Charitable Remainder Trust
Description of Charitable Remainder Trust
A charitable remainder trust allows you to make a significant gift to the Northwest Compassion Foundation while retaining the right for you and/or one or more designated beneficiaries to receive income payments over a specified period of time. Generally, the specified period may be measured by your life or that of your designated beneficiary(ies) or may be fixed to a term not to exceed 20 years. The amount of payments that you and/or your designated beneficiary(ies) will receive during the payout period will depend on how you structure the trust and, to a greater or lesser extent, on the investment performance of the assets in your charitable remainder trust.
A transfer of assets to a charitable remainder trust is irrevocable.
In establishing a charitable remainder trust, you may transfer cash, securities and/or other property to a trustee who is responsible for investing and reinvesting those assets, together with any income therefrom, and for making distributions to you and/or your designated beneficiary(ies). The trustee can be a bank or other institution or entity that you choose, or an individual (including you, in some circumstances). NCF serves as trustee.
When the trust terminates—that is, when the trustee is no longer obligated to make distributions to you and/or your designated beneficiary(ies)—the property remaining in the trust will be distributed to the Northwest Compassion Foundation, for its general charitable purposes or to support a program you have designated.
The two types of charitable remainder trusts—annuity trusts and unitrusts—are briefly described below:
Annuity Trusts
A charitable remainder annuity trust distributes at least annually to you and/or your designated beneficiary(ies) a specific amount equal to a percentage of the fair market value of the annuity trust’s assets as of the date the trust is created. The payout must be at least 5% of the initial net fair market value of the annuity trust asset(s). To qualify, the annuity trust also must pass a test known as the “5% probability test”—an actuarial calculation done to make sure that there is less than a 5% probability that the annuity trust assets will be exhausted before the trust terminates. To qualify as a charitable trust, the present value of the remainder interest (i.e. the projected “gift” portion of the trust) must equal or exceed 10% of the value of the trust at time it is created. No additional contributions may be made to an annuity trust after its initial funding.
Unitrusts
A unitrust differs from an annuity trust in that distributions are based on a fixed percentage of the net fair market value of the trust assets, as determined on a specified day of each year of the unitrust. While the percentage is fixed (again, it cannot be less than 5%), the value of the unitrust assets fluctuates each year. As a result, unitrust payments increase as the value of the trust assets increase, and decrease as the value of the trust assets decrease. When you create the trust, you specify the percentage of the unitrust’s net fair market value that is to be distributed each year.
Additional contributions may be made to a unitrust. Like annuity trusts, the present value of the charitable remainder interest must be worth at least 10% of the value of the assets initially transferred to the unitrust— and, in the case of an additional contribution, 10% of the value of the assets added to the trust.
A trust that pays the stated percentage of the net fair market value of its assets, as determined each year, is called a “standard” unitrust. A unitrust may include a “net income” provision that requires the trustee to pay the lesser of the trust’s net income or the stated percentage of the net fair market value of the unitrust assets, as revalued annually. A “net income unitrust” may also contain a “makeup” provision that operates this way: if you establish a net income unitrust with a gift of real estate, closely held stock or other asset that generates little or no income, the payments made to you or your beneficiary(ies) during the years that the trust holds those assets will be minimal. A “deficiency” will arise, equal to the difference in the percentage amounts for those years (stated percentage multiplied by unitrust’s fair market each year) and the income, if any, distributed to you or your beneficiaries. If those holdings are later sold and the assets purchased by reinvestment produce income that exceeds the stated percentage of the net fair market value of the unitrust’s assets, the surplus income will be used to make up the deficiency.
A unitrust may also be established as a “flip trust.” A flip trust starts out as a net income unitrust, with or without a makeup provision, and switches (flips) to a standard unitrust upon the happening of an event specified in the trust agreement (usually, the sale of the funding assets, such as real estate or closely held stock).
Federal Tax Consequences
Income Tax Deduction
A charitable remainder trust provides you, if you itemize, with an immediate income tax deduction based on the present value of the remainder interest. The value of that interest depends on your age (or the age of your income beneficiary[ies]), the date of funding of the trust, the type of trust created, the payout percentage designated in the trust agreement, the frequency and timing of trust payments and the IRS discount rate in effect at the time the trust is created.
If you use cash to fund your charitable remainder trust, you are permitted to claim the deduction generated by your contribution to the extent that it, together with other gifts to public charities made in cash during that taxable year, does not exceed 50% of your adjusted gross income for that year. If the value of your combined cash gifts is greater than 50% of your adjusted gross income, you can carry over the excess deduction for up to five years.
