A charitable trust allows you to leave some or all of your estate to a 501(c)(3) organization of your choice. You can leave money, stocks, real estate, and other valuable assets, such as artwork. It can be an important part of your estate plan.
You can donate money through other types of trusts, but a charitable trust has the primary goal of donating to nonprofit organizations. You also receive specific tax benefits. A charitable trust can help you minimize your income, estate, and capital gains taxes.
If you only want to leave your belongings to your heirs, you might want to start a revocable trust while you're alive. Policygenius can set you up with both a trust and will that will provide financial protection for your heirs.
Charitable trusts aren’t for everyone, though. For one, they’re a type of irrevocable trust, which means you usually can't make changes to the details of the trust once it’s been created. It also may not be worth the cost of creating the trust if you are only donating small amounts to a charity. In that case, consider making a donation or using a donor-advised fund (DAF).
How a charitable trust works: the basics
A charitable trust is a form of irrevocable trust, which means you cannot cancel it or make any changes once you create the trust.
With a charitable trust, the grantor (creator of the trust) transfers control of assets into a trust. The grantor will designate an organization to serve as the trustee and manage the assets in the trust. There may also be a co-trustee or successor trustees.
Most commonly, the organization will invest the trust assets (or liquidate and then invest in the case of real estate and property) in order to create a regular stream of income. This income provides the organization with regular donations. You can opt to send payments annually, semi-annually, quarterly, or monthly.
However, the income doesn't necessarily all go to the trust. In cases where a trust is created during the grantor’s life, it’s common for grantors to name themselves or their family as trust beneficiaries. This allows them to receive regular payments.
Payments from a charitable last for a set period of time. Known as the payment period, this is the lifespan of the trust. To use a real world example, the payment period of the Bill & Melinda Gates Foundation, a charitable trust originally created by Bill Gates, lasts until 50 years after the Gates’ deaths.
The payment period (as well as who receives payments) is specified in the trust document. This is a legal document that lays out the details of the trust.
Which organizations can receive donations
You can make charitable donations to a 501(c)(3) organization. An 501(c)(3) organization has applied and been recognized by the Internal Revenue Service (IRS) as a nonprofit that qualifies as tax-exempt. This status allows its donors to deduct donations on their tax returns. You can use a trust to give money to a non-501(c)(3) organization, but you won’t be able to deduct your donations.
Many public and private universities, religious organizations, public charities and private foundations qualify as 501(c)(3) organizations.
Even though an organization may qualify, it may not take your donation. Smaller organizations in particular may not have the capacity to manage a trust. Speak with the organization before you create a trust because they may have another way for you to donate.
In some cases, a grantor may designate a private foundation that they have created. This allows you to receive the tax benefits of a charitable trust while maintaining control over how the foundation uses its income.
Perhaps the most well-known private foundation is the Pew Charitable Trusts. Pew began as a private foundation that was the sole beneficiary of seven charitable trusts created by individuals in the Pew family. The foundation’s income has been used to donate to a number of charities and causes.
Two types of charitable trusts
There are two main types of charitable trusts and they differ primarily in how the trust’s income is allocated.
Charitable lead trusts
With a charitable lead trust (CLT), a set amount of the trust income is donated to the charitable organization. Then the remaining income goes either to the grantor’s beneficiaries or it remains in the trust. At the end of the payment period, all of the assets in the trust either go to the organization or the grantor’s beneficiaries.
Creating a CLT is a good giving strategy if you don’t need a set amount of additional income and your primary goal is to donate money to the organization.
Charitable remainder trusts
A charitable remainder trust (CRT), also called a split-interest trust, makes payments in the opposite way of a CLT. Income from the trust goes first to one or more beneficiaries in a set amount and the remaining income goes to the organization.
There are two ways that you can receive trust payments:
a fixed annuity
a percent of trust assets
With a charitable remainder annuity trust, you receive a fixed dollar amount (an annuity) from the trust each year. The benefit to this method is that even if the trust’s income is less than anticipated, you receive the same amount.
You cannot change the annuity once you create the trust so make sure to choose an amount that is enough. If you will receive payments for years, consider the effects of inflation and your future financial needs.
You can also opt for a charitable remainder unitrust, which allows you to receive a fixed percentage of the trust’s assets each year. The trust’s value is reappraised annually and you receive a set percentage of the value.
This strategy means you receive more if the trust does well and less when it underperforms. If you aren’t relying on trust payments as a significant source of income, this could be a good option. The IRS requires that you receive at least 5% of the trust’s value each year.
