This month we’ll delve a bit deeper into some design customization you can do when creating a Charitable Remainder Trust (CRT) that best suits your individual needs. We’ll discuss a strategy using a CRT as a means of saving for retirement on a tax-favored basis and providing a retirement income stream prior to paying out to the charitable beneficiary. We see from our chart above, the CRT would provide a future gift to the charity; it is a complex strategy best served by a professional trustee; and it can provide both income and transfer tax advantages to the donor. This month, we’ll look specifically at a Net Income CRT (NICRUT) and also giving your trust more flexibility by adding a Flip provision to your NICRUT. Both of these strategies require careful drafting by competent legal counsel well versed in charitable trust planning. It is in the drafting of your trust document that you add in the correct terminology to make it operate as a NICRUT or further add the Flip Provision for greater flexibility. For many donors contemplating the use of a CRT, these strategies arise as they are approaching retirement – and in their highest-income-earning years. Bear in mind that the Charitable Remainder Unitrust (CRUT) can receive additional gifts in subsequent years, each of which may be eligible for an income tax charitable deduction in the year of the gift. A donor interested in the CRT strategy and with substantial annual income may be attracted to the idea of offsetting some of that income by receiving an income tax charitable deduction each year for annual donations into the trust. However, with a standard CRT that must pay out the stated income amount each year, that additional trust income can further exacerbate her income tax scenario.
With the use of a NICRUT, you add into the trust document instructions that the trustee will pay out EITHER the stated payout percentage amount OR the Net Income the trust portfolio is producing. By creating a trust investment portfolio that is designed to purposely hold down the income produced by the investments each year, the trustee may be distributing payments to the donor/income recipient that may not substantially add to her taxable income. If she were making additional contributions into the trust each year, that provides another means of retirement savings and may offer income tax charitable deductions related to each of those donations – depending, of course, on her overall income tax scenario. With this NICRUT strategy, you are subject to the whims of the investment markets. We talked about in the early years of the NICRUT, the trustee designing a portfolio to purposely hold down income, ideally producing enough to cover the trust fees, but not creating too much added taxable income for the donor/income recipient who already has substantial earned income. Then, upon the donor’s retirement when she wants to have an income stream from the NICRUT, the trustee would adjust the trust investment portfolio so that it could be more likely to produce income. Again, you are taking a bit of a chance on the whims of the market. Remember, the NICRUT is designed to pay out EITHER the stated payout amount drafted into the document OR the Net Income the portfolio is producing, whichever is less. This could lead to erratic payments for the income recipient who wants to rely on trust income to support retirement needs.
By including a Flip Provision in the NICRUT trust document, you add the flexibility to take advantage of a potentially lower trust payout in the early years of the trust, by holding down portfolio income as described above. The “Flip” occurs as the trust converts to operate as a standard CRT at the beginning of the year following the occurrence of a triggering event described in the document. After that point, the trust would then pay out each year at the stated payout percentage amount identified in the trust document. This may allow for a more steady payment to the income recipient who is relying on trust income for retirement. There is considerable flexibility in the tax code regarding what can be chosen as the triggering event after which the NICRUT would convert or “flip” to a standard payout. With the strategy described in this article, a reasonable choice for triggering event could be to choose a specific date in the future at which the donor/income recipient plans to retire. According to IRS rules, a specific future date is an allowable triggering event to include in the trust document defining when the NICRUT would convert.
To re-cap our strategy for customization of Charitable Remainder Trusts, we discussed using the CRT as an additional means of saving for retirement and providing retirement income prior to ultimately paying out to the charitable beneficiary. The trust would need to be a CRUT instead of a CRAT, so that it could receive additional donations through the years and could have the flexibility to pay out only the Net Income from the trust portfolio as defined in the trust document. With the NICRUT strategy, the trustee can alter the trust portfolio to purposely hold down investment income, thus potentially paying out minimal taxable income for a person with substantial other income prior to retirement and then, by adjusting the portfolio mix later, the trust may be able to pay out a higher amount as retirement income. The “Flip” provision can increase the flexibility of the NICRUT by including language in the trust document that will allow it to convert to operate as a standard CRT at some point in the future, thus potentially providing a more stable retirement income stream. As these are complex planning strategies requiring specific charitable trust expertise, it is essential that you consult competent tax and legal counsel to discuss their suitability for your specific requirements.
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Bonnie Lane, Verde Volunteer
Member, Board of Directors
NAZCCA is not licensed to give legal or tax advice and any planned giving strategies you choose to pursue should be discussed with licensed tax and legal counsel