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

Key Highlights and Takeaways

• Priorities: A Charitable Remainder Trust is a type of tax-planning structure that is financially advantageous for the donor and has a minor charitable component, while a Pooled Income Fund is a charitably focused structure that may or may not be financially beneficial for the donor.
• Tax Rates on Distributions: All Pooled Income Fund distributions are taxed at ordinary income rates. CRUT distributions are taxed at whatever rates the income they generate would otherwise be taxed at. So if a CRUT generates long-term capital gains, the beneficiary will be taxed at long-term capital gains rates on that income.
• Higher ROI: CRUTs provide a higher distribution rate (percentage of trust assets distributed each year) and lower fees than Pooled Income Funds, which creates more wealth for the fund.

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.

What are Pooled Income Funds?

A Pooled Income Fund (PIF) is a type of charitable trust that allows donors to contribute assets, typically cash or securities, into a pooled fund. In return, the donor (or other designated beneficiaries) receives income for life generated by the fund’s investments. After the death of the last income beneficiary, the remaining assets are distributed to the designated charity. Pooled Income Funds are an effective tool for individuals looking to support charitable causes while still receiving a steady income stream during their lifetime.

How Do Pooled Income Funds Work?

The basic premise of a Pooled Income Fund is that a donor contributes assets to a fund. These assets are then combined with contributions from other donors, creating a large investment pool that is invested in income-producing securities like stocks, bonds, and mutual funds. Each donor or beneficiary typically receives about 3% of their assets in the pooled income fund for the rest of their life.

When a donor contributes assets to a Pooled Income Fund, they receive an immediate charitable income tax deduction based on the present value of the remainder interest that will eventually go to the charity. The deduction amount is determined by factors such as the donor’s age, the expected income payments, and the IRS discount rate. Critically the income received by the donor or beneficiaries is taxed as ordinary income. Once the last income beneficiary passes away, the remaining assets in the fund attributed to that donor’s contribution are distributed to the charity, fulfilling the donor’s philanthropic intent.

Benefits of Pooled Income Funds

1. Lifetime Income: Donors or their designated beneficiaries receive a lifetime income stream based on their proportional share of the fund’s earnings. The amount of income can fluctuate depending on the performance of the fund’s investments.
2. Charitable Deduction: Donors receive an immediate charitable income tax deduction when they contribute to a Pooled Income Fund. This deduction is calculated based on the present value of the charitable remainder interest.
3. No Capital Gains Tax on Contributions: Donors can contribute appreciated assets to a Pooled Income Fund without incurring immediate capital gains taxes. This allows the full value of the asset to be reinvested and potentially generate higher income.

Drawbacks of Pooled Income Funds

1. Minimal Income: The income received from a Pooled Income Fund is almost always a much smaller amount than what you could get from other tax deferral options like Charitable Remainder Trusts.
2. Irrevocable Gift: Contributions to a Pooled Income Fund are irrevocable, meaning the donor cannot reclaim the assets once they have been transferred to the fund.
3. Distributions are Taxed as Ordinary Income: The income received from a Pooled Income Fund is taxed as ordinary income, which could result in a higher tax liability for some donors.
4. Less Control over Investments: Donors have limited control over how their contributed assets are invested. This could be a concern for those who prefer to have direct oversight of their investments.

What is an Ideal Pooled Income Fund Situation?

Imagine that Anika, a 65-year-old retiree, wants to support her favorite charity while still receiving income during her retirement years. She owns $500,000 worth of appreciated stock with a low cost basis and is concerned about the capital gains tax if she sells the stock outright. By contributing the stock to a Pooled Income Fund, Anika avoids immediate capital gains taxes and receives an income stream for the rest of her life. In the first year, Anika’s share of the fund generates $20,000 in income. While this income is taxable, Anika also receives a charitable deduction when she contributes to the fund, which can offset some of her tax liabilities. Upon her death, the remaining assets from her contribution are distributed to her chosen charity, fulfilling her philanthropic goals.

Choosing Between Charitable Remainder Trusts (CRUTs) and Pooled Income Funds

The choice between a CRUT and a Pooled Income Fund 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 over their life, a CRUT is the no-brainer choice.
2. Don’t want the sales proceeds and want to maximize charitable donations: If you would rather maximize the outcome for charity, as opposed to maximizing your personal returns, then a Pooled Income Fund can be a better option.

CRUT and Pooled Income Fund 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 she is concerned about the tax implications of selling her shares.

Assumptions:

• Annual distributions will be 3% of your donated assets and will continue for 32 years (in the final year the CRUT will distribute as much as it can).
• Public market investments grow 10% per year.

Results:

• The CRUT maximizes how much Jane would personally benefit, while a Pooled Income Fund doesn’t maximize how much Jane personally benefits but maximizes how much the charity benefits.
• A CRUT distributes ~2.5x more after taxes to Jane than using a Pooled Income Fund.

Conclusion

Choosing between a CRUT and a Pooled Income 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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