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Charitable Remainder Trust 10 Percent Rule

Each contribution to the trust must equal at least 10% of the fair market value of property as of the date it is contributed to the trust.

 

 

Invest Talk Podcast

by Podcast from Invest-Talk Justin, Jillyn Hess-Verdon and R. Kurt Ketchum

Charitable Remainder Trust 10 Percent Rule

Hess-Verdon & Associates – 888-318-4430

Justin (Invest Talk)

Welcome back to Invest Talk. And today, we are going to pivot over to a topic that isn’t discussed much on the show, partly because it can be quite complex, but they shouldn’t be ignored. And that is the type of trust that you might set up and the things that you can accomplish with a trust, from passing assets to next generation to deferring taxes and various goals that you can accomplish with various types of trust. So we’re going to bring on a couple of exciting guests, and I’m going to introduce them here in a minute, but I want to give you a little background on them. First one is Jillyn Hess-Verdon. She is the managing partner of the firm Hess-Verdon & Associates. She has over 30 years of experience in advising high net worth individuals and ultra-high net worth individuals regarding complex trust, estate planning, as well as business, real estate, and charitable planning as well. We also have Kurt Ketchum. He’s a partner at Hess Verdon, an associate whose practice focuses on advising clients regarding advanced trust and estate planning strategies. He is also responsible for advising the firm’s business owner clients regarding all aspects of their closely held businesses, including the structure, ongoing maintenance, compliance, private transactions, and succession planning.

Justin (Invest Talk)

Now, together with the firm’s high net worth and alternate high net worth clients, they work together to customize and implement advanced tax planning strategies, helping clients to grow transfer their assets in a tax-efficient manner so they can build a lasting legacy for future generations and their charitable endeavors. So I’d like to welcome Jillyn Hess-Verdon and Kurt Ketchum. Thank you for being here.

Kurt Ketchum

Hey, Justin. Nice to be here. Justin.

Jillyn Hess-Verdon

Thank you.

Justin (Invest Talk)

An Overview of a Charitable Remainder Trust

The first thing I want to talk about, are charitable remainder trust. I’ve studied a bit about them. Obviously, you have a lot more knowledge and experience with them.

Why don’t you tell our audience what a charitable remainder trust is? Exactly.

Jillyn Hess-Verdon

Sure. So when we talk about charitable remainder trust, I’m so glad you differentiated that from what most people are thinking of as a living trust or a family trust. This is a very special type of trust, and it is designed to go ahead and set up two components. It’s a permanent trust that is set up for the client to be the income recipient they’re called. So that way, whatever assets are put into that trust, they still retain and receive the annual income. But when they’re gone or at the term of the trust, whatever’s left and remaining in the trust ends up going to charity. So when you look at this type of trust, it’s very different than others because of those two main components. And it is something that’s permanent. And it’s done for some very specific reasons. And you’ve probably heard, too, Justin, there’s the charitable remainder annuity trust versus the charitable remainder unitrust.

Differences Between a Charitable Remainder Annuity Trust and a Charitable Remainder UniTrust

Justin (Invest Talk)

What are the differences?

Jillyn Hess-Verdon

So that’s really going to focus on the income stream that’s going to the recipient. A charitable remainder annuity trust is sometimes called a CRAT. And it has nothing to do with annuities, nothing to do with insurance. It just means that the income stream to the client who’s the income beneficiary. It’s going to be a fixed figure so they can count on that rain or shine, no matter how the portfolio goes.

Very different from what’s called the charitable remainder uni-trust or a CRUT or a CRUT. That’s something where the income is going to vary every year based on the portfolio’s performance. So as you can see, those are very distinct types of trust depending on the income payout to the client.

Justin (Invest Talk)

That makes sense. So one is a little more variable, and the other one is fixed. To me, it kind of sounds a lot like an IRA where you aren’t actually taxed until you take some of that money out, correct?

Jillyn Hess-Verdon

Yes. It’s very similar to that compounding effect or how it can grow tax-free. And then the income that you take out, you are going to take it out anyway. If you were already just selling something and you’re going to reinvest it, and you’re going to live off the income or draw on the income, the income is still taxable to the income recipient, but not the growth in that portfolio. So that’s a really good analogy.

Regarding Write-offs of CRT’s

Justin (Invest Talk)

And don’t you get a write off, too, right away? Obviously, that varies based on the amount and actuary assumptions and stuff like that. But don’t you get a write off right away?

Jillyn Hess-Verdon

Yes. One of the benefits is instead of just having it out of your estate and benefiting charities down the road, just thinking for the future effect the year you create the CRT and you transfer assets into it. The Internal Revenue Code also provides a formula to determine what portion of that can you claim as a charitable deduction on your tax return that year?

