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How can you give to charity while providing for your family at the same time? Using charitable trusts—on their own or in conjunction with donor-advised funds—could offer you greater flexibility and control over your intended charitable contributions while helping you fulfill your philanthropic goals, and also helping with estate planning and tax management.
A charitable trust allows a donor to set assets aside for one or more charities. There are two different types of charitable "split interest" trusts—charitable remainder trusts (CRTs) and charitable lead trusts (CLTs). These types of trusts "split" the assets between a charitable and noncharitable beneficiary. Which type you choose depends on your priorities with respect to estate planning and wealth preservation, how you want the charity to receive the gift, and even the types of assets you wish to donate.
CRTs and CLTs are similar in that some of the assets go to the charity and some go to a noncharitable party of the donor’s choosing. The key difference is when the charitable and non-charitable beneficiaries receive their payments. With a CLT, the charity receives an income interest for a term of years or for someone's lifetime, with individuals receiving the remaining assets at the end of the trust term. On the other hand, with a CRT, individuals receive the income interest, while one or more charities receive the remainder.
“With these types of charitable trusts, you can control the timing of your charitable donation, choose whether to make it in a lump-sum remainder or income stream, and decide how much your heirs can benefit from the income or remainder,” says Ajay Sarkaria, a senior wealth planning specialist at Fidelity Investments.
A type of charitable giving program, a donor-advised fund, can be used in conjunction with split interest trusts to easily benefit more than one charity or preserve the ability for donors to be flexible and cost-efficient if their charitable giving priorities shift. Also, with a donor-advised fund, you can advise how the assets are invested and the timing and amount of the distributions to the recipient charities. In the interim, the assets stay invested and could possibly increase the amount of money you have to give.
"While a donor-advised fund cannot provide a stream of income to a noncharitable beneficiary,” says Deborah Segal, a director at Fidelity Charitable®, “setting one up in conjunction with a split-interest trust can enable you to take advantage of the key benefits of the trust and the donor-advised fund."
Charitable remainder trust
With a CRT, you donate certain assets—often highly appreciated or non-income-producing—to the trust, which makes at least an annual payout back to you or to another noncharitable beneficiary for the term of the trust. You choose the time period, which can be for your or someone else's lifetime or up to a 20-year term. When that time is up, the remaining assets, as well as any appreciation generated, go to the charity or charities selected. Notes Sarkaria, “One significant advantage of a CRT is that you can fund it with highly appreciated property, such as stock or real estate, and sell those assets within the trust without paying capital gains taxes.” He adds, “This way, the trust gets the full fair market value of the assets, which means more for the charity and the noncharitable beneficiary.”
Charitable lead trust
“A CLT is almost a mirror image of a CRT,” says Sarkaria, because it makes the at least annual payout to the charity first. After a set time period, the trust terminates and the remainder goes to a noncharitable beneficiary, like a family member or family trust. Offering flexibility similar to that of a CRT, the CLT allows the donor to choose at least annual payout amount and the term of the trust—whether a period of years or a person’s lifetime.
Charitable Remainder and Lead Trusts can preserve wealth for those with charitable intentions, because they can be a tax-efficient way to give. Here are some of their key benefits.
Preserving the value of highly appreciated assets. For those with significantly appreciated assets including non-income-producing property, a charitable remainder trust allows you to take that property, sell it within the trust as tax exempt, and preserve the full fair market value of the property, rather than reduce it by large capital gains taxes. (Read Viewpoints: "Strategic giving.")
Income tax deductions. With a CRT, you have a potential immediate partial income tax deduction based on the value of the eventual gift you’re making to charity. A CLT established during a donor’s lifetime may be designed so that the donor benefits from an up-front charitable income tax deduction in the year it is funded. Please consult your tax adviser for details.
Reducing estate taxes. Generally, once you fund a charitable trust, these assets are out of your estate for estate tax purposes. This may not only reduce the amount of tax your estate has to pay upon your death, it may preserve money for your heirs. If a contribution to a CLT occurs upon the death of the donor, the donor will be eligible for an estate tax deduction for the value of the interest paid to the charity.
Reducing gift taxes. If you make a contribution to a non-grantor CLT during your lifetime, you may be eligible for a gift tax deduction based on the interest going to the charity. However, if the remainder beneficiary on a CLT is not the donor, then the donor might be subject to gift tax on the value of the remainder interest. It’s important to note that there are ways to structure these non-grantor CLTs that could potentially eliminate transfer taxes on the remainder amount passing to the end beneficiary. Please consult your tax adviser for details.
Creating income from non-income-producing property. “If you are charitably inclined and need income but have significant non-income-producing property, you could fund a charitable remainder trust with that property,” says Sarkaria. The CRT, which is tax exempt, would sell the property, preserving the charitable remainder, and, at the same time, provide an income stream back to you, as the donor. What’s more, if you want to avoid taking the income until you’re in a lower tax bracket, you could establish a special type of CRT that allows you to contribute the appreciated assets, and have the trust invest in non-income-producing property so that you are not receiving income from the trust until you are ready (e.g., in a lower-tax bracket in retirement).
Who might consider charitable trusts, and how you might put them to work for you, depends on several factors, such as when you want the charity to get the money, whether you want to create an income stream, and whether you want the flexibility to change your charitable beneficiary.
Using donor-advised funds
“One planning tip we suggest for those setting up a charitable trust is to make your donor-advised fund your charitable beneficiary,” says Segal. “Using donor-advised funds in conjunction with your charitable trust gives you the flexibility to change your ultimate charitable recipients, rather than locking yourself in,” says Segal.
Here’s how this strategy works: You direct the proceeds from your charitable trust—whether the interest payments from a CLT or the remainder from a CRT—to your donor-advised fund rather than to a different charity. Because you, as donor, retain privileges over how donor-advised fund assets are distributed, you can recommend a charity at a later date or change your mind about charities previously chosen. “With this strategy,” says Sarkaria, “not only do you retain flexibility, you can get your family involved in choosing charities and establish a family legacy of giving.”
Replacing assets for heirs
If you plan to give substantial assets to charity but, still want to provide additional resources for your heirs, you might consider using a CRT to help fund the purchase of life insurance. Using this strategy, says Sarkaria, “A donor could contemporaneously set up a CRT for charitable giving, and purchase life insurance [covering his or her life], using the income stream from the CRT to pay the life insurance premiums.” Essentially, you are making one set of assets both fund your charitable intentions (with the remainder) and provide for your heirs (with the life insurance policy). Typically, the life insurance policy is structured so it is owned by an Irrevocable Life Insurance Trust.
Along with the many benefits of charitable split interest trusts come some important considerations in using these vehicles to support your charitable goals. First and foremost, charitable trusts do require setup and ongoing maintenance costs, so you must factor that into your decision to use them. In addition, says Segal, “While charitable split-interest trusts do have certain tax benefits, the IRS has rules about how much you need to leave the charity in order to qualify for the tax advantages.
“Anyone considering a charitable trust needs to have a serious charitable intent, because these trusts are irrevocable,” says Segal. “Just be sure you can afford to set aside assets for charity, and you have other assets to sustain you.”
As always, if you’re considering making charitable giving part of your estate plan, consult with your tax and estate planning adviser to determine the best vehicle and strategy for your situation. In fact, it’s important to communicate about these charitable giving vehicles not only with the financial professionals that support you, but also with your family. What you do from a charitable giving standpoint “should be discussed in the context of your overall family wealth plan,” says Sarkaria, “because this plan has so many moving parts.” Such open communication could minimize tension—particularly over giving away assets that your heirs might have expected to own—and, perhaps more important, could make charitable giving a family endeavor.
Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.
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