This article provides a detailed comparison of two strategies that are commonly used to diversify appreciated assets: Charitable Remainder Unitrusts (CRUTs) and Donor Advised Funds (DAFs).

Key Highlights and Takeaways

• Different Use Cases: With a Charitable Remainder Trust, a donor can come out ahead financially while making a relatively small charitable gift. With a DAF, a donor will never come out ahead financially but will make a larger charitable gift.
• Tax-Free Selling: Both CRUTs and DAFs allow you to sell appreciated assets tax free. But with a DAF, you lose access to the money once contributed. With a CRUT, you retain an income stream.

What are CRUTs?

A CRUT is an irrevocable trust that mitigates capital gains tax on the sale of appreciated assets like stock, crypto, real estate, or privately held businesses and then generates income for a beneficiary (or beneficiaries) for a specified period, after which the remaining assets are distributed to a designated charity.

How Do CRUTS Work?

The basic idea is that a person (the “grantor”) transfers appreciated property to a CRUT and, in return, the CRUT pays the grantor (or another beneficiary) a fixed percentage of the assets in the trust each year for either a set number of years or the beneficiary’s lifetime. When the appreciated assets are sold inside the CRUT, there is no immediate federal or state capital gains tax on the sale; the trust can reinvest and grow the assets pre-tax. Instead, the capital gains tax will be paid by the beneficiary (probably the grantor) when the beneficiary receives distributions from the CRUT. While the capital gains tax is eventually paid, in the meantime the grantor is able to reinvest any untaxed amount inside of the CRUT, generating returns on that entire amount. At the end of the term, anything left over in the trust passes to a charity of the grantor’s choice. In addition, the grantor gets a charitable deduction typically equal to ~10% of the assets they contributed to the trust in the first place. The amount that passes to charity is roughly equal to the 10% charitable deduction the grantor receives adjusted for the growth of the assets over time.

Thanks to the combination of this tax deduction and the powerful tax deferral described above, the grantor typically ends up with significantly more post-tax money than he or she would have had without the CRUT — and a charity gets money, too! That’s a win-win. (You can learn more about CRUTs here and you can estimate the potential returns here.)

Benefits of CRUTs

1. Tax Deferral: The primary advantage of a CRUT is its ability to defer capital gains taxes. By selling appreciated assets inside the trust, the donor avoids immediate capital gains taxes when selling the asset and can reinvest and grow the assets on a pre-tax basis. The donor doesn’t pay taxes on the sale (or any income) realized inside the trust; instead, the seller (as beneficiary) pays taxes on distributions from the trust. Over a long period of time, this can more than double the post-tax dollars the seller receives from a sale.
2. Charitable Deduction: In addition, the donor receives a charitable deduction that is typically 10% of the value of assets contributed to the CRUT. That deduction can offset ordinary income or capital gains income.
3. Income Stream: The CRUT provides at least annual distributions for the length of the trust, which can be a set number of years or the lifetime of the beneficiary.
4. Asset Flexibility: CRUTs can be used with almost any asset ranging from public stocks to private stocks, crypto, real estate, and collectibles.

Drawbacks of CRUTs

1. Irrevocability of Charitable Gift: Once assets are transferred into a CRUT, the donor can’t claw back the charitable gift.
2. Illiquidity: During the term of the CRUT, the donor is limited to annual distributions from the CRUT equal to a fixed percentage of the trust’s assets. Short of terminating the CRUT entirely, there’s not much the donor can do to access the bulk of the principal during the CRUT term.
3. Income Variability: The income generated by a CRUT can vary depending on the performance of the trust’s investments. If the trust’s assets underperform, the income stream may be lower than expected. The flip side is that if the investments overperform, the income stream may be higher than expected. (You can use our CRUT calculator here.)

What is an Ideal CRUT Situation?

Imagine that Bob, a 40-year-old California resident, has a $1,000,000 asset with a cost basis of zero. He wants to sell the asset in a tax-efficient way so he can receive some of the sales proceeds every year to support his lifestyle. If he contributes that asset to a standard CRUT that is designed to last for his lifetime, he’ll get annual distributions from the CRUT equal to about 7% of the value of the CRUT’s assets. So, in Year 1, he’ll get a $70,000 distribution (7% of $1,000,000), in Year 2 he’ll get a distribution equal to about 7% of the value of the CRUT’s assets at that time, and so on. In the meantime, Bob, as Trustee of the CRUT, will generate returns investing the ~$350,000 that would have been taxed immediately without the CRUT. Over his life, Bob will be able to receive about $1,400,000 more after taxes (a 124% additional return) by using the CRUT than he would have been able to generate without it.

