Charitable Remainder Trusts (CRTs) may seem foreign, but they’re actually similar in some ways to a popular tax planning tool you’re probably much more familiar with: the Individual Retirement Account (IRA). Like IRAs, CRTs allow you to defer the taxes you would otherwise owe on your capital gains. But unlike IRAs, CRTs have no contribution limit, allow you to withdraw money when you need it (rather than having to wait until retirement), and do not convert capital gains into ordinary income.
CRTs — and tax planning in general — can be intimidating, in part because most people come to the table with preconceived notions: that tax planning is reserved for people with nine figures of wealth and access to a team of lawyers and accountants, or that it’s only for people with kids, or, more commonly, that it’s something you can put off until you’re older. Or maybe you haven’t thought much about trusts until now.
But tax-advantaged trusts don’t have to be scary. In fact, they’re actually just one type of a very common tax mitigation tool — the tax-deferred account — and, in particular, they are similar to the most popular financial planning vehicle: the Individual Retirement Account, or IRA. In today’s post, we’ll explain those similarities — and some key differences — with the goal of helping you understand how a CRT might fit into your financial plan.
IRA Overview
The IRA is one of the best tools around for minimizing your tax bill on investment gains, but it has some key limitations: There is a (pretty low) cap on contributions, for example, and your withdrawal rights are limited.
Like IRAs, Charitable Remainder Trusts allow you to defer the taxes you would otherwise owe on your capital gains. But they do more, too: CRTs have no contribution limit, and they allow you to use your money today instead of having to wait until retirement.
What are the benefits of deferring taxes on your investment gains?
An IRA, at its core, is designed to be a tax-advantaged retirement account; you deposit money into your IRA, and it grows tax free until you withdraw your money. A 35-year old who invests through a traditional IRA and grows her investment at 8% per year until she is 60 might increase her returns by 70% due to the benefits of tax deferral, compared to the gains she would have realized if she had invested that money in a taxable account.
But CRTs and IRAs have a few notable differences.
How Is a CRT Different from an IRA?
For starters, with an IRA, you are typically limited to a $5,000-$8,000 annual contribution. In practice, this means that it’s very difficult to build up a significant nest egg in your IRA, and, as a result, it’s virtually impossible to use for your already appreciated assets like late-stage startup equity or crypto. With a CRT, by contrast, there’s no limit on contributions. If you have startup equity or crypto worth $10 million, you’re welcome to put it all into a trust — and protect it all from an upfront tax bill.
Second, you have much more flexibility when it comes to withdrawing your money from a CRT. IRA withdrawals are strictly controlled: If you pull your money out before you turn 59 1/2, you’ll pay a 10% penalty (outside of a few exceptions). CRT withdrawals are also subject to detailed rules, but the bottom line is this: With a CRT, you will have access to significant liquidity starting in the very first year of your trust, and you will be able to access as much as the full value of your assets in the first five or ten years, depending on how fast the trust grows.
Third, CRTs don’t change the tax character of the income generated inside of them. Income that would be considered long-term capital gains without the trust will still be considered long-term capital gains with the trust. Income that would be considered ordinary income without the trust (such as interest income) is still ordinary income with the trust. In contrast, because IRAs are meant to magnify labor income, IRAs treat all income as ordinary income, which is taxed at higher rates than long-term capital gains. So, if you invest your IRA funds in Nvidia stock, sell that Nvidia stock, and take a distribution, the distribution will be treated as ordinary income despite the fact that it was generated, at least in part, from the sale of a capital asset.
It’s important to note that there is one key trade-off with a CRT: you are required to donate a portion of the value to a charitable organization at the end of the trust’s term. For some, this is an additional benefit — maybe it fits into their existing charitable plans, or maybe they like the idea of committing a significant sum to charity. But if this isn’t something you care much about, you can just price it in: The benefits of tax deferral typically leave you with more capital than you would have had if you had kept the assets in your name, even after subtracting your charitable gift.
Next Steps
Want to know more about Charitable Remainder Trust strategies? Check out our next post on the flexibility of CRTs and how to manage them, or use our CRT calculator to evaluate the potential return on investment given your situation. And if you have any questions, contact us through our chat button below, or schedule a call with us.
About Valur
We’ve built a platform to give everyone access to the tax and wealth-building tools typically reserved for wealthy individuals with a team of accountants and lawyers. We make it simple and seamless for our customers to take advantage of these hard-to-access tax-advantaged structures. With Valur, you can build your wealth more efficiently at less than half the cost of competitors.
From picking the best strategy to taking care of all the setup and ongoing overhead, we make things simple. The results are real: We have helped create more than $3 billion in additional wealth for our customers. If you would like to learn more, please feel free to explore our Learning Center. You can also see your potential tax savings with our online calculators or schedule a time to chat with us!
