Charitable Remainder Trust: A Private Pension Plan Without Contribution Limits

Isn't it frustrating and annoying? Your income may be well above average, but federal law, in effect, restricts you to an average-size 401(k) or other tax-qualified retirement plan account. Although your plan balance itself is not capped, the plan's annual contribution limit imposed by the tax law greatly restricts the growth of your account. That is why you may want to consider this practical counter strategy: Use a charitable remainder trust (CRT) as a private pension plan.

Unlimited Annual Contributions

With a CRT, you may add any amount you choose to the trust annually. Each year's contribution will be partially tax deductible, and the trust assets may accumulate without tax to become a source of future retirement income. The deduction is available because your trust agreement will require a future transfer of the trust assets to a charity. That will not occur, however, until the end of the trust's term at the time of your death -- or even later, if you name your surviving spouse or someone else as a subsequent income beneficiary.

Your contributions will be more advantageous if you are able to contribute appreciated securities instead of cash. The trustee can sell the securities without having to pay any capital gains tax and can then reinvest the money as desired, but your charitable deduction will be based on the appreciated value, not your cost.

Unlike a tax-qualified retirement plan, a CRT is not permitted to accumulate all its income until you retire. The trust generally must distribute some income to its beneficiary annually, and the distribution must be the lesser of the trust's annual income or a percentage (5% or more) of its assets. (There is also a maximum payout percentage.)

Reduce the CRT's Income and Early Distributions

How can a CRT accumulate retirement assets if it must pay you income before you retire? You simply arrange to minimize the trust's income. The trust will not have to distribute income it does not earn. To reduce the income, you can contribute low dividend stocks and mutual funds, real estate that generates limited income, or other low-income assets, or the trustee can invest in them. With well-chosen investments, the annual income distributions can be below the trust's minimum, or even zero. After you retire, the trust can begin to pay you the required 5% of assets minimum plus a supplement to make up the income you did not receive while working.

On the Other Hand.

A CRT strategy includes a significant risk you need to consider. You could die after a brief retirement, causing a premature transfer of the CRT assets to your chosen charity with nothing left for your family. There are ways around this difficulty, however. As mentioned above, you can extend the term of the trust beyond your lifetime by making your spouse or other family members your successor income beneficiaries. Or, you can establish a second trust to buy life insurance for you. Your family will receive the insurance proceeds free of estate taxes, as long as all the tax law requirements are met.

A second downside of a CRT: the limited tax deduction allowed for contributions, compared to the deduction permitted under a tax qualified plan. The CRT deduction is based on the current value of the charity's future interest in the trust as determined from IRS tables. The less the charity will benefit from the trust, the lower the deduction will be.

Please contact us if you want to discuss using a CRT to supplement your tax-qualified retirement plan.

Disclosures:

  • Consult a tax advisor for advice.
  • To send an email that contains confidential information, please visit the Secure Message Center where there are additional instructions about whether to use Secure Email or Online Banking messaging.
  • Mutual funds, annuities, and other investment products:
    Not FDIC-insured May lose value No bank guarantee