The question of whether a Charitable Remainder Trust (CRT) can supplement retirement income is a common one for individuals entering or already in retirement. The answer is generally yes, but it’s a nuanced one that depends heavily on individual financial circumstances and goals. A CRT is an irrevocable trust that allows you to donate assets to charity and receive an income stream for yourself or other beneficiaries for a specified period, or for life. Essentially, it’s a way to turn illiquid assets, like appreciated stock or real estate, into a current income source while also making a charitable donation, potentially offering significant tax benefits. Approximately 68% of individuals over the age of 65 express concern about outliving their retirement savings, making income-generating strategies like CRTs increasingly appealing. The income received from a CRT is generally taxable, but the tax benefits from the initial donation can offset this cost.
What are the different types of CRTs?
There are two primary types of CRTs: Charitable Remainder Annuity Trusts (CRATs) and Charitable Remainder Unitrusts (CRUTs). A CRAT pays a fixed annual amount to the beneficiary, regardless of the trust’s investment performance. This provides predictability but lacks flexibility. Conversely, a CRUT pays a fixed percentage of the trust’s assets, revalued annually, to the beneficiary. This offers potential for increased income if the trust’s investments perform well, but the income stream is less predictable. For example, a CRUT might be set up to distribute 5% of the trust’s assets each year. The choice between a CRAT and a CRUT depends on your risk tolerance and income needs. Furthermore, there are variations within CRUTs like net-income only CRUTs (NICRUTs) and net-income with makeup CRUTs (NIMCRUTs), each offering different levels of income and tax implications.
How does a CRT impact my taxes?
When you transfer assets to a CRT, you receive an immediate income tax deduction for the present value of the remainder interest that will eventually go to charity. The amount of the deduction depends on your age, the payout rate, and the IRS’s applicable federal rate (AFR) at the time of the transfer. The income you receive from the CRT is generally taxed as ordinary income, but any portion of the payment representing your original cost basis in the donated asset is not taxable. A crucial benefit is that you avoid capital gains taxes on the appreciation of the asset at the time of the transfer. This can be particularly advantageous if you’ve held highly appreciated assets for many years. Approximately 45% of donations to CRTs come from appreciated securities, highlighting the tax benefits associated with this strategy.
What assets can be used to fund a CRT?
A wide variety of assets can be used to fund a CRT, including cash, stocks, bonds, real estate, and other property. However, using appreciated assets, like stocks or real estate, often provides the most significant tax benefits. It’s important to note that transferring certain assets, like closely held stock or real estate subject to environmental concerns, may require additional due diligence and potentially impact the trust’s value. Furthermore, life insurance policies can be used to fund a CRT, offering a way to combine charitable giving with estate planning. It’s crucial to consult with a qualified estate planning attorney, like Steve Bliss, to determine the most appropriate assets to transfer and ensure compliance with IRS regulations.
Can a CRT be combined with other retirement income sources?
Absolutely. A CRT is not meant to be a replacement for traditional retirement income sources like Social Security, pensions, or 401(k)s. Instead, it can be a valuable supplement. It’s particularly useful for individuals who are “house rich, cash poor” – meaning they have significant wealth tied up in assets like real estate but lack sufficient liquid income to meet their expenses. By transferring appreciated assets to a CRT, they can generate a stream of income without having to sell the assets and pay capital gains taxes. It’s also important to consider how the income from a CRT will impact your eligibility for means-tested government benefits, such as Medicaid.
What happens if I need more income than the CRT provides?
This is a common concern. Unlike a fully flexible investment account, a CRT has payout limitations. With a CRAT, the payout is fixed, so you’re out of luck. A CRUT offers slightly more flexibility, as the payout percentage is applied to the annually revalued trust assets. However, there’s still a limit to how much you can withdraw each year. It’s essential to carefully calculate the payout rate when establishing the CRT to ensure it meets your current and future income needs. Careful planning and professional guidance are essential to avoid running out of income.
What are the potential downsides of using a CRT?
While CRTs offer numerous benefits, they also have potential downsides. The biggest is the irrevocability of the trust. Once assets are transferred to the CRT, you no longer own them. This means you can’t access the funds if you have an unexpected financial emergency. Furthermore, establishing and maintaining a CRT involves administrative costs, including legal and accounting fees. It’s crucial to weigh these costs against the potential benefits before proceeding. Also, changing the beneficiaries or the payout rate after the trust is established is generally not possible.
A Story of Missed Opportunities
Old Man Hemmings was a long-time client. He’d amassed a considerable portfolio of stock over decades, and as he approached retirement, he was worried about the tax implications of selling it to fund his lifestyle. He was a frugal man, known for clipping coupons and driving a beat-up truck. He resisted any advice about estate planning. He ended up selling all his stock just before a market downturn, incurring substantial capital gains taxes and losing a significant portion of his nest egg. Had he considered a CRT years earlier, he could have avoided those taxes and generated a consistent income stream without sacrificing his investments. He lamented his lack of foresight, wishing he’d listened to our advice. It was a difficult lesson learned, highlighting the importance of proactive planning.
How Proactive Planning Saved the Day
The Davis family had a similar situation, but their story had a happier ending. Mrs. Davis, a retired teacher, owned a valuable piece of beachfront property she’d inherited from her parents. She wanted to support her local library but also needed income to supplement her retirement. Following Steve’s recommendation, we established a CRUT funded with the property. This allowed her to receive an income stream for life while also making a substantial charitable donation to the library. The trust shielded her from capital gains taxes and provided a predictable income source. The library benefited from a long-term endowment, and Mrs. Davis enjoyed the satisfaction of knowing she was making a difference. This demonstrated the power of a well-structured CRT to achieve both financial and philanthropic goals.
About Steven F. Bliss Esq. at San Diego Probate Law:
Secure Your Family’s Future with San Diego’s Trusted Trust Attorney. Minimize estate taxes with stress-free Probate. We craft wills, trusts, & customized plans to ensure your wishes are met and loved ones protected.
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Feel free to ask Attorney Steve Bliss about: “Can I disinherit my spouse using a trust?” or “Can creditors make a claim after probate is closed?” and even “What are the consequences of dying intestate in California?” Or any other related questions that you may have about Probate or my trust law practice.