Introduced by the Tax Reform Act of 1969, the charitable remainder trust is a popular plan because of the financial and estate-planning flexibility it offers. This trust is similar to other types of trusts, except that a charitable beneficiary receives the remainder interest. A donor transfers property under a trust agreement that specifies how trust income and principal are to be distributed, and the trust may be created to become effective during life or at death.

An irrevocable trust qualifies for special tax consideration if it is in one of two forms:

Charitable Remainder Unitrust - The primary feature of a unitrust is that it provides for payment to the beneficiary (or beneficiaries) of an amount that may vary. The payment must equal a fixed percentage of the net fair-market value of the trust assets as valued annually. The donor determines the fixed percentage when creating the unitrust in consultation with financial or legal advisors and the trustee. Payment must be at least 5% of the value of the trust assets. Depending on the donor's estate planning objectives, he or she may emphasize the charitable deduction (by choosing a lower rate) or the annual return (by selecting a higher rate).

The unitrust payment must be made at least annually (may be more frequently) to the beneficiary (or beneficiaries). The unitrust may be set up for life or a term of years not exceeding 20.

Example: A 6% unitrust valued at $100,000 will pay out $6,000 its first year. If the trust assets are valued at $110,000 in its second year, the payout will be $6,600. The variable nature of unitrust payments may provide a hedge against inflation - assuming a growth in the value of the assets comparable to the inflation rate.

The donor is allowed a charitable deduction equal to the present value of the charitable organization's remainder interest in the unitrust based on the fair-market value of the asset transferred, the payout rate chosen, and the age and number of beneficiaries (or the term of years). Funding the unitrust with appreciated, long-term, capital-gain securities or real estate can increase the tax benefits.

These trusts have enabled donors to support worthwhile causes while augmenting current income.

Example:  Ima Donor, 67, endows a fund in memory of her husband. She uses stocks owned for more than 12 months valued at $100,000 with a cost basis of $30,000, which pay dividends equivalent to a 2% annual return. By creating a 6% unitrust with herself as sole payment beneficiary for life, not only does Mrs. Donor increase her income, she also realizes a charitable deduction of $44,003. In her 36% income-tax bracket, her gift produces a net tax savings of $15,841. She also avoids capital-gain tax of $14,000 ($70,000 gain x 20%) that she would have incurred by selling the stock to buy higher-yielding securities.

The first year she receives payments totaling $6,000 for the trust (6% x $100,000). After that, she receives 6% of the value of the trust assets as revalued annually. Mrs. Donor may choose to make additional gifts to the unitrust in the future.

Charitable Remainder Annuity Trust - The annuity trust shares many common features with a unitrust, the principal difference being the manner of calculating the payment to the beneficiary. Instead of a payout that may vary, the annuity trust provides a fixed payout of not less than 5% of the initial fair-market value of the gift in trust.

Among the benefits to the donor contributing to an annuity trust are a deduction for the present value of the charitable remainder interest and avoidance of capital-gain tax on the transfer of appreciated, long term, capital-gain property. The fixed-payout feature of the annuity trust makes it particularly suitable for a beneficiary who needs the security of a specified payment.

Example: If Mrs. Donor chooses an annuity trust rather than a unitrust for her endowment, her initial deduction will be $46,451 and her resulting tax savings $16,722. The payments she receives from the trust will be fixed at $6,000 and will never vary, whatever the fluctuations of interest rates and stock prices. Because of the rules governing charitable remainder annuity trusts, she cannot add to the annuity trust in the future as she can to the unitrust.

Whichever trust she chooses, however, a final benefit to Mrs. Donor is that her estate will pay no tax on the principal of the charitable remainder trust that establishes her memorial fund.  

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