A charitable remainder unitrust has unique financial and tax advantages for both the charity and the individual donor.
As a foundation or endowment with long-term missions and goals, you know that donors typically favor those charities with missions that are aligned with their own personal values or goals, or because they feel their funds will be invested in a way that benefits the causes and communities the non-profit serves. At the same time, donors often have personal finance objectives to consider, such as generating additional income, reducing taxes, or leaving wealth to their heirs. In some situations, charitable remainder unitrusts (CRUTs) can simultaneously help accomplish complex personal finance goals of the donor and the funding needs of the foundation or endowment.
Foundations and endowments are navigating unprecedented times. Operating budgets are feeling the impact of inflation as the cost of doing business goes up. Some non-profits are seeing lower levels of charitable giving, as donors become more sensitive to economic and financial conditions. In addition, many donors are faced with a variety of dilemmas, primarily the prospect of longer life expectancies, higher imbedded capital gains on investable assets and real estate, and the inevitable impact of taxes on their wealth.
A great question to ask potential donors is Do you want your money to go to heirs, charities, or the Internal Revenue Service? Presumably leaving a legacy to both heirs and charitable organizations (and not to Uncle Sam) is the preference. The question then becomes What is the best way to help donors achieve their objectives?
Philanthropic financial guidance, which Mercer Advisors offers, can help the donor create a plan for their estate while encouraging giving to the foundation or endowment. At the same time, non-profits can mitigate the effects of inflation and financial market conditions on donor activity through the strategic use of planned giving, which helps ensure future cash flows for the non-profits, while also encouraging more immediate donations. In this way, the charitable remainder unitrust can often be leveraged to increase planned giving.
A charitable remainder unitrust (CRUT) is a type of trust that provides several benefits to the non-profit, the donor, and beneficiaries. The foundation or endowment receives a tax-free benefit while the donor’s beneficiaries receive estate tax benefits and an income stream. For example, a trust might hold real estate and pass along any income generated by the property to beneficiaries. If properly structured, a CRUT can provide financial and tax benefits well beyond simply donating to the non-profit.
A charitable remainder unitrust can be a useful vehicle for a non-profit’s philanthropic guidance because it enables the grantor (donor) to accomplish three main goals:
The following two examples illustrate the power of the CRUT and demonstrate the possibility to help increase the value of future donations, while creating value for the donor, and potentially encouraging immediate giving. 1 Assume that we have a 70-year-old donor with a life expectancy of 91.
The donor has an appreciated asset that is currently worth $250,000, which has an original cost basis of $50,000. So, the untaxed gain is $200,000. The donor decides to sell the asset and invest the proceeds into a balanced portfolio and withdraws 5% of the balance each year. The sale price of the asset is $250,000 less an assumed capital gains tax of 20% ($40,000), leaving a net amount of $210,000 to invest. 2 Based on the assumed annual investment return and the annual withdrawal rate, the remaining balance of the portfolio is $317,000 (going to heirs and/or charity) at the end of the donor’s lifetime, with a total withdrawal value of $279,412 (income to the donor, before taxes) during the lifetime of the donor.
Instead of selling the $250,000 asset, the donor transfers the appreciated asset to a CRUT and converts the asset to a balanced portfolio with a payout of 5% of the balance each year. 2 Because the trust assets are ultimately going to charity, the donor receives an immediate charitable deduction for the present value of the assets that are calculated to ultimately pass to the charity. Based on the assumed investment return within the CRUT, and the annual payout rate, the charity will receive $374,322 at the end of the donor’s lifetime and the donor will receive a cumulative income of $332,634, including an estimated tax savings of $33,688, equaling a total of $366,322 of income during the lifetime of the donor. 3
The bottom line is that the donor would receive $86,910 in additional income and the charity would receive $57,322 in additional funding—that is about a 27% increase of income and 20% more going to charity. Additionally, the donor’s annual income goes up, increasing the possibility to donate more because of the excess cash flows.
If a donor is concerned about leaving assets to heirs, there are additional options that can be used in combination with the charitable remainder unitrust. These involve leveraging the income tax savings from the donation (in Example 2) to offset the taxes on converting pretax retirement savings to a Roth or utilizing the additional annual income to purchase a life insurance policy with the heirs listed as beneficiaries. There are opportunities to structure charitable giving in ways that only slightly decreases inheritances, but that greatly increases the potential for charities to receive more.
There are several other planned giving strategies, including bequests, beneficiary designations, donor advised funds, and charitable lead trusts. Since there is no “one size fits all donors,” it is important to consider the complexity and suitability of each strategy.
Fortunately, non-profits don’t need to have experts on staff to navigate the myriad of possibilities. Instead, harnessing the knowledge of wealth advisors, financial planners and other outside professionals can play a critical role in developing a comprehensive giving plan. Plans can be customized to each donor, helping provide a guide for future planned giving, and identifying ways to increase giving in the present. The charitable remainder unitrust does just that.
1 This is a hypothetical example provided for illustrative purposes only.
2 Assume portfolio has a 7% annualized return. Investing involves risk, future investment risk cannot be guaranteed.
3 Assuming a 30% tax rate.
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