The season of giving is here. For many families, the holiday season is the time for contributing their money, time and other resources to their favorite charitable causes. It’s the season for helping other families who are less fortunate.
The end of the year is also a popular time to conduct a financial review, especially with regard to taxes. You’ll soon start receiving year-end tax documents and preparing your returns. You have limited time left to take action to minimize your tax exposure.
You may be considering charitable donations as part of your tax management strategy. Charitable gifts are often tax-deductible. If you have assets with a significant amount of appreciation, however, you may want to consider an advanced strategy—a charitable remainder trust.
A charitable remainder trust is a financial tool that allows you to accomplish a few important objectives:
- Gifting assets to a favorite cause or charity
- Selling highly appreciated assets without creating a tax liability
- Obtaining a current income tax deduction
- Generating lifetime income
Below are a few common questions and answers about using a charitable remainder trust and how it could work for you. A financial and estate planning professional can help you better analyze your needs and develop a charitable giving strategy.
How does a charitable trust work?
A charitable trust is simply a legal entity that facilitates the sale and distribution of your charitable gift. Assume you own stock that has appreciated significantly. If you were to sell the stock, you would incur taxes on your gains.
Instead, you could donate the asset to your charitable trust. The trust then sells the asset and uses the funds to diversify and purchase a mix of other securities and assets. The new assets are used to generate income for you and your spouse for the rest of your life. Upon your death, the balance of the trust is donated to the charity of your choice.
This arrangement has a few important tax implications. Your gift to the trust is tax-deductible because it’s intended for charity. That’s a deduction you can take on your current return. Also, the sale of the asset is exempt from capital gains taxes because it’s for the benefit of the charity. You get to help your favorite cause, minimize your taxes and create a lifetime income stream.
What are the income options?
There are two ways to generate income out of your charitable trust. One is to take a fixed percentage of the trust value each year, such as 4 percent. The trust assets are revalued at the beginning of the year, and your income is reset to the fixed percentage of the trust balance.
This approach may be appropriate if your goal is to pass as much as possible to the charity upon your death. If the assets decline in value, so too will your income. That reduces the possibility of your income depleting the trust assets. On the other hand, if the assets increase in value, you may get a pay raise.
The other option is to take a fixed amount of income each year. In this case, the income amount stays the same every year regardless of whether your assets increase or decline in value. This approach will give you income certainty. If your assets decline in value, however, the distributions could be problematic. Similarly, if the trust asset values increase, you won’t see a pay raise.
Why shouldn’t I use a charitable remainder trust?
There are a number of reasons why a charitable remainder trust may not be appropriate. The biggest may be that the action is irrevocable. Once you donate assets to the trust, they are gone. You can get income out of the trust, but you can’t undo the trust and reclaim your assets.
If you think that you may need the assets for an emergency or that you may change your mind about donating them to charity, a charitable remainder trust may not be a good idea. Your financial professional can help you explore other options for selling your appreciated assets and creating income.
Ready to plan your charitable strategy? Let’s talk about it. Contact us today at Crescent City Retirement. We can help you analyze your needs and develop a plan. Let’s connect soon and start the conversation.
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