In this series of posts, we'll be explaining each of the three main types of charitable remainder unitrust, starting with today's entry on the standard CRUT.
What is a Charitable Remainder Unitrust?As you likely know by now, charitable remainder trusts (CRUTs) are a form of tax-deferred account, much like an IRA, that are designed to incentivize charitable giving in exchange for significant tax benefits: tax deferral and the ability to lower your tax rate via income smoothing.
We offer three basic forms of Charitable Remainder Unitrust: the standard CRUT, the NIMCRUT, and the Flip CRUT. These formats carry similar benefits — they are all tax exempt, you get a charitable deduction when you put assets into each, and you'll leave the remainder for a charity at the end. The primary difference — and the focus of this post — is in how and when you receive distributions from the trust.
What is a standard Charitable Remainder Unitrust?A standard Charitable Remainder Unitrust is the most basic form of charitable remainder trust available. Like all of the CRUTs we offer, the standard CRUT is tax exempt, which means it does not pay taxes on its gains (with a few exceptions not relevant here); it is irrevocable, so it cannot be modified after creation; it's designed to last for a defined term or for your lifetime; and it's a "split interest" trust, so whatever is left in the trust at the end goes to the charity of your choice.
The most important distinction between standard CRUTs and the other forms is that with the other versions, there is some complex maneuvering to be done around when you withdraw money, and how much you pull out. With standard CRUTs, by contrast, things are simpler: You receive payouts each year that are a set percentage of the trust's assets. That percentage is determined at the start of the trust based on its expected length, and it doesn't change during the trust's term. So once you put your assets into the trust, you'll receive those payouts no matter what.
How does a standard CRUT work?
- Choose an asset. You, the individual setting up the trust, choose an appreciated asset that you'd like to contribute to a trust. This could be any asset that has appreciated or is likely to appreciate significantly; the most common assets we see from our users are start-up equity, crypto, public equities, and certain alternative private assets.
- Designate a beneficiary. You designate an income beneficiary — the person who will receive payments from the trust every year. Most of our users choose to be the income beneficiary themselves and/or name a partner or child.
- Transfer assets & get a deduction. You transfer your chosen assets to the trust, and you get an immediate charitable deduction, usually equal to about 10% of the value of the asset you put in. Sell assets tax free. You sell your asset and, in most cases, the trust pays no taxes on that sale, allowing you to grow more money for longer.
- Take your annual withdrawal. With a standard CRUT, this is a fixed percentage of your trust's assets. (See below for more details.)
- Leave the remainder to charity. The remainder —whatever is left in the trust at the end of the trust's term — is donated to a charitable organization. Recall that this is the reason your money gets to grow tax free in the first place: You get the tax exemption, and in exchange you promise to leave the remainder to another tax-exempt entity — a charity.
You can read more about CRUT payouts in general in our series on withdrawals, but for our purposes there's one point worth highlighting: What makes standard CRUTs different from the other CRUTs is that a standard CRUT is required to pay money out every year. How much? The calculation is actually fairly simple. Your annual payout percentage is determined by an IRS formula that takes into account (1) how long your trust will last (your chosen term or, in the case of a lifetime trust, the IRS's actuarial estimation of the expected length of the trust) and (2) the IRS's statutory discount rate, which is just how much the IRS expects your assets to grow in the trust. (The IRS has a very conservative view of these things; right now it's using a 1% expected growth rate.)
We use that formula to calculate your payout rate, which will typically be about 11% for 20 year term trusts and will vary between about 5% and 8% for lifetime trusts. What this means is that if you use a standard CRUT, then every year you will receive a payout from the trust equal to that fixed percentage times the value of all of the assets in the trust.
An exampleHere's a simple example: Suppose that you have $500k in start-up equity, crypto, public securities, or another asset. You've decided to use a 20 year term structure. What are the associated benefits?
- Immediate deduction. First things first: You would receive an immediate charitable tax deduction equal to 10% of the assets' current value. In this example, that would allow you to reduce your taxable income by $50k this year (or, if you prefer, you can spread that deduction out over up to five years).
- Payouts. Because we're working with a 20 year term this would make your payout rate approximately 11% annually. At the end of the first year, the trust would owe you 11% of $500k, or $55,000. (The payout is typically calculated based on the value of the trust at the beginning of the year.) Now say that you have a good year, and the value of the assets doubles to $1 million. At the end of the second year, the trust would pay you 11% of $1 million, or $110,000. (If, instead, the asset had plummeted to $100k, you'd be entitled to a payout equal to 11% of $100k, or only $11,000.
- Charitable remainder. At the end of the trust's term, the remainder left in the trust will go to the charity you designated.
- Returns. The main practical insight is that, with a Standard CRUT, there's no flexibility in when the trust pays you out. Because Standard CRUTs pay out a steady share of the trust's assets every year, they tend to have slightly lower returns than NIMCRUTs. This makes sense, since forcing annual payouts means your money has less time to grow and compound tax free. (It's worth noting, though, that the returns are often still positive as compared to a taxable account.)
- Hedge. At the same time, some view this additional constraint as a positive thing, because a Standard CRUT will pay out even if your assets don't grow and increase income (whereas a NIMCRUT will not). For that reason, some use this type of trust for volatile assets that may not end up growing significantly.