One sermon I love to give is reminding people that it really is important to consider asset location when determining an appropriate investment plan. For clients with Charitable Remainder Trusts (CRTs), this is particularly relevant. Income and capital gains, in their various iterations, are directly tied to liquidity constraints, creating challenges that sometimes need to be addressed with a certain level of creativity. This is perfect example of the need to examine asset purpose, long/short term location, yield and return objectives, and tax considerations holistically in the creation of an investment plan.
There is some debate as to the long term future of charitable trusts, but any change will likely allow laws governing older trusts to be grandfathered in. Why would you consider a charitable trust? Believe it or not, you might be well served to create a CRT even if your intent is not charitable.
Since I’m a finance guy, I can’t avoid doing some sort of example. Forgive me, but I do think it will be a valuable exercise. While it makes sense in other situations, one common purpose is to help reduce the tax burden in the sale of highly appreciated assets, so I’ll use an example of that nature:
You have a majority stake in a family business, Free Money, Inc., and are doing some succession planning. Your stake in the business is worth $5,000,000 (most of it capital gains) and your net worth is $11,000,000.
You are married, your effective tax rate is 25%, your average annual income is around $350,000, and you have a life expectancy of 10 years.
If you sold your business outright you would pay capital gains taxes of $720,000. However, if you were to create a CRUT and gift your shares prior to selling them, not only would you pay $0 in capital gains, you would realize an income tax deduction as well as reduce your estate tax burden by the value of the sale price. A CRUT will pay you a percentage of the principal each year, and under this scenario, the maximum payout would be 21.23% annually. This is $1,061,500 for the first year. Depending on the circumstance, you can serve as trustee and beneficiary. As a result, you retain substantial control over the investments in the CRUT.
Over 10 years your savings would be as follows:
- $720,000 in capital gains tax savings
- $452,804 in investment returns on the $720k above, assuming 5% annually
- $1,926,000 in estate taxes at death, assuming 45% federal rate
- $125,564 in income tax savings
- $78,966 in investment returns on the $125k above, assuming 5% annually
- Total savings = $3,303,334. In addition, at the maturity of the trust, if all goes according to plan, the charity you chose will receive hundreds of thousands of dollars.
For simplicity’s sake, the example above used many assumptions. There are 1,001 iterations of this plan, each of which will make more or less sense under one situation or another. Some might include the purchase of life insurance with income tax savings. The important thing is to understand what you really want to accomplish, and why; then you will work backwards, with an estate attorney, your investment consultant, tax counsel, and possibly an insurance consultant, to tweak the plan to accommodate your intentions. As intimidating as it might sound, it can actually be pretty fun. Having a network of best-in-breed advisors is truly essential to this process.
If something in this sounds worthy of exploration, give me a call and we can orchestrate an initial consultation, possibly alongside estate and tax counsel, to determine whether this or something else makes sense in your situation.