Charitable trusts: Strategic planning and giving

“Using charitable trusts enables donors to achieve significant tax savings while supporting causes they care about,” said Garrett Harbron, J.D., CFA, CFP®, head of advised wealth management strategies at Vanguard and author of the recent research paper Charitable Trusts: Balancing Tax Efficiency and Philanthropy. “With the right planning, these trusts can be a win-win for families and the charities they support.”

To understand how charitable trusts work in practice, it’s helpful to start with the basics of split-interest trusts. Split-interest trusts split a single gift into two distinct parts: an income benefit and a remainder benefit. This enables the trusts to meet multiple objectives. The two main types of charitable split-interest trusts are the charitable remainder trust (CRT) and the charitable lead trust (CLT). Each has a specific structure that suits different donor needs.

A CRT is structured so that either the donor or a beneficiary designated by the donor receives income from the trust for a specified term or for life, with the trust transferring the remaining assets to the charity once the income period ends. The donor receives an up-front charitable deduction equal to the value of the charitable interest and can avoid capital gains tax on in-kind donations. The income recipient pays income tax, while the trust itself is tax-exempt.

Which donors benefit from CRTs? Donors who want to leave money to charity and want to take a significant tax deduction in the near term will likely find CRTs useful. This may include donors anticipating a spike in income—such as during retirement when they cash in stock options, upon the sale of a business, or following a Roth conversion. CRTs may also be appropriate for those who wish to retain income while they support a charity over the long term. 

A CRT is tax-exempt, so it does not pay taxes on transactions within the trust; however, the income recipient is taxed on the payments they receive. The tax treatment of income payments is complex, and it should be fully understood by the donor and/or income recipient before the CRT is created. Once the income period ends, the remaining assets transfer to the charity with no further tax consequences.

A CLT is designed so that the charity receives income for a set period, after which the remaining assets are transferred to a noncharitable beneficiary, such as the donor or their heirs. CLTs are primarily used for wealth transfer and estate planning, especially when assets are expected to appreciate.

CLTs can be established in two main forms, each with different treatment for estate planning and tax purposes:

• Grantor CLT. The donor retains ownership and receives an up-front deduction but is also responsible for paying the taxes on the assets. There are no estate tax implications.
• Non-grantor CLT. Assets are removed from the estate without an up-front deduction, enabling a “zeroed-out” transfer to reduce estate and gift tax. As the trust isn’t tax-exempt, undistributed income is taxed at trust rates, while distributed income is taxable to the recipient. Because the charity is tax-exempt, it will not incur any tax liability on the income it receives.

Which donors benefit from CLTs? Donors who want to transfer appreciating assets tax-efficiently to heirs, or those planning for annual charitable giving when estate tax is a concern. 

Establishing a charitable trust involves several key decisions, including asset type, beneficiary selection, valuation, income term, and payout structure. These trusts are complex and expensive to establish and maintain. They require careful structuring as well as professional guidance. If a donor’s goals don’t align with philanthropic giving, these trusts may not be suitable.

“Charitable trusts are valuable tools for combining financial and philanthropic goals,” Harbron said. “CRTs and CLTs serve distinct purposes and require thoughtful planning to ensure they meet the donor’s objectives. Donors should consult with an advisor to determine if either is a good fit based on personal goals and financial circumstances.”