If you use appreciated property (held by you for more than one year) to fund your charitable remainder trust, the value of your deduction is based on the full fair market value of that property on the date of contribution. The deduction generated by your contribution, when combined with all other gifts of appreciated property to other public charities, may not exceed 30% of your adjusted gross income for the year of contribution, with a five-year carryover for any excess.
Capital Gains Implications
A charitable remainder trust provides an additional income tax benefit when funded with appreciated assets. You do not pay capital gains tax on the appreciation when you create the trust. And, because a charitable remainder trust is tax exempt for federal tax purposes, it pays no capital gains tax when the trustee sells appreciated assets. The entire value of your contributed assets can be put to work to generate income and growth of principal.
Tax Treatment of Payments
The tax treatment of payments made to you and/or your designated beneficiary(ies) depend on the type of income earned by the trust. The trust is required to maintain a historic ledger of income earned and gains realized each year. Each payment to the income beneficiary(ies) retains the character it had in the trust. Each payment is treated as follows in this order:
Ordinary income (interest and dividends), to the extent of the trust’s current and past undistributed ordinary income.
Federal Gift and Estate Tax
If you name individuals other than yourself and your U.S. citizen spouse as beneficiary(ies), the value of their interests will be treated as potentially taxable gifts upon funding the trust. Gift tax implications—depending on the terms of the trust—can often be avoided by reserving the right to revoke by your will a beneficiary’s interest in the trust. If your spouse is the only individual beneficiary (other than you), his or her interest will qualify automatically for the gift tax marital deduction.
If you create a charitable remainder trust for yourself that continues for a spouse or another at your death, or if you create a trust at the death of your spouse or another, the value of the interests of those individuals will be included in your estate and may be subject to federal estate tax. If your spouse is the only beneficiary of the trust, his or her interest will qualify for the estate tax marital deduction.
If the beneficiary is your grandchild, or a person who is treated as being two generations or more removed from you, the value of his or her interest may be subject to the generation-skipping transfer tax.
General Unitrust Investment Philosophy
Each asset allocation is analyzed and customized to maximize the growth potential and income expectations for your particular trust. The specific allocation of assets is dependent upon the income needs and expectations of the beneficiaries, the growth requirements and inflation protection of the charitable beneficiary(ies) and the percentage payout. The goal is for long-term growth while balancing the needs of the income beneficiary(ies) and the charitable beneficiary(ies).
Costs
As is common with most trusts, there will be certain fees incurred for trust administration— including fees for investment management and accounting and tax reporting services. NCF employs an agent to provide those services for charitable remainder trusts and is paid from trust assets. Fees can be charged against trust income or principal, depending on the terms of the trust agreement and applicable state law. Further information regarding fees is available upon request.
Individual Information
The consequences of a charitable gift depend in significant part on each donor’s particular circumstances. This general discussion of charitable remainder trusts does not address every issue, nor does it take into consideration the type of assets you are contributing to your charitable remainder trust, the particular terms of your trust, your individual tax situation or your estate and gift tax planning objectives. Additionally, there are other factors, such as state and local taxes, that may be relevant to your gift. Regarding those considerations, as well as for a description of other ways to structure charitable gifts, you are most strongly urged to consult your tax and estate planning advisors.
Typical Timeline for Establishing a Charitable Remainder Trust
Straight Unitrusts
Philosophy: Manage unitrust on a total return basis.
Strategy: Emphasize common stock weighting to maximize total return within portfolio constraints.
Result: Long term corpus growth that benefits both the income beneficiary and the charitable beneficiary through higher annual distribution and principal value.
Net Income Unitrusts
Philosophy: Establish portfolio target yield that balances income and growth.
Strategy: Earn reasonable income while maintaining adequate growth.
Result: Income distribution that meets the income beneficiary’s reasonable expectations while achieving long-term corpus growth, which will benefit both the income beneficiary and the charitable beneficiary.
Annuity Trusts
Philosophy: Manage annuity trust on a cautious total return basis because of fixed payment.
Strategy: Allocation is moderately aggressive to provide potential growth and downside protection.
Result: Grow trust assets to lower the effective payout percentage.
