What Is a Charitable Remainder Trust and How Does it Work?

Trusts are often complex, and there are many types. Therefore, it's always a good idea to have expert assistance when establishing one, especially if the trust is irrevocable. According to the Business Dictionary, the definition of a trust is "a legal entity created by the trustor through which the trustee holds the right to manage the trustor's assets or property for the benefit of the beneficiary." The  main types of trusts are living, testamentary, revocable, irrevocable, funded, and unfunded. Within each of those, there are further variations.

While the definition specifies that the trust assets are managed for the beneficiary's advantage, the trustor can also benefit, and in some cases, there can be more than one beneficiary. For example, some people may want to leave assets and income for their heirs, reserve income for their use during their lifetime, reduce their tax obligations, and also support designated charities. Investors may seek to achieve this combination of goals by establishing a charitable remainder trust.

How Does a Charitable Remainder Trust Work?

There are two variations of this type of trust: a charitable remainder annuity trust and a charitable remainder unitrust. In the annuity version, the trustor makes a single contribution to fund the trust and cannot make additional supplementary infusions. The return annuities are fixed. With a charitable remainder unitrust, the trustor can make multiple contributions to the account. The income that returns to the trustor (or beneficiary) is a percentage that can be revalued annually depending on the contributions made.

How Are the Payments Determined?

The intent is to provide income for either you as the trustor or a beneficiary and then contribute to a selected nonprofit organization. The trustor creating the trust decides whether the account will make payments to the beneficiary (whether that is the trustor or someone else) for a set period not to exceed 20 years or for the beneficiary's lifetime. The trustor also determines the amount and schedule, but the percentage of assets paid out must be between five and fifty percent of the account's holdings.

What Are the Tax Advantages of a Charitable Remainder Trust?

First, the contributions that you place into the charitable remainder trust are tax-deductible. Keep in mind that this type of trust is irrevocable. But you can't deduct the entire amount that you put into the trust because you, or the beneficiary that you designate, will be receiving income from the trust for the period established in the trust. So the deduction (which you can extend over five years) is equal to the amount that the charity should receive once the income distribution period is complete.

Second, the assets you have contributed to the trust don't count as part of your estate, which helps if your holdings are significant enough to meet the threshold for the estate tax.

Finally, placing appreciated real estate into a charitable remainder trust may eliminate the capital gains tax you would otherwise need to pay if you sold the property.