Tax benefits of charitable trusts
One of the main reasons that donors create a charitable trust is the tax advantages. You can limit your income taxes, capital gains taxes, and your estate taxes.
Income tax deduction
A donor can make an income tax deduction for the value of their trust assets. You can take the entire deduction in the year you execute the trust or you can spread it over five years.
However, calculating the amount of your deduction is tricky. The deduction isn’t simply the value of the assets. You need to subtract the amount of the payments that you expect to receive from the trust over the payment period. This calculation considers a number of factors like your life expectancy, the number of heirs you have, the details of your trust document, and inflation. The attorney who helped create your trust should be able to help you.
To give an example of how the deduction works, let’s say you donate assets worth $50,000 and you plan to receive income payments of $20,000. The IRS will calculate your gift’s value, and your available deduction, at $30,000.
Capital gains tax
If you have an asset that has increased significantly in value since you got it, you will need to pay capital gains tax on that appreciation. Donating the asset via a charitable trust is one way to legally avoid that tax.
For example, you may own real estate that has appreciated greatly in value. When you put it in a charitable trust, the organization will normally sell it in order to buy something that produces income, like stock market investments. A 501(c)(3) is tax-exempt and doesn’t have to pay capital gains tax, so the entire amount from the real estate’s sale goes into the trust.
Charitable trusts are a common estate planning tool because they allow you donate assets and property while avoiding estate tax. When you add assets or property to a trust, they are no longer yours. The trust is the legal owner and in the case of irrevocable trusts, the assets are not included in your estate.
Most estates won’t pay estate tax anyway, though. As of 2020, the federal estate tax applies only to estates worth more than $11.58 million, although this will go up to $11.7 million in 2021. Only a handful of states have an estate tax, though some also have lower exemptions than the federal tax. The estate tax exemption was $11.4 million in 2019.
How to create a charitable trust
In order to create a charitable trust, you will need to work with a professional. An estate planning attorney can help you, as can some financial advisors.
Generally, there are a couple of steps for creating a charitable trust:
Determine what assets you want to add to the trust. Remember that your donations are irrevocable.
Decide on your beneficiaries and whether you want the trust income to pay them or the organization first. As you think about payments, also consider the value of your tax deduction.
Work with a professional to draw up a trust document. You will move assets into the trust at this time, unless you are creating the trust as part of a will.
Again, you should always talk with an organization before you create a charitable trust. It’s possible they will have preferences on how and where to donate. For example, it may be easier to donate to some organizations through a donor-advised fund (more on that in the next section).
Another thing to note is that you do not have to create a charitable trust during your lifetime. It’s possible to create a testamentary trust in your will, or to use a pour-over will to put your assets in a trust you already established. If you do that, the trust document is included in your will and the trust will be created after your death.
A will also allows flexibility because you can make changes after you’ve written it. So if you create a will that leaves everything to a charitable trust, but you decide a few years later that you want to leave assets to another beneficiary, you can make changes to your will.
Donor-advised funds (DAFs): a trust alternative
One of the major advantages of a charitable trust is that you can donate while also creating a regular source of income for you or your beneficiaries. If you don’t need that income and you just want to make a donation, consider a donor-advised fund (DAF).
With a DAF, an organization known as a sponsoring organization creates a fund that it uses to invest assets and make donations. In order to donate, you create an account with the fund. Then you can donate assets, which the fund manages.
You can donate the same assets as with a charitable trust and just like a trust, your donations are irrevocable. You cannot get them back. You do qualify for a tax deduction in the year you make a donation.
Pros and cons of a donor-advised fund
A DAF is simpler and cheaper to donate to than a trust. The other big advantage is that you can have a say in how the fund uses your donation. For example, you can request that your donations are used to create a grant funding scientific research. The DAF isn’t required to do as you request, but they often work with their donors to choose grants, charities, and donations that the donor would want.
One reason to choose a charitable trust over a DAF is that you can create more of a legacy with a trust. For example, you could create a trust that makes donations for many years after your death. A trust can also allow near complete control if you create a trust that donates to a private foundation you have also created.
If you’re considering donating to a DAF, check to see if the organization of your choice has a fund. Some large organizations manage their own funds. Also consider a fund from a financial-service firm, which commonly has a nonprofit branch to manage funds. For example, Fidelity Charitable, Schwab Charitable, and Vanguard Charitable, each manage billions of dollars’ worth of assets. These large funds provide flexibility with what assets you can donate and how they can use the assets you donate.