What Are Charitable Trusts?

Leaving a lasting legacy is an important element of estate planning. Charitable trusts can be a powerful way to support causes you care about while managing your tax burden and preserving wealth. You’re able to give back while enjoying several financial benefits.

This article explains how charitable trusts work and the advantages and drawbacks of using one. It also outlines where they fit within a broader estate plan and how to establish one with the help of a qualified estate planner or financial advisor.

How Charitable Trusts Work

Charitable trusts are legal arrangements that allow individuals to set aside cash for philanthropic purposes while still retaining financial benefits. Trusts operate as separate legal entities, protecting assets within them.

There are typically two types of charitable trusts: charitable remainder trusts (CRTs) and charitable lead trusts (CLTs). With the former, you (the donor) place assets into the trust and receive income from them for a set period or the duration of your life. The remaining assets are dispersed to a charity of your choosing. The latter, however, does the opposite, sending income to charities first and beneficiaries after the term ends.

Both types of trusts are irrevocable, which means their terms aren’t easily changed once they’re established. You can fund these with cash, securities, real estate, and other appreciated assets.

How Charitable Trusts Strengthen an Estate Plan

Charitable trusts are powerful estate planning tools that bring tax benefits and shield assets. But, distinguishing themselves from other irrevocable trusts, they allow you to contribute to causes that matter to you during and after your lifetime.

Marcus Denning, senior lawyer at MK Law, explains that charitable trusts are “actually control devices for affluent clients who want to keep control of asset deployment while minimizing estate tax exposure.” More specifically, these are often for “clients who have appreciated assets,” such as “real estate, company shares, or heirloom family holdings where capital gains exposure would be substantial.”

Below is a breakdown of the various specific ways charitable trusts complement an estate plan:

Tax-Efficiency

Within a comprehensive estate plan, charitable trusts can help reduce estate and capital gains taxes. Reducing estate taxes means more of your assets can go to loved ones or charitable causes, rather than the government. Additionally, you may qualify for an immediate charitable income tax deduction in the year the trust is established.

The deduction is based on the present value of the charitable gift, calculated using IRS formulas that consider factors like the trust’s structure, the payout amount (if any), and the length of time before the charity receives the remainder. While the exact deduction varies, it can be substantial, especially when funding the trust with highly appreciated assets that would otherwise trigger capital gains tax upon sale.

Asset Protection

Because they’re irrevocable, charitable trusts grant asset protection benefits that are important for estate planning. Once you place assets within this type of trust, they are part of that entity and no longer under your control. This protects them from external forces, such as creditors, divorce, or probate.

Ensuring Your Wishes Are Followed

Finally, establishing a charitable trust is another way to ensure your wishes are met after death. In the case of a CRT, your assets will go to a charity of your choosing either after the income duration ends or you pass away. Conversely, a CLT will contribute to a charity during the income term, and then to your designated beneficiaries afterward.

Drawbacks to Consider

Despite their advantages, charitable trusts aren’t right for every estate plan. They involve legal complexity, require long-term commitment, and may not be practical for smaller estates. Before setting one up, it’s important to consider the following drawbacks:

• Irrevocable structure. Once you establish the trust, it’s difficult to alter or amend it.
• Complex to set up and maintain. Establishing a charitable trust typically requires a significant investment of time, money, and effort, as well as the hiring of a professional.
• Requires significant assets. To generate income and fulfill charitable goals, a large upfront contribution is usually necessary.

Matt Fitzsimmons, chief operating officer and senior wealth manager at The Watchman Group, emphasizes that charitable trusts aren’t something to enter lightly. “Once the trust is in motion, you’re largely committed to the structure. It’s not something to rush into.”

For the reasons above, charitable trusts are typically an option most suitable for high-net-worth and ultra-high-net-worth individuals. With more assets, these clients can more easily realize the benefits and put in the requisite effort to establish one.

Establishing a Charitable Trust

Setting up a charitable trust requires careful planning, legal precision, and financial expertise to make sure your goals are met and that you stay compliant with IRS rules. Here’s what the process typically involves:

• Determining your goals. First, it’s important to decide what type of charitable trust to select and the reason for choosing it. This may include tax benefits or income you want to receive, as well as causes to support.
• Selecting beneficiaries. Here, you’ll decide on charities or individuals to send income to via the trust.
• Working with professionals. Setting up a trust typically takes effort from you, an estate planning attorney, and a financial advisor.
• Funding. To establish a trust, you must fund it with assets.
• Administering the trust. The trustee, whether an individual, institution, or professional, will manage the trust according to its terms and tax filing requirements.

Because charitable trusts are irrevocable and legally complex, working with a qualified estate planner or financial advisor is essential. “I always tell clients: this is not a DIY moment. Get your estate attorney and CPA on the same page from day one,” says Fitzsimmons.

Fitzsimmons adds that the “advisor drives strategy, the estate attorney builds the vehicle, and the charity confirms they can accept and administer it. We keep all parties looped in to ensure tax benefits aren’t accidentally blown with sloppy execution.”

Frequently Asked Questions

Who should establish a charitable trust?

In general, charitable trusts are geared toward high- and ultra-high-net-worth clients. This is because these require a substantial investment of time and money. Benefits like reducing estate size, minimizing capital gains, and receiving income concurrently with donating assets typically require significant assets.

Can you take money out of a charitable trust?

You may only receive income from a charitable remainder trust (CRT) for a certain period. Once this ends, the remainder is sent to a charity of your choice. You aren’t able to, however, withdraw funds at will because these trusts are irrevocable.

Are charitable trusts protected?

Because they’re irrevocable, charitable trusts are generally protected from creditors, divorce, probate, and other third parties. They’re also difficult to alter and amend once you’ve set them in motion, which can be a downside if you want constant access to your assets.