Trusts can be an effective way to accomplish charitable gift-giving. While there are some disadvantages to setting up a charitable giving trust, such trusts also offer many benefits, making them a valuable estate planning tool for many individuals interested.
How a Charitable Trust Works
In a charitable trust, there is a grantor or donor—the person who creates the trust and then funds the trust by transferring assets to it. A charitable organization, usually a 501(c)(3) or tax-exempt organization, is one of the named beneficiaries. Additional beneficiaries typically include the donor and/or the donor's family members.
The donor also designates a trustee who will manage the assets in the trust. The income and principal from the trust are then distributed according to the terms of the trust. If non-income-producing assets are transferred into the trust, the trustee usually sells the assets and invests the proceeds of the sales into income-producing property.
Types of Charitable Trusts
There are two primary types of charitable trusts:
- Charitable lead trust. In a charitable lead trust, the income produced by the trust is distributed to the designated charity for a set number of years, after which time the assets remaining in the trust are distributed to the other named beneficiaries.
- Charitable remainder trust. With a charitable remainder trust, the opposite is true. The income produced by the trust is distributed to the non-charity beneficiaries, and at the end of the trust, the remainder is given to the designated charity.
When people talk about a charitable giving trust, they're likely to be thinking about a charitable remainder trust. The charitable lead trust is more useful to wealthier individuals who want to give to their favorite charity and who don't have any need for the income generated by the trust.
There are two types of charitable remainder trusts:
- Charitable remainder annuity trust. This type of trust provides the beneficiaries with a stated amount (that is, a fixed annuity) every year until the trust is terminated. This type of trust works best for those who want to know exactly how much they will get from the trust each year.
- Charitable remainder uni-trust or unit trust. With this type of charitable remainder trust, the beneficiaries receive a set percentage of the value of the trust's assets every year. This trust works well if you have concerns about the risks of inflation on the income you will receive yearly from the trust.
Benefits of a Charitable Trust
Charitable trusts offer donors several benefits, including the following:
- Charitable tax deduction. Because the purpose of a charitable trust is to give donations to the specified charity, you will be eligible for a charitable deduction on your income tax. Note, however, that with a charitable remainder trust, the amount of the donation won't be the value of the assets transferred to the trust. The amount depends on a number of factors, including the total amount of income you expect to receive through the life of the trust.
- Capital gains tax. Since a charitable trust is an irrevocable trust, once an asset has been transferred to the trust, it is owned by the trust. Because the trust is a charitable trust, when the trust sells the asset, the proceeds of the sale do not attract capital gains tax. This makes a charitable trust an ideal vehicle for assets that have appreciated in value.
- Estate tax. Due to the irrevocable nature of charitable trusts, any assets held by the trust are not counted as part of the donor's estate for the purpose of estate taxes after the donor's death. Most people will have no need to minimize estate tax, as only high-value estates are subject to estate tax, but for wealthier individuals, charitable trusts can be an effective means of minimizing estate tax for their beneficiaries.
Disadvantages of a Charitable Trust
There are, however, some disadvantages to a charitable trust, including the following:
- Inflexibility. In order to be valid, a charitable trust must be irrevocable. This means you can't terminate the trust, make any changes to the terms of the trust (with some limited exceptions), or take your assets back out of the trust.
- Loss of control. The irrevocable nature of the charitable trust also means you lose control over the assets you've transferred to the trust. The trustee has sole control over how the trust assets are managed, and their duty is to the trust, and not to you, the donor.
- Costs. While some trusts can be fairly easy to implement with a DIY approach, the same cannot be said for a charitable trust. Messing up the terms of a charitable trust can have disastrous financial consequences, so it's usually a good idea to retain the services of an experienced attorney to help you set up the trust.
How to Create a Charitable Trust
Like any other trust vehicle, starting a charitable trust involves setting up the trust document, funding the trust, designating beneficiaries, including a designated charity, and appointing a trustee. When creating a charitable trust, the following are some important considerations:
- The duration of the trust. You can have the trust set up for a set period of time (up to a period of 20 years) or for the lifetime of a specified beneficiary.
- Lead or remainder trust. You need to decide if you want your beneficiaries to receive a stream of income from the trust, or if you want your designated charity to receive the trust's yearly income, with any assets left in the trust going to your beneficiaries.
- Fixed distribution or percentage of value. If setting up a charitable remainder trust, you also need to decide whether you want an annuity trust, which will distribute a fixed amount each year, or a uni-trust, which will distribute a percentage of the value of the trust every year.
The irrevocable nature of the charitable trust means you cannot change your mind about most of the terms of the trust once it's been created, so it's important to take the time to consider and evaluate how you want your charitable trust to be set up.
Charitable giving trusts can be an ideal option in an estate plan if charitable giving is important to you, but you still want your beneficiaries to benefit from the donated assets, either through a steady income stream or when the trust ends.