Understanding Donor-Advised Funds

What Are Donor-Advised Funds?

A Donor-Advised Fund (DAF) is a charitable giving vehicle that allows individuals to donate assets like cash, stocks, or real estate. The donor receives an immediate tax deduction when they contribute to the DAF, even though the funds can be distributed to their chosen charities at a later date. By donating assets directly to the DAF, donors can avoid paying capital gains tax on the appreciated assets and increase the amount that ultimately goes to charity.

Overall, Donor-Advised Funds offer a simple and efficient way to achieve philanthropic goals. But a donor won’t come ahead personally by donating to a DAF. For each dollar contributed, the donor will at best receive $0.52 in tax savings. For a gift to a DAF to make sense, a taxpayer must be charitably inclined.

What are the benefits of Donor-Advised Funds

1. Maximize Your Charitable Impact: Since you’re not paying capital gains tax, more of your money goes to the causes you care about. Let’s say you donate stocks worth $50,000 that you originally bought for $10,000. If you sold them outright, after taxes you might have $40,000 left to give. But with a DAF, you can donate the entire $50,000 of stocks directly to the DAF tax-free.

3. Immediate Tax Benefits: You get a tax deduction in the year you make the donation, even if you don’t give the money to a charity until later. This can be useful if you’ve had a year with higher-than-usual income and want to offset some of that with charitable deductions.

What are the downsides of Donor Advised Funds?

• Negative Value: While you get a charitable deduction for DAF’s, the value of the assets you give away is significantly more than the value of tax savings you receive. It doesn’t make sense to use a DAF for tax planning (however it can make a lot of sense if you are focused on philanthropic giving v. tax savings)
• Limited Control Over Investment Decisions: While donors can recommend how their contributions are invested within a DAF, they do not have direct control over the specific investments. The sponsoring organization ultimately makes the investment decisions, which may not always align with the donor’s preferences or risk tolerance.

What is an ideal Donor Advised Fund situation?

The idea DAF situation is when someone has appreciated assets and they don’t want the proceeds for their or their family’s use but rather simply want to give it charitable causes. Financially you won’t come ahead but in this situation that’s not the goal!

Choosing Between Charitable Remainder Trusts (CRUTs) and Donor Advised Funds (DAFs)

The choice between a CRUT and a DAF often depends on an individual’s financial goals, tax considerations, and philanthropic intentions.

1. You want to use the sales proceeds personally: If an individual’s primary goal is to use the proceeds of the sale to support his or her lifestyle, a CRUT is the no-brainer choice.
2. You want to maximize charitable donations: If you are primarily focused on supporting charity, not benefitting yourself or your family, then a DAF is almost always a better option.
3. You want to give private stock or real estate to charity: Most DAFs will not accept private stock or real estate. If you’d like to gift private stock or real estate to a DAF, one option is to set up a CRUT with a short term, sell the private stock or real estate inside the CRUT, and then gift the assets to a DAF.

CRUT and Donor Advised Fund (DAF) Case Study

Consider Jane, a tech entrepreneur with a $5 million concentrated public stock position in a successful company she co-founded. Jane is 55 years old and has plans for retirement, with a strong desire to contribute to environmental causes. Her stock has appreciated significantly, and she wants to sell it to support her lifestyle but is concerned about the tax implications of selling her shares.

Assumptions:

• Annual distributions starting at $190,000 in the first year and continuing for 32 years.
• Public market investments grow 10% per year.

Results:

• The CRUT maximizes how much Jane would personally benefit while a DAF minimizes how much the charity would benefit.
• A CRUT distributes to Jane ~137% more after taxes than doing nothing and infinitely more than a DAF.

Conclusion

Choosing between a CRUT and a Donor Advised Fund requires careful consideration of various factors, including tax efficiency, income needs, philanthropic goals, and control over assets. Both strategies offer unique advantages and potential drawbacks, making it essential to align the chosen approach with the individual’s broader financial objectives. You can use our Comparison Calculator here to understand the financial trade-offs.

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