What is a Trust?
A trust is an arrangement in which legal title to assets is transferred to a trustee to be held on behalf of specified beneficiaries during the term of the trust. Commonly, the benefit received is the payment of the income earned by the assets. When the term of the trust ends, the remaining property passes to another beneficiary.
Charitable Remainder Trusts
A charitable remainder trust pays you and/or another beneficiary an amount of money for the beneficiary’s life or a term of years up to a maximum of 20 years. At the end of the trust term, the remainder is then paid to a charitable beneficiary.
Charitable remainder trusts offer a great deal of flexibility. Payments may be made to you throughout your life, and then directed to your spouse or another beneficiary after your death. Or, the trust may be set up by your will, benefiting a loved one for his or her lifetime. The eventual distribution to the YBBBS Foundation will take effect only at the death of the trust’s beneficiaries.
There are two kinds of charitable remainder trusts, and each has subtle differences:
A Charitable Remainder Annuity Trust makes payments to the donor in a fixed dollar amount each year. The payment amount must, according to law, equal at least 5 per cent of the fair market value of the assets initially placed in the trust. You may not add to an annuity trust in future years. This is a particularly suitable option for a beneficiary who needs the security of a fixed annual income.
Annuity Trust Example. Tim Christy, 76, set up a charitable remainder annuity trust and funded it with $150,000. He named himself and his wife as income beneficiaries at $10,500 per year (a 7 per cent annuity rate) for the rest of their lives. At their deaths, YBBBS will receive the trust principal to be added to our endowment to continue the work of YBBBS.
A Charitable Remainder Unitrust requires an annual payout equal to a specified percentage of the annual value of the trust’s assets. Tax law requires this payout percentage be equal to at least 5 per cent of the assets’ fair market value: therefore, the amount the income beneficiary receives each year will increase or decrease as the asset values change. Because the payout is based on an annual valuation, you may add to the principal of a unitrust in future years. The variable nature of the unitrust payment may provide the beneficiary with a hedge against inflation, assuming growth in value of the trust assets is comparable to or better than the inflation rate.
Unitrust Example Janice Muir, 65, transferred $300,000 to a unitrust. She elected to receive 6 per cent of the fair market value of the unitrust assets each year, payable quarterly for her lifetime. During the first year, she receives $18,000 (6 percent of $300,000) and the assets appreciate in value of $310,000. So during the second year, Janice is paid $18,600 (6 percent of $310,000). Each subsequent year the same valuation and payment process is followed.
If you place low-yielding securities in the trust, the trustee can sell them and reinvest the proceeds in assets paying higher yields, and neither the trust nor you will have to pay any tax on the capital gains that are realized at that time.
You, or the beneficiary of the trust, will pay federal income tax on income distributed by the trust. Income you receive retains the character from the trust.
Example: If the trust received both ordinary income and capital gains, your distribution is deemed to come first from the ordinary income while any excess is deemed to be from the capital gain income. Depending upon the amount of the payments to you and the amount of the trust’s income, there may be no tax on the capital gains attributable to the sale of the appreciated securities.
Whether you choose to set up an annuity trust or unitrust, you enjoy a number of benefits including professional management of the assets in the trust and a degree of financial protection.
You receive an immediate federal income tax deduction for the year the charitable remainder trust is established, subject to the prevailing percentage limitations on charitable gifts. The amount of the deduction will be determined by a calculation, which takes into consideration whether yours is a unitrust or an annuity trust, the amount or percentage to be paid out each year, the number of people to whom the payments would be made, and the age(s) of the individuals receiving the payments.
In the year she created and funded the unitrust, Janice Muir got a federal income tax charitable deduction of approximately $121,884 (as determined by official U.S. Treasury tables based on quarterly payments and an applicable federal discount rate.) This example assumes a 4 percent rate.