Do you have a significant college reunion that’s inspiring you to make a large gift? Perhaps there is a capital campaign for your favorite cause. These are the kinds of giving opportunities that should have you considering a charitable trust. For example, a charitable remainder trust allows you to make a major gift while still affording you the security of a reliable income stream—the ultimate win-win.
In terms of tax benefits and structure, a charitable trust (in the form of either a remainder trust or a lead trust), differs from other types of giving, such as outright gifts or bequests and donor-advised funds.
With a charitable remainder trust, you generally designate how you would like to receive income during your lifetime with the charities of your choice getting the “remainder” at your death. Your options are to take a fixed amount as an annuity (an annuity trust) or to take a percentage of the trust’s assets annually (a unitrust).
You also get to choose the duration of the trust—maybe 10 years, or perhaps the duration of your lifetime and your spouse’s lifetime. These choices will affect the IRS’s determination of the “remainder interest” that the charity will be likely to receive, which dictates the charitable deduction you will receive when you fund your trust.
A Tool for Diversifying Large Holdings
Another advantage of the charitable remainder trust is that if you have a concentrated position in one or more stocks, you can diversify your portfolio without incurring capital gains taxes.
Let’s say you bought or received a large amount of a stock 20 years ago and its price has since appreciated from $20 a share to $80. You establish a $200,000 trust, funded by your stock. And once the stocks are in the trust, they are sold by the trustee. You do not incur any capital gains taxes because such transactions are not taxed when the trust qualifies as a charitable trust. Subsequently, the trustee creates a well-diversified portfolio that provides a source of lifetime income for you as well as a substantial remainder for the charity.
Income for Someone Else
Should your goal be to provide lifetime income for someone else if you predecease (pass before) that person (perhaps a sibling), you could create a testamentary charitable remainder trust. Your estate rather than you would receive the charitable tax deduction at the time the trust is funded, resulting potentially in a lower estate tax bill and benefits for your sibling and a favorite charity all at the same time.
Charitable Lead Trusts
In the charitable lead trust, it is the charity that “leads” —as the primary beneficiary of distributions from the trust for a period of time that is determined when the trust agreement is drafted. You or your estate receives a charitable income tax deduction at the time the trust is funded.
Like the remainder trust, a charitable lead trust can be beneficial if you own a large concentration of a particular security. However, in this type of trust, your goal is not income or diversification. Instead, the lead trust allows you to retain the stock in the trust because you believe that it has the potential to appreciate significantly. A charitable lead trust enables you to get the stock out of your estate at a relatively low price and ultimately transfer it to your heirs. You can also use the testamentary model in a lead trust.
With a lead trust, the donor is betting that when the assets in the trust are to be distributed to heirs, the stock remaining in the trust will have a much higher value than that used by the IRS at the trust’s inception to calculate the estimated remainder amount. Regardless of how much the stock in the trust might have been appreciated, there will be no additional estate taxes owed when the assets revert to the heirs.
A Charitable Gift
Given the complexity of establishing and maintaining a charitable trust, it is wise to consult a professional, such as an estate planning attorney, to learn more. When considering a charitable trust, the key part of this concept is “charitable.” While all types of gifts to charity result in tax benefits, a “gift” is still about you “giving.” You will own fewer assets and the charity will own more. Regardless of which type of trust you choose, your long-term objective needs to be two-fold: meeting your financial needs and enjoying a deeper, more rewarding relationship with one or more of your favorite charities.
→ Christine S. Fahlund, Ph.D. and CFP, is a senior financial planner and vice president of T. Rowe Price Group, an investment management firm based in Baltimore, Maryland.
This article originally appeared in the October 2013 issue of the AAII Journal.
If you are not an AAII member and want to gain access to all the benefits of membership, simply take a risk-free 30-day Trial AAII Membership and start becoming an effective manager of your own assets.