Justin (Invest Talk)

Wow. So not only do you defer your taxes on whatever that appreciated asset is, but you get some tax benefit right away, which is pretty nice now isn’t typically for small assets. Right. So there’s a minimum amount of value that’s needed to make a CRT make sense, right. So what is that minimum value?

Minimum Value where a Charitable Remainder Trust Makes Sense

Kurt Ketchum

So from a very general standpoint, we typically see the range from about 300,000 to about 500,000. Is the range, the starting range. That really makes sense for a CRT. 

But in reality, it does rely a lot on factors that are specific to each individual client, including their age, their desired level of income, and also the nature of the assets and how they plan to invest the assets. 

But the important piece is just that the value of the assets are significant enough to justify the formation costs and ongoing maintenance of the CRT.

Typical Assets to  put in a CRT

Justin (Invest Talk)

Now, what kind of assets are your clients typically putting inside a CRT? And can you put multiple assets in the same CRT?

Kurt Ketchum

The key factor for most CRTs is appreciated assets, right. So the most common asset we typically see is unencumbered real estate. But most forms of appreciated assets can work well in a CRT, including stocks and other securities cryptocurrencies, some forms of closely held business interests, they all can work really well in CRTs. Regarding a question about whether they can hold multiple assets, that’s kind of a multi phase answer. So if you’re finding multiple assets at the beginning of the trust, the formation of the trust generally the answer is yes. So if you have multiple different stocks, you want to put in the same CRT. Generally, that works. The question to whether you can add additional assets after formation is different for a CRAT or a CRAT. Actually, you’re prohibited from making future contributions. So whatever you put in the trust at the opening, what’s in the trust of the life of the trust for a unit trust or CRUT. Technically, you’re allowed to contribute assets in the future, but generally it’s discouraged because there are a lot of initial requirements and testing that has to go through for a CRT to be approved.

Kurt Ketchum

And when you add additional assets down the line, it can dramatically change those calculations and take a trust that did qualify the CRT and disqualify it. So while it can be done, it’s generally discouraged.

Justin (Invest Talk)

Got it. So ideally, you want to have a large plan if you have multiple assets. I’m thinking of somebody who maybe they’ve invested in real estate throughout the years, and with interest rates going down and property prices going up, maybe they’re approaching retirement or retirement. They don’t want to be landlords anymore, and they have multiple properties. Could they take all of those properties? Maybe they have 7,8, 10 different properties, put them all in one trust, sell them all, and then now live off the income from those properties.

Kurt Ketchum

Yes. As long as the key factor is that it’s all done at the same time. Right. So especially with the CRAT really with both kinds of trusts, it’s really important the value of the assets going into the trust. So if they’re separated by six months, it doesn’t really work. If the assets are all able to go in the trust simultaneously and then be sold within relative short order and reinvested, then that can work.

Justin (Invest Talk)

Well, we talked about there’s minimums because there’s cost to set it up. That is not cheap, but also ongoing maintenance costs. So what is that typically per year, the ongoing maintenance costs for CRT.

Ongoing Maintenance of a Charitable Remainder Trust

Jillyn Hess-Verdon

So the nice thing is CRTs are not maintenance-heavy. What’s critical is that you have to have a good CPA. CPA can go ahead and do the return the tax return for the CRT every year. If you want to be your own trustee, you can. If you want to hire professional trustee, you can. What we definitely recommend to clients, though, if they’re their own trustee, especially, is that we just have an annual meeting, get your team on the phone, get a Zoom meeting, just get together once a year and say, all right, are we following the restrictions and the rules and the way this was set up? Is everything working according to plan? And hey, how’s that portfolio going? Because is it really being maximized or optimized for what the goals were for the client, the income recipient, and eventually for the charity who you’re going to really help with any remainder?

What are the Pros and Cons of a CRT

Justin (Invest Talk)

Now, what would you say is the biggest drawback or downside to CRTs in general?

Kurt Ketchum

I think it’s less of drawbacks or downsides. It’s really more misconceptions and lack of knowledge of CRTs. So right now we get a lot of people calling in to our office asking to set up a CRT because they’ve heard they’re a great way to defer taxes. Right. So they thought it was great. I have this big asset, I can sell it pay no capital gains, and it’s great. But a lot of people don’t realize or don’t take into account the restrictions and requirements that come with a CRT. Right. So, for example, the way CRTs have to be set up is at the formation of the trust. You have to stay somewhere between five and 50% of the trust income of the value of the trust is going to be distributed out each year. And that’s at the beginning. Also, there’s tests required. It says a minimum of 10% of the value of the trust must go to charity. Right. And they have actuarial tables and formulas to determine when the trust is formed to see if it matched that test. But because of those two, CRT is not an instrument where you can go and spend the money, how you want buy houses.

