Charitable Remainder Trusts: A More Flexible IRA
❗ Key takeaway: Charitable Remainder Trusts (CRTs) may seem foreign, but they're actually very similar to a popular tax planning tool you're probably much more familiar with: the Individual Retirement Account (IRA). Like IRAs, CRTs allow you to defer the taxes you would otherwise owe on your capital gains. But unlike IRAs, CRTs have no contribution limit and allow you to withdraw money when you need it, rather than having to wait until retirement.
If you've been following our work over the past few months, you will have read a lot about tax-advantaged trusts. These trusts--and tax planning in general--can be intimidating, in part because most people come to the table with preconceived notions: that tax planning is reserved for people with nine figures of wealth and access to a team of lawyers and accountants, or that it's only for people with kids, or, more commonly, that it's something you can put off until you're older. Or maybe you haven't thought much about trusts at all until now.
But tax-advantaged trusts (and, specifically, the Charitable Remainder Trust (CRT), the tool most of our customers use) don't have to be scary. In fact, they're actually just one type of a very common tax mitigation tool--the tax-deferred account--and, in particular, they are very similar to the most popular financial planning vehicles: the Individual Retirement Account, or IRA. In today's post, we'll explain those similarities--and some key differences--with the goal of helping you understand how a CRT might fit into your financial plan.
Charitable Remainder Trusts: A more flexible IRA
The IRA is one of the best tools around for minimizing your tax bill on investment gains, but it has some key limitations: There is a (pretty low) cap on contributions, for example, and your withdrawal rights are limited.
Like IRAs, Charitable Remainder Trusts allow you to defer the taxes you would otherwise owe on your capital gains. But they do more, too: CRTs have no contribution limit, and they allow you to use your money today instead of having to wait until retirement.
What are the benefits of deferring taxes on your investment gains?
An IRA, at its core, is designed to be a tax-advantaged retirement account; you deposit money into your IRA, and it grows tax-free until you withdraw your money. A 35-year old who invests in a traditional IRA and grows her investment at 8% per year until she is 60 might increase her returns by 70% due to the benefits of tax deferral, compared to the gains she would have realized if she had invested that money in a taxable account.
CRTs work the same way at a high level: Your gains are still tax-deferred; if you have a big capital gain coming, you can move your equity, crypto, or other assets into a CRT and only pay taxes when you pull the money out.
But CRTs and IRAs have a few notable differences.
How is a CRT different from an IRA?
For starters, with an IRA, you're limited to a $6,000 annual contribution. In practice, this means that it's very difficult to build up a significant nest egg in your IRA, and, as a result, it's virtually impossible to use for your already appreciated assets like late-stage startup equity or crypto. With a CRT, by contrast, there's no limit on contributions. If you have startup equity or crypto worth $10 million, you're welcome to put it all into a trust—and protect it all from an up-front tax bill.
Second, you have much more flexibility when it comes to withdrawing your money from a CRT. IRA withdrawals are strictly controlled: If you pull your money out before you turn 59 1/2, you'll pay a 10% penalty (outside of a few exceptions). CRT withdrawals are also subject to detailed rules, but the bottom line is this: With a CRT, you will have access to significant liquidity starting in the very first year of your trust, and you will be able to access as much as the full value of your assets in the first five or ten years, depending on how fast the trust grows.
It's important to note that there is one key trade-off with a CRT: you are required to donate a portion of the value to a charitable organization at the end of the trust's term. For some, this is an additional benefit--maybe it fits into their existing charitable plans, or maybe they like the idea of committing a significant sum to charity. But if this isn't something you care much about, you can just price it in: The benefits of tax deferral typically leave you with more capital than you would have had if you had kept the assets in your name, even after subtracting your charitable gift.