Troy: In today’s video, we’re going to show you how you can deposit money into a charitable trust without losing access to it, you can create an income string for yourself while also creating potentially massive tax breaks.
I have a CPA as a client, and we were doing some tax planning on one of his recent reviews. He tells me, he says, “Troy, I think I want to spend a little bit more income. Do we have enough? Is it going to be okay?” We pull up the software, we start modeling different levels of income, and we get into the tax planning discussion because we have to consider taxes when we start to generate more income.
He already has a Roth conversion plan in place, but his non-IRA account has some pretty big dings in it. If we sell those stocks to create more income, it means that our adjusted gross income is going to be higher. Possibly, we would have to alter the rough conversion plan, but most definitely, it’s going to increase his level of taxation because we’re selling stocks to create more income, so I bring up the concept of a charitable remainder trust.
He stops me right there and he says, “Troy, while I would love to give to charity when I pass away, I just don’t feel comfortable today giving a large sum of money to charity because I want to make sure that if something happens to me, my family’s going to be okay. I want to ensure that I don’t run out of money, and I just want to sleep a little bit better at night knowing I’m not giving too much money away and possibly sacrificing the quality of life for me and my family.”
Once we got into how the charitable remainder trust works, he actually thought it was a really great option for him, and it may just be a really good option for you.
Three Types of Charitable Remainder Trusts
Okay, so there are three main versions here. There’s a charitable remainder annuity trust, the CRAT. The charitable remainder unitrust or CRUT, and the NIMCRUT. The NIMCRUT sounds a little bit funny, but it can be a very valuable planning tool and I’m going to cover all three of them for you today.
The first one we’re going to cover is the CRAT. What we have here is stock that has appreciated in value. We purchased it for $100,000 and it’s grown. It’s done quite well, and it has increased in value to $500,000. A couple of things to note here. One, as a concentrated position increases in value over time, so does your level of risks. We probably have, in this particular instance, too much money in one particular company. The charitable remainder trust not only can be a good income-providing and tax-planning strategy, it can also help you reduce risk.
The basic concept here is we take the $500,000, we deposit it into this charitable remainder trust. We can then go ahead and sell that stock and pay 0% capital gains tax because it is a charitable trust. Just like the CPA said earlier, “Well, Troy, I can’t give $500,000 to a charitable trust if it’s just going to go charity, I need that money for my retirement,” what’s really cool about the charitable remainder trust is the IRS says, “We can then, not only sell this stock tax-free, but we can provide ourselves an income string.”
Now, we have options. We can take a minimum of 5% per year of this account balance up to 50% per year. Now, if you take 50%, the trust is going to be depleted much sooner and allow the tax benefits to go away, but let’s just assume we take 5%. We can do that over a period of your life, over two lives, or a term from 1 to 20 years. For some reason, you can’t do 22 years or 25 years. It’s either 1 to 20 years as your term, or over the course of life.
We put the 500,000 in here, we sell that stock tax-free. Let’s say we decided to take 5% a year for life and that’s $25,000 a year. Now, the A in CRAT, charitable remainder annuity trust, that annuity word stands for a fixed level of income. Once we decide how much or what percentage of this trust balance that we are going to take as an income stream, it is fixed for life or fixed for whatever term that you choose.
We not only get a capital gains tax reduction on the sale of the stock inside the charitable remainder trust, there is an actuarial calculation that takes place. It’s called a remainder trust. You also receive an income tax deduction today subject to charitable gifting AGI limitations, which we’ll cover. The remainder value based on this actuarial calculation so if you’re going to receive 25,000 per year for life, that is going to reduce the amount of money in the trust, but once you sell this, you can invest in stocks, and bonds, and whatever investment tools that you want to inside that trust.
There’s a calculation that shows that this charitable remainder trust could go in value even though you’re taking money out, so that calculation determines what your remainder interest is. Let’s say your remainder interest is $500,000, just as a hypothetical example. We create, or this creates an income tax deduction for you today. You have two tax deductions here. One, you can sell the stock tax-free, no capital gains tax on the appreciated value of that security.
