The purpose of estate tax planning is to maximize the assets you pass on to future generations by minimizing gift and estate taxes. Estate-tax strategies revolve around the use of irrevocable trusts. This article discusses the most common types of irrevocable trusts that are used to minimize gift and estate […]
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.
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.
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.)
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.
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.
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.
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.
The choice between a CRUT and a Pooled Income Fund often depends on an individual’s financial goals, tax considerations, and philanthropic intentions.
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:
Results:
| Pooled Income Fund | CRUT | Nothing | |
|---|---|---|---|
| Distributions | $36,260,606 | $69,260,606 | $39,898,892 |
| Capital Gain Taxes | $18,130,303 | $25,575,864 | $13,774,162 |
| Charitable Donation | $38,491,394 | $5,491,394 | $0 |
| Net distributions after taxes (to you) | $18,130,303 | $43,684,743 | $26,124,730 |
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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