Estate Planner Jul-Aug 1998
The new 20% capital gain tax rate may take the steam out of such planning vehicles as charitable remainder trusts (CRTs). Formerly, one of the primary benefits of a CRT was avoiding capital gains. But, with the new lower tax rate on capital gain, couldn’t you just sell the asset, reinvest the proceeds and come out the same or better? Let’s take a look.
Scenario 1: Sell and Reinvest
Assume you and your spouse are both 65 and have securities with a basis of $100,000 that are now worth $1 million. If you sell the securities, you have a gain of $900,000, a capital gains tax of $180,000 (ignoring any state tax) and $820,000 available to reinvest.
Investing at an 8% rate of return, you would receive annual pre-tax income of $65,600. If you and your spouse each live for another 21 1/2 years, you would receive a pre-tax income stream over your remaining years of about $1.4 million. Also, at the end of that time you would still have your $820,000 that can go to your children, but would be subject to estate tax.
Scenario 2: CRT
Now, suppose you instead transfer the securities to the CRT, and the trustee sells them for $1 million. Since the CRT, as an exempt entity, does not pay taxes, the trustee could invest the entire $1 million to earn an 8% return. You and your spouse could receive annual pre-tax income of $80,000 per year, about a 22% increase in your cash flow. This annuity would mean a pre-tax income stream over your life expectancy of $1.72 million. Although your annual cash flow is increased, at the end of that time your children would not have access to the funds in the CRT, and the $1 million would be earmarked for charity.
In addition, if your gift to the CRT would entitle you to an income tax charitable deduction of $173,000, you would save about $68,500 (assuming you are in the 39.6% tax bracket) in income taxes. If you put this tax savings into an investment fund that appreciated at 10% per year over your life, it would grow to about $530,000 that would be available to your children. If you also choose not to spend $5,000 of additional income you will receive from the CRT each year and put it annually into an investment fund growing at 10% after tax, in 21 1/2 years it would accumulate to approximately $330,000.
The Up Side of the CRT
Under the CRT arrangement:
- The total investment fund available for your children would be about the same ($820,000 and $860,000) as without the CRT ($820,000),
- Your annual cash flow would have increased during your lifetime, and
- Charity would receive $1 million.
The Down Side of the CRT
Are there down sides to this CRT plan?
Naturally. First, without the CRT, you would have the after-tax sale proceeds of $820,000 available for emergencies. As noted above, the longer you and your spouse live, the more money builds up in the investment fund and the more assets are available for an emergency. But in the short term, there could be a problem and, if you do not have other financial resources available to you, the CRT may be too risky.
Second, if you and your spouse do not live as long as your life expectancy, the investment fund will not be there for your children. Also, if the investment fund grows at a rate substantially below 10%, a smaller fund would be available for your children. If this is a major concern, the easy option is to use part of the CRT plan savings to purchase wealth replacement life insurance to benefit your children. In fact, this insurance option is a major advantage of the CRT plan because the insurance can be held in trust and remain out of your estates for estate tax purposes.
Good for Many People
CRTs are complex planning vehicles and you will need the help of an experienced practitioner. It is important that projections be made, using various alternative assumptions. The reduction of the capital gains rate from 28% to 20% has tended to make the benefits of a CRT plan less dramatic, but under the right circumstances, a CRT can still be a win-win situation. Please check with us to see if this option is best for you.
|Planning With and Without a CRT
|CRT||Sell and Reinvest|
|Value of Securities||$1,000,000||$1,000,000|
|20% capital gains tax||——–||(180,000)|
|Cash flow at 8%||$80,000||$65,600|
|Cash flow payments over lifetimes (21 1/2 years)||$1,720,000||$1,410,400|
|Investment fund for children at life expectancy date||$820,000 to $860,000||$820,000|
|Distribution to charity||$1,000,000||——-|