A charitable trust is a trust that holds money or assets for distribution to charity but also generates income or distributions for the donor or their beneficiaries. Charitable trusts are irrevocable, meaning donors can’t reclaim the assets. That can reduce some taxes, making charitable trusts useful in estate planning.
How charitable trusts work
In general, charitable trusts function as follows: People deposit cash or other assets into a charitable trust and then the trustee distributes the cash or assets to one or more beneficiaries at a certain time or over time.
Charitable trusts support IRS-qualified public charities and private philanthropic foundations; they must meet certain requirements in order to qualify for tax-exempt status. Otherwise, the IRS considers them private foundations, which come with their own tax rules and regulations.
There are two primary types of charitable trusts: charitable remainder trusts (CRTs) and charitable lead trusts (CLTs).
Charitable Remainder Trust (CRT)
Charitable remainder trusts (CRTs) are charitable trusts in which the assets generate income for the donor and/or a noncharitable beneficiary for a certain period of time, but then the remainder (see what they did there) goes to charity.
Charitable remainder trusts are frequently referred to as “split interest” trusts because they split payments between the donor and a noncharitable beneficiary for a certain period of time.
There are two main types of charitable remainder trusts:
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Charitable Remainder Annuity Trust (CRAT): This kind of CRT pays a fixed dollar amount to beneficiaries each year. Additional contributions aren’t allowed. The dollar amount is determined when the trust is created and has to be 5% to 50% of the initial value of the property or assets placed in the trust. CRATs generate a consistent annual payment, similar to a salary, from the trust and the remainder goes to charity.
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Charitable Remainder Unitrust (CRUT): This kind of CRT pays a consistent percentage of its value to noncharitable beneficiaries, and that amount is recalculated each year. Additional contributions are allowed. Annual payments from the trust to beneficiaries must be 5% to 50% of the fair market value of the trust’s assets. With a CRUT, as the value of the assets in the trust fluctuate over time, the annual payment adjusts accordingly and the remainder goes to charity.
Charitable Lead Trust (CLT)
Charitable lead trusts (CLTs) are the opposite of CRTs. They support designated charitable organizations for a set period of time, and then once that time period ends any remaining assets in the trust pass to noncharitable beneficiaries such as family members or other loved ones. In other words, the charity gets paid first and the family gets paid second.
Similar to a CRT, payouts from a CLT can be structured as a fixed amount — like a regular, annual salary (annuity trust) — or as a percentage of the total value of the trust (unitrust).
There are two main types of charitable lead trusts:
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Grantor charitable lead trust: The individual who sets up the trust (the grantor) can take an immediate tax deduction for the present value of the amount they plan to give to charity in the future. The exact deduction depends on various things, such as whether the beneficiary is a public charity or a private foundation. However, the grantor will still have to pay taxes on any taxable income the trust earns from investments.
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Nongrantor charitable lead trust: The individual who sets up the trust (grantor) can take an immediate tax deduction for the amount going to beneficiaries at the end of the trust’s term; this is because the charity (nongrantor) becomes the owner of the assets. The trust pays taxes on any income it earns that isn’t distributed to beneficiaries, and the trust takes the tax deduction for the donations to the charity, not the individual.
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How to set up a charitable trust
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The process to set up a charitable trust is complex and can vary by state and jurisdiction. The assets you wish to donate and who your beneficiaries are can add complications as well. Consult an experienced estate planning attorney or tax pro to ensure you set up your charitable trust properly and in a way that meets your giving goals.
There are six key steps to setting up a charitable trust.
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Define your giving goals. What impact do you want to have through your charitable giving? Are you passionate about literacy? Access to higher education? Public health? Once you have this bigger picture in mind, you can begin the process of setting up a charitable trust.
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Determine what assets to place in the trust. This can also help you determine what type of charitable trust you should establish. You can use cash, real estate, certain types of stocks, bonds and other investments.
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Identify your beneficiaries. Select the organizations and charities you’d like to support. Determine who your noncharitable beneficiaries will be: a spouse, children, grandchildren, etc.
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Select your trustee(s). Choose who will actually manage your trust. You can designate a friend or family member, or you can get a third-party such as a bank to administer your trust.
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Draft the trust deed. Together with your estate planning attorney, prepare the legally binding document outlining the specific terms and conditions of your charitable trust. State the purpose of the trust, how you will fund the trust, the powers and responsibilities of the trustees and any other relevant provisions or documents related to the trust, such as a power of attorney.
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Register the trust and complete required tax filings. Depending on which state you’re in, you may need to register your charitable trust with the appropriate government agency — perhaps the state attorney general, for example, or the secretary of state. You will likely need to file an IRS Form 990 every year; you may also have to fill out a split interest trust return (IRS Form 5227) or a trust return (IRS Form 1041 or 1041-A).
Charitable trust pros and cons
It’s a good idea to consult with an estate planning attorney to figure out if setting up a charitable trust is the right move, and, if it is, which type of charitable trust would be appropriate.
A legal, financial or investment advisor can help you weigh your own risks and benefits of establishing a charitable trust, but here are some of the common ones.
Charitable trust advantages
A legacy. The biggest advantage to setting up a charitable trust is the philanthropic legacy you will leave behind. Not only is it an effective estate planning tool that will help you manage long-term distributions to support your loved ones with steady income, but you can ensure some of your assets go to organizations and causes you care about.
Charitable trust disadvantages
Permanence. Charitable trusts are irrevocable and unamenable. You will not have access to any of the assets you put in the trust.
Cost and complexity. It takes time to process the paperwork to set up a charitable trust, and you’ll likely need to pay a lawyer or tax pro to do the work. You’ll need to do a cost-benefit analysis to determine which type of trust could work as the most efficient financial structure for your philanthropic effort. You don’t have to be a millionaire or billionaire to start a charitable trust, but there might be more cost-effective ways to give back.
Potential tax obligations. Despite their potential tax benefits, a charitable trust might still generate a tax bill for you or your beneficiaries because distributions can be taxed as ordinary income.
This article was written by Erin Oppenheim, a freelance writer and communications professional working in the nonprofit and philanthropy space.
