These irrevocable trusts are characterized by:
- a fixed rate of return for the beneficiaries (most often the grantor)
- a substantial income-tax deduction for the grantor at the time the trust is funded
- freedom to diversify and manage trust assets with little or no tax consequence
- a handsome gift to charity upon the grantor's death
The income tax benefits can be dramatic: A large upfront tax deduction for the grantor and tax-free management of the trust principal. Strict compliance with federal tax law is essential to gain the tax benefits.
The Grantor selects the annual payout rate, which current tax law requires to be at least 5%. Various choices are available to the grantor for the payment of income, including the selection of a fixed, annual dollar amount for life or of a fixed percentage of the trust's value (which offers the possibility of an annual increase or decrease in the payout).
Charitable trusts offer an attractive, tax-free means of converting assets with a very low cost basis (often paying little or no income), into a significantly higher income stream. When the trust is funded, the grantor receives an immediate and usually sizable charitable deduction. The size of the deduction is based on the duration of the trust and the percentage of income the grantor specifies. Upon the sale of trust assets, capital gains taxes are deferred or permanently avoided altogether.
Examples of assets ideally suited for this strategy are real estate and low-yielding stock with a very low tax cost.
Even with all their tax benefits, charitable remainder trusts generally make sense only for those grantors with a strong charitable intent.