Kurt Ketchum

That’s not what it’s meant for. It’s meant to provide the settlor with an income stream for life, whether they want a fixed or variable, but an income stream for life and then the remainder of charity. Also, the other big one that a lot of people don’t focus on is, again, the point that the remainder must go to charity. 

If you have assets that you want to leave to your children or grandchildren or future generations, CRT isn’t going to work. 

And there are some techniques that we can use to help with that. Right. So, for example, sometimes what we’ll do if it works for a client is we’ll have them set up a life insurance policy that’s funded with a portion of the income they’re drawing from the CRT. 

And that way they’re able to build an estate for their future generations with a life insurance policy while also taking advantage of the charitable benefits of the CRT itself.

Justin (Invest Talk)

So that income can go pay for say, a term life insurance policy. So when you do die, maybe the asset doesn’t transfer, but there’s a million dollars insurance policy on you for when you do die. And that goes to the next generation or whoever you want to earmark that dollar amount for, correct?

Jillyn Hess-Verdon

That’s right, Justin, because one of the things we look for is that remember that increased income stream, you’re doing so well because you’ve got the full proceeds to invest. Why not take a portion of that? If the client’s insurable and then get a policy that’s separate not part of this trust at all, and that goes into a life insurance trust, so that’s out of the estate as well. And then your family has what’s kind of a gift replacement. And it works in a tremendous way. If the client’s insurable.

Justin (Invest Talk)

That makes sense. I’m imagining potentially even insure yourself for more than what that value was, right. And the insurance company pay out for more than that initial value, correct?

Kurt Ketchum

Yeah, sure. As long as the insurance company sees you have insurable interest in that amount and the income can cover the premiums for the insurance. Absolutely.

Justin (Invest Talk)

To me, that’s what kind of woke me up to wow. This is a really interesting vehicle that people can use and accomplish a lot of different types of goals. 

Now, what other types of trusts are you commonly using with clients for tax planning purposes? I know there’s your standard living trust. Are there any other kind of unique things that you’re doing with clients that is common for your clients?

Other Types of Trusts for Tax Planning

Jillyn Hess-Verdon

One you mentioned already, and that is an ILIT, ILIT and Irrevocable life insurance trust that works so well even if you don’t have a CRT. If you have any life insurance in your portfolio, this is the time under the current tax exemptions that we have to move those policies into an insurance trust. So they’re out of everyone’s estate. And it works beautifully to have those funds available for liquidity or for long-term planning. So anyone with life insurance should really consider an insurance trust as a given, regardless of the size of the estate. It’s something that’s just smart planning. And then we also look, if the client is philanthropic, then why not look at donor-advised funds? They have some of the same benefits that we’ve been talking about, but they have a different application. 

And then there are some clients that have a million or more in assets that they look and say maybe they should actually be creating a family foundation. 

A family foundation can be the charitable beneficiary of the charitable remainder trust. So the larger the amount going into the CRT, we want to take a second look and see what they benefit from a charitable foundation.

Private Foundation

Jillyn Hess-Verdon

It’s a private family foundation. Now, those are just some of the obvious ones. I think with your kind of a podcast, you could go on for a couple of hours on irrevocable trusts that are available for children and grandchildren. We advise clients, please do not buy a house in the child’s name. And we’re talking adult children. If they were to get into a divorce, lawsuit, or any kind of problems, they’re going to lose it if they’d had it in an irrevocable trust for that child or grandchild.

Now, you gave them a great gift, but you gave them all of this protection around it and it’s even set up for their kids and they don’t have to worry about having a separate trust for that. So there are irrevocable trust that can be utilized in so many ways and even fun ones like IDGT.

Justin, you can have a podcast just on digits, so intensely Defective Grantor trust, and then we can’t forget LLC’s, limited liability companies, and partnerships. Those are actually really important for clients in their own businesses or own real estate, no matter what state they’re in. Those entities are good for income tax planning and excellent for estate tax planning.

Jillyn Hess-Verdon

So those are just a few.

Justin (Invest Talk)

Great! Well, I appreciate all of that. And I’m sure, like you said, there’s a lot of potential avenues to go down, and maybe one day we’ll have you on again and go down one of those roads and explain those in more detail, kind of like we did with CRTs today. So once again, Jillian, Kurt, I appreciate you coming on, explaining this to my audience. I’m sure it’s going to benefit a lot of those out there, especially those that have, like you said, appreciated real estate, maybe crypto, maybe investable stocks and bonds, things like that. And it will help a lot of people. 

So thanks again for coming on, and we’ll have you on again soon.

Jillyn Hess-Verdon

We’re glad to help and glad to help you with your clients. You’re giving them really good advice to the public, and we really appreciate you getting that information out to them.

Justin (Invest Talk)

Yeah, thanks a lot, Justin. It’s great being here.

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