Then two, however, the actuarial calculation works out, the remainder value is a charitable gift that you can take an income tax deduction for today. You definitely want to talk to a qualified financial planner or a qualified CPA to help you understand some of the nuances of this. I want to go through these at a high level, some of the things that you should be aware of.
First is this actuarial calculation, there has to be at least a 10% projected trust balance remaining for this to be a viable strategy. If during your life, because that’s a projection, the actuarial calculation, if during your life the trust balance actually drops to 5%, it’s automatically going to be distributed to charity, your income will stop and that’s the end of the plan. This has not been a popular strategy over the past, let’s call it 15 years or so because the actuarial calculation that determines your income tax deduction today is more favorable for you when interest rates are higher.
When interest rates are real low, the actuarial calculation doesn’t work in your favor, so not a lot of people took advantage of this strategy because while yes, you could get the capital gains tax deduction today or over the past 15 years, you didn’t create the income tax deduction. Let me just explain how that works high level. If we’re going to receive $25,000 a year and you have a, let’s say 15-year life expectancy, they’re going to take the sum total of that income over that period of time and then discount it to the present value. It’s a time value of money calculation.
When interest rates are higher, it’s discounted to a greater extent. That means that the present value of this future income stream is smaller because interest rates are high, which means the remainder balance is greater. The greater the remainder balance, the higher your income tax deduction today. If I temporarily lost you while talking about the time value of money and that concept doesn’t really sink in for you, I want to show you the math.
Let’s assume we’re receiving $25,000 payments, and I’m going to assume your life expectancy is 20 years here. The future value has to be at least 10% of the amount you deposit, so that’s where the $50,000 comes from. The IRS uses what’s called the Section 7520 rate, otherwise known as the AFR rate, the applicable federal rate. Currently, it’s 5.07. We’re going to compound this annually. We’re going to discount the payments that you receive over a 20-year period at the AFR rate.
With this, as the required minimum future value, the present value of that income stream is $328,000. That is how much you are going to receive. You deposited $500,000, the difference between 500 and 328, $172 let’s say, that is your remainder interest. That is the amount that will go to charity. That is the amount of an income tax deduction that you can take today subject to what are known as the charitable gift AGI limitations.
One more thing to note here before I cover the CRUT and the NIMCRUT and then talk about the charitable gift AGI limitations. Even though we sell this stock tax-free, when we start to receive this income, it comes to us in the same character of the original taxation of that asset. That means that this $ 25,000-a-year income will be subject to capital gains tax. We’re going to go through the income tax deduction calculation.
Adjusted gross income, AGI, this is on your 1040, your tax return. The limitation for publicly traded securities, long-term capital gains is 30%. We take 30% multiplied by your adjusted gross income, that’s $60,000. That is your maximum income tax deduction today. In that example we just went through, it was about $172,000. The law says that you can carry this deduction forward, that 172 for up to five years. You take a $60,000 income tax deduction today, a $60,000 next year, and then 52,000 in that final year.
Before I jump into the CRUT and the NIMCRUT, just I want to get you thinking here. What can we do with this? We create an income tax deduction. What is the timing of our charitable remainder trust contribution? A lot of people do it in years where they have large sums of income coming in. It could be from a restricted stock or some type of vesting of some type of stock. It could be the sale of an asset, could be anything that creates a large tax burden in any particular year.
We can keep the strategy potentially in our back pocket and then use either the capital gain, the ability to not pay capital gains by depositing that asset into the trust. We can take advantage of it if we’re receiving a big tax bill from the sale of any type of asset, or we could maybe combine the income tax deduction we receive from this possibly to offset a Roth conversion. If we get a $60,000 income tax deduction, maybe we combine that with a $60,000 IRA to Roth conversion. I just want to get the wheels turning.
When we use these advanced planning strategies to help you reduce taxes, can we also combine them possibly with other tax planning strategies to get either an offset or a mitigation of the income tax liability due to help create far more value, think of a synergy of decisions that create more value than this one singular decision at this time.
