A planning strategy that can turn low yields and high income taxes into high yields and lower income taxes.
By Mark Grunder, CFP®
As we are all painfully aware, in our current financial environment yields are extremely low and the top federal income tax rates were recently increased for ordinary income to as high as 43.4%, while long-term capital gains rates increased to as high as 23.8%. What can you do in such a financial situation?
Well, if you are charitably inclined and are interested in a planning strategy that can provide increased income while simultaneously lowering your total income tax, consider the well-known and established Charitable Remainder Trust [CRT].
How does it work?
1. You decide:
- Who the income beneficiaries will be: generally, that is either you, or you and your spouse.
- Who the remainder charitable beneficiaries will be.
- What will the annual payout rate be: generally, it must be at least 5% of the value of the assets in the CRT.
- How long will the CRT last: if you designate a number of years, it cannot be for more than 20 years; if you designate your lifetime or joint lifetimes (husband and wife, for example), it can be for more than 20 years. ■ How much you will contribute to the CRT.
- Which assets you will contribute to the CRT – for example, appreciated assets such as securities, real estate, a business with a recent valuation, and/or cash.
- Who will be the trustee[s].
2. You choose between the two main types of CRTs: a Charitable Remainder Unitrust or a Charitable Remainder Annuity Trust.
Here are the primary differences:
- Remainder Unitrust – Can make additional contributions after the initial funding at any time. Annual payout is based upon annual value of the trust.
- Remainder Annuity Trust – No additional contributions permitted. Annual payout is static.
3. Your attorney prepares the legal document for the CRT.
4. You fund the CRT with assets.
5. During the term of the CRT, the income beneficiaries receive monthly, quarterly, semi-annual or annual payouts.
6. You receive an immediate charitable deduction based on the computed remainder interest that eventually goes to your chosen charity(ies). If you do not use all of the deduction in the initial year, you can deduct the balance over the next five years. If appreciated assets are contributed to the CRT, you can deduct up to 30% of your Adjusted Gross Income for the year.*
7. At the end of the CRT, the remaining assets are distributed to your chosen charities.
Example: A Look at the Financial Impact
Henry and Wanda, ages 59 and 57, are looking to increase current income, reduce portfolio risk and fulfill their charitable desires. They have a sizable equity portfolio but it is largely concentrated in a single stock that they have held for many years.
The annual dividend on the stock is only 1%. The stock has a market value of $1 million and a cost basis of only $100,000. They contribute the stock to a Charitable Remainder Unitrust with a 6% annual payout for their joint lifetime and 6% investment return.
Result: A six-fold increase in current year income, tax-free portfolio diversification and a charitable income tax deduction of about $216,000, saving them over $85,000 in taxes in an assumed 39.6% federal income tax bracket.
Thus, a CRT in the right circumstances is not only a tax-efficient planned giving vehicle but it also affords tax-free portfolio diversification and the potential to increase current income.
As you can see from this example, there are immediate income tax benefits, as well as increased income. The CRT strategy can be a very effective retirement income supplement.
Other key benefits can include:
- Significant gift to your favorite charity[ies] delayed until the termination of the trust
- Option to change charities by you at any time, even after funding
- Estate tax deduction
- Deferral, and possible reduction, in recognition of capital gain taxes
As with all planning strategies, there are other considerations and offsets, including:
- Assets distributed to charities, not to your children or grandchildren at termination
- Reduction of your liquidity when the trust is funded, since assets no longer belong to you
- CRTs are irrevocable – they can not be undone
- Costs for an attorney to prepare the legal document
- Annual tax returns
- Trustee fees
In summary, if you are charitably inclined, would like to receive a higher yield, receive a substantial charitable income tax deduction and defer your capital gains tax, a Charitable Remainder Trust can help. Your BB&T Wealth advisor, in conjunction with a BB&T Financial Planning Strategist, can provide objective and highly experienced advice.
About the Author
Mark Grunder, CFP®
Senior Vice President and BB&T Wealth Regional DirectorMark is a BB&T Wealth Regional Director. He has more than 25 years of financial planning experience, has published articles on financial planning and is an active member of the Financial Planning Association. Mark has been with BB&T since 2005.