While we frequently tout the benefits of irrevocable life insurance trusts (ILIT) as a means of creating benefits for heirs, there are certain situations in which these might not be the best choice.
Say, for example, you want to provide for a beneficiary while, at the same time, give to a charity. An ILIT may not work for this because an ILIT must be set up to benefit a living person. It can’t leave money to an entity, like a charity.
There is another type of trust, though, that could be used — the charitable remainder trust. This trust allows you to create a stream of income for beneficiaries and give to charity. While these trusts can be funded with a wide range of assets, two of the more common sources of funding are IRAs or permanent life insurance policies.
What Is a Charitable Remainder Trust?
A charitable remainder trust is unique because it allows you to provide for beneficiaries and also leave something behind for charity. What happens is the trust is funded, usually with appreciating assets. The beneficiary will then receive regular payments from the trust for a period of time. When that payment period ends, the remaining funds in the trust are given to the listed charity.
There are two structures that a charitable remainder trust can take:
- Charitable remainder annuity trust (CRAT). A CRAT pays the beneficiary a fixed annuity benefit for a period of time and the remainder is donated to charity at the end of the distribution period for the beneficiary. The value of the trust is determined when the funds or assets are added and is not reevaluated every year.
- Charitable remainder unitrust (CRUT). In a CRUT, payments to the beneficiary will fluctuate because the value of the trust is evaluated annually. Depending on market conditions, the payment to the beneficiary can change significantly over time.
Which form of trust you choose will often be based on the assets that you hold in it. Annuity trusts, for example, are only appropriate for more liquid assets because it requires the items that fund it be available for yearly payments. On the other hand, if you want to keep contributing to the charitable trust, you’ll need to use a CRUT because this structure allows you to recalculate the value of the trust on a yearly basis.
Deciding which form is better requires looking at the assets you put in it, your age, and your overall risk tolerance. In either case, charitable remainder trusts offer a tax shelter for highly appreciating assets and allow you tax breaks on the donations you make to them.
Of course, charitable remainder trusts also have their limitations. Like an ILIT, these trusts are irrevocable. In addition, charitable remainder trusts have a maximum timeline of 20 years when paid over a limited term, or they can be structured to pay income over the lifetime of the individual or individuals they are intended to pay income to.
Funding a Charitable Remainder Trust with an IRA
One common way that individuals get around estate taxes and income taxes when leaving an IRA to a family member is to make a charitable remainder trust the beneficiary of an IRA. In this case, the money technically goes to a charity, but at the same time, permits the beneficiary of the trust to receive an ongoing stream of payments funded by that IRA. Only as the heirs receive the payments will they have to pay taxes on the amount received.
To remain a qualified trust, the charitable remainder interest must be at least 10% of the trust’s value. So if the IRA is valued at $1 million, the amount reserved for charity must be at least $100,000. Annual distributions to heirs can’t be less than 5%, but they also can’t be more than 50% of that initial value.
Life Insurance in a Charitable Remainder Trust
There is another option for funding a charitable remainder trust that may allow your funds to go a bit further and allow you to leave more behind for charity. That option is to hold a permanent life insurance policy in a charitable remainder trust.
Here is how it works. The charitable remainder trust purchases the life insurance policy using money donated to it. Then, when the insured dies, the charitable remainder trust pays out a portion of benefits to the initial beneficiary for a set number of years or until he or she dies. The remaining funds in the account are given to a charity when the beneficiary’s distribution years end.
This is usually something best leveraged with index universal life insurance because this type of life insurance allows the trust to benefit from higher market-based returns. These returns can keep the funds growing enough to ensure that beneficiaries and the charities get to enjoy the benefits of these higher earnings.
Charitable remainder trusts also allow for some valuable tax write-offs for charitable giving, which aren’t generally available for ILITs because ILIT contributions aren’t considered charitable contributions.
Trusts can be a valuable tool in managing estate tax and can create a way for you to give to charity and beneficiaries at the same time. Creating these trusts requires working with the right people to ensure your trust remains compliant, especially if you’re funding one with life insurance. Contact a Howard Kaye advisor today at 800-DIE-RICH for more information on choosing the best trust to build an ongoing legacy with your assets.