Payout Options
The Straight Unitrust
Under this arrangement, the trust makes a payment each year based on a fixed percentage (5% or greater) of the net fair market value of the assets of the trust as valued at least once a year. Thus, if the net asset value of the trust increases, the annual payout also increases. Conversely, if the trust value declines, the annual payout is reduced. In this form of unitrust, if the annual income earned is insufficient to meet the payout obligation, the principal of the trust is invaded. If more than sufficient income is earned, the excess income normally reverts to principal. The payout percentage cannot be changed once the trust is established, although additional assets may be added by the donor at any time in increments of not less than $10,000.
The Net Income Only Unitrust
Under this arrangement, the trust pays out either the fixed percentage of the net asset value of the trust or the actual net income earned, whichever is less. The principal of the trust will never be invaded to make payments to beneficiaries. The “net income only” unitrust is an ideal vehicle for gifts of nonincome producing assets where there may be a delay in the sale of the asset and reinvestment for income. No payment to the beneficiary is required until the trust’s assets produce income.
The Net Income with Makeup Unitrust
This type of unitrust follows the form of the “net income only” unitrust with an additional provision. It stipulates that any payment insufficiencies in the early years between the fixed percentage due and the actual net income earned and paid will be reimbursed to the beneficiary. This is possible when, in future years, the trust earns income in excess of the fixed percentage due. Like the “net income only” unitrust, this form of unitrust is often used when funding a trust with real estate, which may not produce liquid assets for some time. This form of payout arrangement is also an excellent retirement planning vehicle. In the early years, the trust may be invested in non-income or low-income producing assets expected to appreciate in value. Upon retirement, the appreciated trust assets may then be sold and reinvested to produce a larger income, giving the beneficiary the benefit of the higher annual payment, plus any additional income in satisfaction of the balance due for insufficient payments made in previous years.
A charitable remainder trust allows you to make a significant gift to the Northwest Compassion Foundation while retaining the right for you and/or one or more designated beneficiaries to receive income payments over a specified period of time. Generally, the specified period may be measured by your life or that of your designated beneficiary(ies) or may be fixed to a term not to exceed 20 years. The amount of payments that you and/or your designated beneficiary(ies) will receive during the payout period will depend on how you structure the trust and, to a greater or lesser extent, on the investment performance of the assets in your charitable remainder trust.
A transfer of assets to a charitable remainder trust is irrevocable.
In establishing a charitable remainder trust, you may transfer cash, securities and/or other property to a trustee who is responsible for investing and reinvesting those assets, together with any income therefrom, and for making distributions to you and/or your designated beneficiary(ies). The trustee can be a bank or other institution or entity that you choose, or an individual (including you, in some circumstances). NCF serves as trustee.
When the trust terminates—that is, when the trustee is no longer obligated to make distributions to you and/or your designated beneficiary(ies)—the property remaining in the trust will be distributed to the Northwest Compassion Foundation, for its general charitable purposes or to support a program you have designated.
The two types of charitable remainder trusts—annuity trusts and unitrusts—are briefly described below:
Annuity Trusts
A charitable remainder annuity trust distributes at least annually to you and/or your designated beneficiary(ies) a specific amount equal to a percentage of the fair market value of the annuity trust’s assets as of the date the trust is created. The payout must be at least 5% of the initial net fair market value of the annuity trust asset(s). To qualify, the annuity trust also must pass a test known as the “5% probability test”—an actuarial calculation done to make sure that there is less than a 5% probability that the annuity trust assets will be exhausted before the trust terminates. To qualify as a charitable trust, the present value of the remainder interest (i.e. the projected “gift” portion of the trust) must equal or exceed 10% of the value of the trust at time it is created. No additional contributions may be made to an annuity trust after its initial funding.
Unitrusts
A unitrust differs from an annuity trust in that distributions are based on a fixed percentage of the net fair market value of the trust assets, as determined on a specified day of each year of the unitrust. While the percentage is fixed (again, it cannot be less than 5%), the value of the unitrust assets fluctuates each year. As a result, unitrust payments increase as the value of the trust assets increase, and decrease as the value of the trust assets decrease. When you create the trust, you specify the percentage of the unitrust’s net fair market value that is to be distributed each year.
Additional contributions may be made to a unitrust. Like annuity trusts, the present value of the charitable remainder interest must be worth at least 10% of the value of the assets initially transferred to the unitrust— and, in the case of an additional contribution, 10% of the value of the assets added to the trust.
