn an appreciated asset into a diversified portfolio that pays income. Because of the tax advantages, the grantor usually ends up with a higher income than if he had sold the property, paid the capital gains taxes, and invested the after-tax amount to generate income.
The CRT also gets the assets out of the grantor’s estate, avoiding estate taxes.
Disadvantages of the CRT are that a trust must be created (which isn’t cheap), and a trustee must manage the trust. In addition, the grantor loses control over the property, cannot get it back, and cannot leave it to his heirs.
An alternative that doesn’t get enough attention is the charitable gift annuity.
With the CGA, the owner gives property or money to a charity and gets to deduct part of the value. The charity promises to make payments to the donor annually or more frequently. The payments last for a term of years, life, or the joint life of the donor and a selected beneficiary, whichever option the donor selects.
The disadvantages are the same as those of any annuity. The payments are fixed, so there is no inflation protection. In addition, the security of the payments depends on the financial strength of the charity. Also, except for payments to any beneficiary you name, there is nothing for your heirs from the annuity. Any payments to a beneficiary reduce your lifetime payments.
The CGA will pay less than a commercial annuity. Most charities that offer CGAs use a payout rate determined by the American Council on Gift Annuities (www.acga-web.org). The payout rate is set so that about 50% of the original gift will go to the charity at the end of the payout period.
An estate planner should show you the effects of both a CRT and a CGA. In most cases, when you compare the two the payout rate on the CGA will be higher than the payout rate on the CRT, perhaps much higher. The CRT will generate the higher charitable contribution deduction in the year of the donation. You have to determine if the tax benefits of this donation are high enough to offset the higher income from the CGA.
A portion of each payout from the CGA is tax free as a return of your principal. Payouts from a CRT, however, usually are all ordinary income.
The older you are, the higher the payout will be under the CGA and the more attractive it will be. Those ages 75 and older should consider using a CGA instead of a CRT, and should consider a CGA instead of a commercial annuity.
In addition, it might be possible to boost the payout from a CGA.
Generally, there isn’t much competition among charities that offer CGAs. They tend to follow the recommended payouts from ACGA. An option is for you to ask the charity if it is willing to give you a higher payout by using your donation to purchase a commercial single premium immediate annuity.
This strategy could have benefits for you and the charity. You will receive a higher payout. In addition, the risk of the charity’s not being able to make your payouts will be reduced, because of the annuity. The advantage for the charity is that your entire donation won’t be needed to buy the annuity. The charity will have 10% to 50% of the donation available to fund other projects now.
The charity could enhance its financial position by using the excess donation to purchase insurance on your life. That will multiply the amount the charity eventually gets to use. Most charities, especially the largest ones, will not purchase a commercial annuity to back the CGA. They self-insure because of the large number of CGAs they issue. But there is no harm in asking.
Take a careful look at the long-term benefits of each strategy. It is likely that over a lifetime, the CGA will generate far more cash for you than a CRT. The older you are, the better the CGA is likely to look.