The CRUT, the only difference here is the U, it stands for Unitrust. If you remember back to the CRUT, it is a 5% fixed payment. Technically, 5 to 50%, but the higher your income stream, the more income that you’ll receive, the less the remainder interest is, and therefore, the lower income tax deduction that you will receive. With the U in the Unitrust, same principle, but instead of that income amount that you choose in the previous examples, 5% of 500, which was 25,000 per year, that’s always going to be 25,000 per year, unless the trust value drops to a point below 10% to hit the 5% level and there’s a forced distribution to charity.
With the Unitrust, same thing, except it’s not a fixed payment, it is a variable payment. You have to get it revalued every single year. A little bit more administrative expense in the management of the trust. Let’s say you deposit 500,000, you picked a 5% rate, same terms we discussed as before, your first-year payment would be 25,000. Let’s say the trust doesn’t increase in value that first year, it actually drops to 450,000, well, it’s revalued, your income payment adjusts, that’s what the U is.
Now, your percentage stays the same, but your income actually drops because the percentage multiplied by a lower trust value creates a lower income. Now, conversely, if the trust value increases, your income payment that you’ll receive will also increase.
The third and final one I want to talk to you about is the NIMCRUT. I know it sounds a little bit funny, but it is a very powerful planning tool for highly compensated individuals.
When we’re working with doctors or successful business owners, or possibly highly compensated executives from some of the oil and gas companies here in Houston or all over the country, this makeup provision means that everything works the same. It’s the CRUT. The Unitrust, this is a variable payment, but everything else we’ve talked about is exactly the same, except you do not have to take the income stream immediately. You can defer that income stream, and then the M for makeup provision means it’s going to accumulate how much income you could have taken.
Let’s say we defer it for four years because that’s your planned retirement date, and then we start to take $75,000 as opposed to the 25,000 that was before. All these numbers are just hypothetical to communicate the concept to you. Now, one thing to keep in mind here, that how you invest the money inside the trust makes sense. If you invest it into a lot of bonds and you have a lot of interest being generated, that interest will still have to be kicked out because that is income, and the rule state, that income must be kicked out.
If we invest in assets that don’t generate income, we can hopefully just watch them appreciate, have the capital appreciation, then whenever you retire and you’re in a much lower income tax bracket and you need retirement income, guess where we’re going to go? We’re going to go to the NIMCRUT, take that accumulated growth as a distribution. Of course, the tax character of the original asset that you put in, that will flow through to you.
Most likely long-term capital gains, but still, you made the deposit over here in year one, you’ve created a pretty big income tax deduction for yourself, you’ve been able to sell that asset with no capital gains at that time, probably diversify that asset and let it continue to grow until you retire. Then you start to activate the income stream, same as before, you select a term, number of years, or for life. When you’re in a much lower income tax bracket, you start receiving that income. What’s really cool about this strategy is it’s really three parts of the retirement success plan.
It’s income planning, it’s tax planning, and it’s also estate planning. If you’d like to look at implementing this for your retirement possibly, there’s always a link in the description where you can reach out to us. Just like all the tax planning strategies and retirement planning videos that we put on this channel, this strategy here should not be looked at by itself. These decisions, the timing of income, how much we deposit, all of those decisions should be made with respect to what else you’re doing and the timing of everything in your retirement plan.
This is why we call it the Retirement Success Plan because we’re coordinating all the decisions that you are making or could potentially make to help you pay less tax, generate more income, reduce risk, and have a more secure retirement. We’re the conductor of the orchestra. These tools like tax planning strategies, charitable remainder trust, these are the instruments. It’s our job to make sure that these instruments are finely tuned in playing the music of your retirement. While these are financial planning strategies, it’s important to work with a qualified CPA or tax attorney who has experience with charitable trusts in order to do these tax calculations.
Do you need a Retirement Success Plan that goes beyond allocating funds to truly fit your needs? We can help you create a retirement life plan customized for your retirement vision and legacy. Call us at (877) 404-0177 or fill out this form for a free consultation: https://click2retire.com/charitable-remainder-trusts