A trust that pays the stated percentage of the net fair market value of its assets, as determined each year, is called a “standard” unitrust. A unitrust may include a “net income” provision that requires the trustee to pay the lesser of the trust’s net income or the stated percentage of the net fair market value of the unitrust assets, as revalued annually. A “net income unitrust” may also contain a “makeup” provision that operates this way: if you establish a net income unitrust with a gift of real estate, closely held stock or other asset that generates little or no income, the payments made to you or your beneficiary(ies) during the years that the trust holds those assets will be minimal. A “deficiency” will arise, equal to the difference in the percentage amounts for those years (stated percentage multiplied by unitrust’s fair market each year) and the income, if any, distributed to you or your beneficiaries. If those holdings are later sold and the assets purchased by reinvestment produce income that exceeds the stated percentage of the net fair market value of the unitrust’s assets, the surplus income will be used to make up the deficiency.
A unitrust may also be established as a “flip trust.” A flip trust starts out as a net income unitrust, with or without a makeup provision, and switches (flips) to a standard unitrust upon the happening of an event specified in the trust agreement (usually, the sale of the funding assets, such as real estate or closely held stock).
Federal Tax Consequences
Income Tax Deduction
A charitable remainder trust provides you, if you itemize, with an immediate income tax deduction based on the present value of the remainder interest. The value of that interest depends on your age (or the age of your income beneficiary[ies]), the date of funding of the trust, the type of trust created, the payout percentage designated in the trust agreement, the frequency and timing of trust payments and the IRS discount rate in effect at the time the trust is created.
If you use cash to fund your charitable remainder trust, you are permitted to claim the deduction generated by your contribution to the extent that it, together with other gifts to public charities made in cash during that taxable year, does not exceed 50% of your adjusted gross income for that year. If the value of your combined cash gifts is greater than 50% of your adjusted gross income, you can carry over the excess deduction for up to five years.
If you use appreciated property (held by you for more than one year) to fund your charitable remainder trust, the value of your deduction is based on the full fair market value of that property on the date of contribution. The deduction generated by your contribution, when combined with all other gifts of appreciated property to other public charities, may not exceed 30% of your adjusted gross income for the year of contribution, with a five-year carryover for any excess.
Capital Gains Implications
A charitable remainder trust provides an additional income tax benefit when funded with appreciated assets. You do not pay capital gains tax on the appreciation when you create the trust. And, because a charitable remainder trust is tax exempt for federal tax purposes, it pays no capital gains tax when the trustee sells appreciated assets. The entire value of your contributed assets can be put to work to generate income and growth of principal.
Tax Treatment of Payments
The tax treatment of payments made to you and/or your designated beneficiary(ies) depend on the type of income earned by the trust. The trust is required to maintain a historic ledger of income earned and gains realized each year. Each payment to the income beneficiary(ies) retains the character it had in the trust. Each payment is treated as follows in this order:
Ordinary income (interest and dividends), to the extent of the trust’s current and past undistributed ordinary income.
- Capital gains income, to the extent of current and past undistributed gains (short-term first).
- “Other” (tax-exempt) income, to the extent of current and past undistributed other income.
- Return of trust principal. A return of principal is not subject to income tax.
Federal Gift and Estate Tax
If you name individuals other than yourself and your U.S. citizen spouse as beneficiary(ies), the value of their interests will be treated as potentially taxable gifts upon funding the trust. Gift tax implications—depending on the terms of the trust—can often be avoided by reserving the right to revoke by your will a beneficiary’s interest in the trust. If your spouse is the only individual beneficiary (other than you), his or her interest will qualify automatically for the gift tax marital deduction.
If you create a charitable remainder trust for yourself that continues for a spouse or another at your death, or if you create a trust at the death of your spouse or another, the value of the interests of those individuals will be included in your estate and may be subject to federal estate tax. If your spouse is the only beneficiary of the trust, his or her interest will qualify for the estate tax marital deduction.
If the beneficiary is your grandchild, or a person who is treated as being two generations or more removed from you, the value of his or her interest may be subject to the generation-skipping transfer tax.
General Unitrust Investment Philosophy
Each asset allocation is analyzed and customized to maximize the growth potential and income expectations for your particular trust. The specific allocation of assets is dependent upon the income needs and expectations of the beneficiaries, the growth requirements and inflation protection of the charitable beneficiary(ies) and the percentage payout. The goal is for long-term growth while balancing the needs of the income beneficiary(ies) and the charitable beneficiary(ies).
Costs
As is common with most trusts, there will be certain fees incurred for trust administration— including fees for investment management and accounting and tax reporting services. NCF employs an agent to provide those services for charitable remainder trusts and is paid from trust assets. Fees can be charged against trust income or principal, depending on the terms of the trust agreement and applicable state law. Further information regarding fees is available upon request.
