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The Pros And Cons Of Charitable Trusts

By Kathryn Tully

Charitable trusts offer tax-efficient ways to support your favorite causes, but finding the right structure for you and your family is critical.

Over the next 30 years, philanthropic bequests by ultra-high-net individuals around the world are expected to total $300 billion, according to research company Wealth-X. For affluent individuals, setting up a charitable trust can be a great way to structure those bequests, receive significant tax benefits and even generate income for donors or their family members.

However, it is crucial that donors pick the right trust structure to meet their specific needs. In the U.S., for example, Charitable Remainder Trusts, which can allow individuals to donate cash or assets to charity and retain some income, are extremely popular, but they aren’t the best solution for everyone.

“You really need to think carefully about your objectives when setting up a trust,” says Greg Robinson, Vice President and Director of Trust Services for the East Region at BBVA Compass. “Do you want to maximize your legacy and teach your family about philanthropy? How important are the value of tax breaks and do you need an income from trust assets?”.

Charitable Remainder Trusts

For individuals in the U.S. who want to donate cash or assets to a charity, but continue to use those assets or receive an income from them, Charitable Remainder Trusts are a popular solution. The individual or designated family member receives an annual income and the designated charity receives the asset – or principal amount donated – after a set period of time.

Charitable Remainder Annuity Trusts pay a fixed percentage of at least 5 percent of the initial value of trust assets in income each year, and so provide a fixed income, while Charitable Remainder Unitrusts pay a fixed percentage of at least 5 percent of the annual value of trust assets each year, and so provide a variable return that could grow if the trust’s assets perform well.

Charitable Remainder Annuity Trusts can’t be topped up once they are established, but donors can add to the principal amount in Charitable Remainder Unitrusts over the years. In both cases, the donor doesn’t pay capital gains or estate taxes on the donated amount and can also deduct the value of any remaining interest the trust earns each year after annual distributions are made.

Charitable Lead Trusts

For those individuals that want to maximize their income tax deduction immediately or reclaim their assets after a period of charitable giving, Charitable Lead Trusts might be the best solution.

These provide income payments to one or more charities for a set period of time, before trust assets are returned to the donor or to another nominated family member. Donors receive an income tax deduction the year the trust is created for the net present value of the income interest they are giving to charity.

“With a Charitable Lead Trust, you can give assets to charity at outset, but those assets eventually go back to you or your heirs,” says Robinson. “You can prioritize charitable donations now, but your family can still benefit from those assets later.”

Private Foundations

Individuals who do want their charitable giving to create a permanent legacy might consider establishing their own private foundation. These can exist in perpetuity, benefit many charities, and give individuals complete control over their assets and giving. Individuals can minimize their estate taxes, receive an income tax break on gifts of cash and other assets to the foundation and avoid capital gains tax on contributed property.

Private foundations also offer their founders the chance to educate the next generation. “They are great if you want to pass on value of giving to the rest of your family. You can put your children and grandchildren on the board, get them involved, even give them a small salary,” says Robinson.

However, they are also complex and costly to set up and administer. “You need to donate a significant amount to justify the expense and time of setting up a private foundation and you also need enough surplus funds to provide for you and your family. Once cash or other assets have gone into a foundation, they stay there,” says Robinson. Private foundations also have to allocate five percent of their net asset value to charity each year, regardless of how their assets are performing.

Donor Advised Funds

Donor Advised Funds administered by public charities can be a more flexible alternative – they can be set up immediately, have much lower set up and administrative costs, better income tax breaks on donated cash and assets, and no mandatory annual charitable contribution. However, the assets donor advised funds can receive and the grants they can make are more restricted than for private foundations and they do not offer donors the same permanence or autonomy.

While private foundations require a much bigger commitment than other charitable trusts, most of these options require an irrevocable commitment of cash or assets, so it is critical to select the right vehicle for your needs. With the right structure in place, however, you can support your favorite causes and your family in the years to come.

Kathryn Tully is a business and finance journalist who is based in New York.

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