Charitable Remainder Trust - Explained
What is a Charitable Remainder Trust?
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What is a Charitable Remainder Trust?
A charitable remainder trust refers to a tax-exempt trust intended to cut down the taxable income of various individuals by dispersing trust income to the trust's beneficiaries for a certain period. The next step usually involves donating the remainder to the charity. This is usually a split-interest that allows a trustor to contribute to the trust and avoid income and estate taxes, while also taking care of beneficiaries. As such, here are the benefits of a charitable remainder trust:
- Reducing your existing income taxes through the deduction of charitable income tax
- Benefitting from various charities
- Leaving more money to your beneficiaries through life insurance trust with the aim to replace the asset
- Reducing your estate taxes
- Receiving asset protection from creditors
- Having a second stream of income
How Does a Remaining Charitable Trust Work?
A charitable trust is achieved when you transfer a high valued asset into an irrevocable trust. Usually, this removes the specified asset from the estate. When you die, there won't be estate taxes. You'll also be eligible to receive an income tax deduction. The main idea of a charitable remainder is to cut down taxes. This is achieved by donating various assets or estates into the trust fund. The process is usually followed by having the trust pay the beneficiary, particularly for a certain period. Once the time-frame has expired, the remainder is transferred to different charities where there are beneficiaries. As such, charitable remainder trusts have been irrevocable, implying that they can't be modified or ended without the consent of the recipient.
A few years ago, Max, as well as Jane Brody, bought some stock worth $100,000. Currently, the same commodity is $500,000. The due would like to trade it for some retirement income. If the stock is sold, they shall have gained $400,000. They would also pay $60,000 in tax gains. The equation would leave them with a balance of $440,000. If the stock is re-invested such that they earn a return of 5%, the two will make $22,000 in yearly income. To achieve the total lifetime income, the return is multiplied by their life expectancy which is 26 years. Therefore, the total income tax would be $572,000. Since they are still the owners of these assets, they won't have protection from creditors. They will also not have a charitable income tax deduction. But, if the assets are transferred to a charitable remainder trust, they can take a charitable income tax deduction of approximately $90,375 instantly. The duo is in the 35% tax bracket. Therefore, their existing federal income tax will have reduced by $31.325.
Charitable Remainder Trusts come in two forms:
- Remaining Charity Annuity Fund - This type of trust holds that a certain percentage of the fair market value of the available assets in a trust, compiled annually should be paid to the beneficiaries once per year for up to 20 years.
- Charitable Remainder Annuity Trust - This type of charitable trust holds that a specific dollar amount of at least 5 percent of the market value of assets should be paid to the income beneficiaries at least once annually.
Usually, the trusts term is tailored for the donors life. However, it cant exceed 20 years. In the long run, the total balance is channeled to a charity. As such, charitable remainder trusts are utilized by older people. The use of charitable trusts is specifically for charity because theres no asset in the trust fund that may be directed to the heir.
How is the income tax deduction determined?
While determining the deduction is often the most challenging step in the entire process, the amount is based on the beneficiaries of the income as well as the IRC 7520 rate that often fluctuates. Some of the best assets an individual can invest in are those that have appreciated throughout the years. Notably, they should be publicly traded securities or real estate. Others can invest in stock in successful corporations. However, S-corp doesn't qualify for this type of income tax deduction. One can be their own trustee. However, they have to be sure that they have hired an excellent administrator for the trust such that every asset is administered appropriately. If the administration is not done accordingly, one can't see their tax advantages. Of course, you still have some control as long as you live. This is also dependent on the trustee you've elected and not the actual charity. The person you select should control your assets. Therefore, your trustee needs to follow your instructions to be able to allocate all the portions accordingly. Immediately an irrevocable trust has been signed; one cannot make any form of change. You need to be sure that you internalize the contents of the document before signing it. If you're worried about the value of the asset your recipients are likely to receive, you can take your income tax savings as well as part of the total income from the charitable remainder trust to fund a life insurance trust. When it comes to handling a trust, the insurance proceeds will be excluded from the estate. Therefore, you'll successfully avoid estate taxes. One can also keep the proceeds of the trust for more than five years while making distributions to the children as well as grandchildren. Life insurance may end up being affordable as a way of replacing children's assets. In the past, the IRS has come down on various individuals who have set up a charitable remainder trust and ended up withdrawing up to 90% of the total savings in a year. This implies that a charitable remainder trust can quickly blow up on someone's face. As such, beneficiaries may end up receiving up to 5% of the yearly income.
- Succession Planning
- Chartered Trust and Estate Planner
- Cy Pres Doctrine
- Exordium Clause
- Non-Contestability (No Contest) Clause
- Per Stirpes
- Elective Share
Qualified Domestic Relations Order (QDRO)
- Declaration of Trust
- Uniform Gifts for Minors Act
- Acceptance of Office by Trustee
- Beneficial Interest
- Asset Protection Trust
- Bare Trust
- Blind Trust
- Charitable Lead Trust
- Credit Shelter Trust
- Discretionary Trust
- Generation Skipping Trust
- Grantor Trust Rules
- Living Trust
- Inter Vivos Trust
- Qualified Domestic Trust (QDOT)
- Qualified Terminal Interest Protection Trust (QTIP)
- ABLE Account
- Accumulated Income Payments (Canada)
- Charitable Split-Dollar Insurance Plan
- Coverdell Education Savings Account