Individual Information
The consequences of a charitable gift depend in significant part on each donor’s particular circumstances. This general discussion of charitable remainder trusts does not address every issue, nor does it take into consideration the type of assets you are contributing to your charitable remainder trust, the particular terms of your trust, your individual tax situation or your estate and gift tax planning objectives. Additionally, there are other factors, such as state and local taxes, that may be relevant to your gift. Regarding those considerations, as well as for a description of other ways to structure charitable gifts, you are most strongly urged to consult your tax and estate planning advisors.
Typical Timeline for Establishing a Charitable Remainder Trust
- The Northwest Compassion Foundation receives the trust information/application form from the donor.
- A preliminary review will include discussions about the type and terms of the trust including the payout rate and how the trust will be funded.
- This information is sent to NCF’s legal counsel who will draw up a draft trust document at no charge to the donor.
- The draft trust document is then sent to the donor and/or the donor’s attorney, the Northwest Compassion Foundation, NCF’s agent.
- The trust document is amended with any recommended revisions and approved by all parties.
- Three copies of the final trust document are circulated for notarization and signatures from the appropriate parties.
- NCF’s agent assigns an account number to the trust which is now ready to be funded.
- If the trust is to be funded with securities, transfer instructions will be sent to the broker.
- An acknowledgement letter with the charitable deduction and trust payout will be sent to the donor with one fully executed trust document.
- When income is payable, NCF’s agent will mail, or deposit directly, the distribution check in accordance with the trust document.
- Each year, NCF’s agent will send the donor a K-1 tax letter and all the necessary tax forms including forms 1041 and 1041-A and 5227 for state/federal withholding.
Straight Unitrusts
Philosophy: Manage unitrust on a total return basis.
Strategy: Emphasize common stock weighting to maximize total return within portfolio constraints.
Result: Long term corpus growth that benefits both the income beneficiary and the charitable beneficiary through higher annual distribution and principal value.
Net Income Unitrusts
Philosophy: Establish portfolio target yield that balances income and growth.
Strategy: Earn reasonable income while maintaining adequate growth.
Result: Income distribution that meets the income beneficiary’s reasonable expectations while achieving long-term corpus growth, which will benefit both the income beneficiary and the charitable beneficiary.
Annuity Trusts
Philosophy: Manage annuity trust on a cautious total return basis because of fixed payment.
Strategy: Allocation is moderately aggressive to provide potential growth and downside protection.
Result: Grow trust assets to lower the effective payout percentage.
Payout Options
The Straight Unitrust
Under this arrangement, the trust makes a payment each year based on a fixed percentage (5% or greater) of the net fair market value of the assets of the trust as valued at least once a year. Thus, if the net asset value of the trust increases, the annual payout also increases. Conversely, if the trust value declines, the annual payout is reduced. In this form of unitrust, if the annual income earned is insufficient to meet the payout obligation, the principal of the trust is invaded. If more than sufficient income is earned, the excess income normally reverts to principal. The payout percentage cannot be changed once the trust is established, although additional assets may be added by the donor at any time in increments of not less than $10,000.
The Net Income Only Unitrust
Under this arrangement, the trust pays out either the fixed percentage of the net asset value of the trust or the actual net income earned, whichever is less. The principal of the trust will never be invaded to make payments to beneficiaries. The “net income only” unitrust is an ideal vehicle for gifts of nonincome producing assets where there may be a delay in the sale of the asset and reinvestment for income. No payment to the beneficiary is required until the trust’s assets produce income.
The Net Income with Makeup Unitrust
This type of unitrust follows the form of the “net income only” unitrust with an additional provision. It stipulates that any payment insufficiencies in the early years between the fixed percentage due and the actual net income earned and paid will be reimbursed to the beneficiary. This is possible when, in future years, the trust earns income in excess of the fixed percentage due. Like the “net income only” unitrust, this form of unitrust is often used when funding a trust with real estate, which may not produce liquid assets for some time. This form of payout arrangement is also an excellent retirement planning vehicle. In the early years, the trust may be invested in non-income or low-income producing assets expected to appreciate in value. Upon retirement, the appreciated trust assets may then be sold and reinvested to produce a larger income, giving the beneficiary the benefit of the higher annual payment, plus any additional income in satisfaction of the balance due for insufficient payments made in previous years.
If you would like a to set up a Charitable Remainder Trust with Northwest Compassion Foundation, please contact us at (425) 368-2682 or use our Contact Form.
