Charitable Remainder Trusts and Wealth Replacement Trust

Charitable Remainder Trusts

A Charitable Remainder Trust (CRT) is a very popular estate planning tool because it allows you to benefit your favorite charity and receive a stream of income during your lifetime (and that of your spouse if married) or for a specific term of years, while not interfering with your other estate planning objectives. Usually established during your lifetime, the mechanics of a CRT are as follows: after your attorney drafts the CRT instrument creating the trust, you transfer assets (usually stocks, real estate, or other property that has appreciated substantially in value since you acquired it) into the CRT. The trust will pay you income for life (and a percentage of the principal if desired), and the remaining trust property will then pass to the charity at your death.

Because the trust is for the ultimate benefit of a charity, you can take a charitable deduction now on the present value of the assets that will pass at your death, and you do not have to pay any capital gains tax. The trust, as a charitable entity, can then sell the appreciated asset without having to pay capital gains tax. This leaves the entire value of the assets in trust to generate a greater income stream for you.

With this increased income, along with the additional income tax savings from the charitable deduction, you can often purchase a life insurance policy (inside of an Irrevocable Life Insurance Trust) for your heirs that will more than replace the value of the assets that you transferred into the CRT. The result is that you have given away an appreciated asset without having to pay capital gains tax, benefitted your favorite charity, increased your current cash flow, and replaced the value of the asset with life insurance that passes to your heirs, tax-free, outside of your estate.

Charitable Remainder Unitrust (CRUT) vs. Charitable Remainder Annuity Trust (CRAT):

CRUT: A Charitable Remainder Unitrust (CRUT) pays a fixed percentage of the trust’s value, which is reevaluated annually, to one or more human beneficiaries. The percentage is typically set between 5% and 8%. As the trust’s value fluctuates, the income paid to the beneficiaries adjusts accordingly. A Unitrust offers the potential for income growth if the trust assets appreciate over time. It is commonly used to provide income to beneficiaries while ultimately also supporting charitable causes.

CRAT: A Charitable Remainder Annuity Trust (CRAT) pays a fixed dollar amount to one or more beneficiaries for lifetime or a term of years, the fixed dollar amount being determined at the time the trust is established and remaining constant throughout the term of the trust. Unlike a Unitrust, the income paid from an Annuity Trust does not fluctuate based on the trust’s value. An Annuity Trust is useful if you prefer a predictable income stream and do not want it to vary based on changes in the trust’s investments or market conditions.

Key Differences:

  • Income Structure: Unitrusts provide a variable income based on a percentage of the trust’s value, while Annuity Trusts provide a fixed income amount.
  • Income Fluctuation: Unitrust income fluctuates annually based on changes in the trust’s value, whereas Annuity Trust income remains constant throughout the trust’s term.
  • Investment Impact: Unitrust income to the beneficiary(ies) is influenced by the performance of the trust’s investments, while Annuity Trust income is unaffected by investment returns.
  • Flexibility: Unitrusts offer potential increased income to the beneficiary(ies) if the trust assets appreciate, while Annuity Trusts provide a stable, predetermined income stream.
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