The Charitable Remainder Trust and Wealth Replacement Planning: A Potent Combination

The Peconic Land Trust and I have worked together to assist families who wish to encompass donative intent in tax-wise Estate Planning.  The use of a Charitable Remainder Trust (CRT) coupled with a wealth replacement plan has proved very effective in enabling individuals to ensure the preservation of land, increase family income, achieve a charitable intent and replace the value of the amount of the charitable gift.  The purpose of this article is to explain how a CRT and wealth replacement planning work, and how they may benefit your family and you.


A CRT is a trust that annually pays the beneficiary either a fixed dollar amount, or fixed percentage of the value of the principal of the trust (which is valued annually).  Upon the death of the beneficiary or beneficiaries, the trust terminates and the remainder (the principal value of the trust at that time) is paid to a recognized charity or charities.


The procedure to establish the CRT is relatively straightforward.  The Trust Agreement is written and signed by the individual making the gift to the trust, the “Grantor,” and the person receiving the gift, the “Trustee.”  The trust must be irrevocable.  The Trustee holds the assets given to the trust for the benefit of the beneficiary, typically the Grantor and the Grantor’s spouse.  The charity has the remainder interest and is known as the remainderman.  The Grantor may be the Trustee.  The gift to the trust can create an income tax deduction for the charitable contribution that is the value of the remainder interest as of the date the trust is created.  Each year a payment from the trust is made to the beneficiary.  The payments can be made in monthly, quarterly, semi-annual or annual installments.


Typically, a CRT is used when a person has highly appreciated, low income producing assets such as stocks, that they desire to sell in order to invest in a higher income producing investment.  A CRT, thereby, enables the individual to make a charitable contribution and receive a higher income.  The sale of these assets would produce a significant capital gain between the sale price and the low-cost basis, resulting in an income tax on the gain. The payment of the tax will result in the loss of up to 30% of the sale proceeds (20% federal tax and up to 10% state tax).  This will reduce the amount available for reinvestment by up to 30%.  The value of the CRT is that, by giving the asset to the CRT and having the CRT, as owner, sell the asset, there is no capital gain tax due at the time of the sale because the CRT is tax-exempt.  Therefore 100% of the sale proceeds are available to generate the fixed income payment to the beneficiary.


For example, if “A” has land or stock worth $1,000,000 with a cost basis of $100,000 and “A” sold the property, the gain is $900,000 and the tax at 30% is $270,000.  Thus, a net of $730,000.  If invested in a safe haven investment such as bonds, the return will typically be approximately 5% or $36,500 per year ($730,000 x .05= $36,500).


On the other hand, if “A” has created a CRT, made the gift of the asset to the CRT and the CRT made the sale, the net is $1,000,000.  If the CRT provided that “A” (or “A” and “A’s” Spouse) receive an annual payment of 9% of the trust principal, the first year’s payment would be $90,000 or $53,500 more than in the previous example (subject to applicable income tax).  Typical percentage payment range between 5% and 12%, depending on the age of the Grantor and the Grantor’s spouse.  If, hopefully, the trust appreciated in value due to prudent investment in a combination of stocks and bonds, the annual payment can increase.


The drawback of the CRT is that the principal may not be invaded (except to the extent of the percentage payment) and that the principal is not available to the family at the death of the Grantor.  With respect to the first, it is usually the case that the Grantor would not be using the principal even if it were in his or her own name.


Here is where wealth replacement planning can replace the value of the remainder (the trust principal) that is given to the charity in order to make the family “whole.”  This is accomplished by the Grantor and the Grantor’s spouse  purchasing a Second to Die Life Insurance Policy (or Single Life Insurance Policy if there is no spouse) through an Irrevocable Life Insurance Trust which is the owner and beneficiary of the policy.  Because the policy is owned by the trust it is not subject to state tax in the estate of the Grantor or the Grantor’s spouse.  The $53,500 additional income provided by the CRT (refer to example) is the source of payment of a life insurance premium.


The combination of the CRT and wealth replacement strategies provides important planning tool and achieves a number of significant benefits.  A charitable deduction may be obtained, more income can be received and, through wealth replacement, the family is made whole or better via insurance trust.  Last, but far from least, a significant charitable contribution of lasting importance and value is made to the charity or charities.  You, your family and the charities, not the IRS, enjoy the benefit.  It is a question of whom you wish to benefit and the choice is yours.


Does the CRT and wealth replacement have a place in your planning?  Very likely.  Peconic Land Trust and I would be pleased to discuss your situation with you.