Because the estate tax exemption currently tops $5 million, fewer people need life insurance to provide their families with the liquidity to pay estate taxes. But life insurance can still play an important part in your financial plan, particularly in conjunction with charitable remainder trusts (CRTs) and other charitable giving strategies.

How Does a Charitable Remainder Trust (CRT) Work?

A CRT is established through a transfer of assets into trust during your life.  In exchange for this transfer, the trust provides an annual stream of payments to one or more non-charitable beneficiaries for a term of years, not exceeding 20, or for your life or the joint lives of you and your spouse. When the non-charitable interest expires, the remainder interest in the CRT is distributed to charity.

There are two types of charitable remainder trusts: the charitable remainder annuity trust (CRAT) and the charitable remainder unitrust (CRUT). In both, the value of the charitable remainder must be at least 10 percent of the net value of property transferred in trust on the date of contribution to the trust. Also, in both, the payout must be no less than 5 percent and no more than 50 percent annually.  They differ in how the annual amount to be paid to the non-charitable beneficiary is determined.

How a CRUT Work

Under a charitable remainder unitrust (CRUT), you make a contribution to the trust, and the non-charitable beneficiary will receive a percentage of the total value of the trust assets, which will fluctuate annually based on the fair market value of the assets.  For example, if you make a contribution to the trust of $1,000,000 and the distribution is set at 5 percent, the beneficiary will receive a distribution of $50,000 in the first year.  If the next year, the trust value has appreciate to $1,500,000, the beneficiary will receive a distribution of $75,000.

How a CRAT Works

In a charitable remainder annuity trust (CRAT), on the other hand, you make a contribution to the trust and the non-charitable beneficiary will receive a fixed amount based on the contribution at the time the trust was established. For example, if you contribute $1,000,000 and the distribution is set at 5 percent, the beneficiary would receive $50,000 per year regardless of the value of the trust assets.

These trusts are particularly useful when you contribute highly appreciated assets, such as stock or real estate, and want to reduce capital gains tax exposure. Because a CRT is tax-exempt, it can sell the assets and reinvest the proceeds without a capital gain tax.

At the end of the term, the charitable beneficiary receives a large distribution.  While this may be one of your goals, the funds the charity receives reduces the amount that will go to your heirs.

Using Life Insurance in Charitable Planning

You may be wondering how life insurance plays into this; here is where it comes into play: A life insurance policy can replace that “lost” wealth in a tax advantaged way.  If you retain the annuity payments, they can be used to fund a life insurance policy that names your heirs as the beneficiary.  In this way, the charity receives a large benefit and your heirs still receive the insurance proceeds.

If done properly, a CRT can provide an immediate income tax charitable deduction and avoid the income tax on appreciated property used to fund the trust.   Combining the CRT with life insurance can allow you to receive these income tax benefits and make a large bequest to charity without impacting the inheritance your heirs receive.

For more information, contact your ORBA advisor at 312.670.7444.  Visit ORBA.com to learn more about our Wealth Management Group.