In this article, we answer the question: what are the different kinds of charitable trusts? We explain the difference between charitable lead trusts, charitable remainder trusts, and donor-advised funds. We also discuss the difference between a fixed annuity charitable remainder trust and a charitable remainder unitrust.
For some foundational information about charitable trusts, check out our article: Charitable Trusts Explained.
There are two main types of charitable trusts – charitable lead trusts (CLTs) and charitable remainder trusts (CRTs). They differ primarily by how the trusts’ incomes are allocated.
Charitable lead trusts give a set amount of the trust’s income to a charitable organization, and then the remaining income either goes to the grantor’s beneficiaries or stays in the trust. CLTs are a great giving strategy when you don’t need a set amount of additional income, and your primary goal is to donate money to an organization.
On the other hand, charitable remainder trusts, also referred to as split-interest trusts or CRTs, make payments the opposite way of CLTs. Income from a charitable remainder trust goes first to one or more beneficiaries in set amounts, and then the remaining income goes to a charitable organization.
With this arrangement, it’s common for individuals to name themselves or their family members as primary beneficiaries. Beneficiaries can receive trust payments in two ways: a fixed annuity or a percentage of the trust’s assets. Income generated by a CRT that is distributed to the non-charitable beneficiaries is taxable, according to a four-tier system. This system of taxation has a general “worst-in, first-out” rule. The trust’s ordinary income from the interest and dividends would be passed through prior to capital gains.
With a charitable remainder annuity trust, beneficiaries receive an annuity or a fixed dollar amount from the trust each year. The benefit of a CRT is that even if the trust’s income is less than anticipated, beneficiaries still receive the same amount. However, once the trust is created, you cannot change the annuity – so even if the trust’s income is more than anticipated, beneficiaries will still receive the same amount. Theoretically, you can make the annuity payments as high as you want. However, it’s important to be realistic. The higher the payments, the lower your income tax deduction, and high payments may diminish your principal balance, leaving less income for the charity.
With a charitable remainder unitrust, beneficiaries receive a percentage of the trust’s assets each year. The trust’s value is reappraised annually, and the beneficiaries receive a set percentage of the trust’s current value. This way, if the trust does extremely well, the beneficiaries will receive more, and if the trust under-performs, they will receive less. This strategy is great if you don’t need to rely on trust payments as a main source of income. The Internal Revenue Service does require that beneficiaries receive at least 5% of the charitable trust’s value each year.
A potential alternative to a charitable trust is a donor-advised fund (DAF). A DAF is cheaper and easier to donate to than a charitable trust. With a DAF, a sponsoring organization creates a fund that it uses to invest assets and make donations. An individual can donate the same assets to a DAF as he or she can to a charitable trust, and similar to a charitable trust, those donations are irrevocable. A big advantage of DAFs is that the donator can have a say in how the fund uses his or her donation. The DAF isn’t required to comply with this request, but they do often try to choose grants, charities, and donations that the donor would agree with.