Category: Charitable Remainder Trust

6 Proven Retirement Income Planning Strategies Beginning at Age 62

Post author By Robert Klein
Post date January 17, 2022

This article was originally published in, and has been reprinted with permission from, Retirement Daily.

When you contemplate your life, you can usually pinpoint pivotal moments that changed the trajectory of who you are today. Often times, there are one or more magical moments that you will never forget.

In the retirement planning world, age 62 is that moment. Until then, you accumulate assets for some unspecified future date when you will transition from working full time to perhaps part time, and then, in most cases, fully retire. Your primary source of income, i.e., employment, will eventually come to a grinding halt.

Beginning at age 62, several things will begin to quickly unfold that will require you to change your retirement planning mindset from asset to income accumulation. You will need to figure out how to convert the assets that you worked hard to save into a predictable income stream beginning on a specified date, or within a range of dates, that will enable you to match your projected financial needs in retirement. Furthermore, you will need to develop various strategies for creating after-tax retirement income in order to optimize the longevity of your assets for the rest of your life. Needless to say, this is no small task.

This article provides an overview of six proven strategies that can be implemented beginning at age 62 that are at the core of the transition from retirement asset to retirement income planning. Strategies #4 and #5 should be considered before age 62 whenever possible and strategy #6 when applicable. Most important, all potential strategies should be evaluated as part of a holistic retirement income plan.

Strategy #1: Defer Social Security Start Date

You can start your Social Security retirement benefits as early as age 62 or as late as age 70. Unless you’re no longer working and have no other sources of income or you have a life-threatening illness, it generally isn’t advisable to start receiving Social Security at age 62. This is due to the fact that benefits may be 30 percent less than what they would be at your full retirement age which is between 66 and 67 depending upon the year you were born.

Your Social Security benefits will increase by 8% per year plus cost-of-living adjustments for each year that you defer your start date between full retirement age and age 70. Social Security can be used to insure your, and, if married, your spouse’s longevity risk.

The decision regarding when to begin receiving Social Security retirement benefits should be carefully analyzed, especially if you’re married. In addition to locking in the amount of your benefit, you are also potentially establishing the amount of your spouse’s monthly payment in the event that you die first.

Strategy #2: Gain Unrestricted Access to Home Equity

As discussed in my 5 Key Financial Metrics When Evaluating a HECM Reverse Mortgage article, housing wealth, although it represents about one half of an average household’s net worth, is often ignored as a retirement income planning tool. There are numerous strategies that can be used to provide readily available tax-free liquidity to pay for planned and unforeseen expenses throughout retirement by monetizing a portion of the equity in one’s home.

Several of the strategies can be used in conjunction with home equity conversion mortgages, or HECMs, the most popular reverse mortgage program. You can qualify for a HECM beginning at age 62. All homeowners age 62 or older with or without a mortgage should evaluate a potential HECM for its ability to provide unrestricted access to an increasing tax-free line of credit without the downsides of a home equity line of credit, or HELOC.

When implemented early and used strategically to unlock illiquid home equity, a HECM reverse mortgage can be used to increase after-tax cash flow at opportune times throughout retirement while providing peace of mind.

Strategy #3: Reduce Medicare Part B and D Premiums

Medicare Part B and D premiums are determined using modified adjusted gross income (MAGI) from your federal income tax return two years prior to the current year. Assuming you enroll in Medicare when you become eligible at age 65, your MAGI from two years prior, or age 63, will determine your Medicare premiums at 65. 2021 Medicare Part B monthly premiums range from $148.50 to $504.90 per person depending upon tax filing status and 2019 MAGI

Medicare Part B and D premium planning should begin at age 62 when you’re one year away from having your income determine your premiums when you turn 65. You should incorporate the Medicare income brackets into your income tax projections every year for the rest of your life to determine the amount of your projected Medicare Part B and D monthly premiums. Using this information, you can develop strategies to reduce your projected MAGI and associated premiums.

You need to always keep in mind when planning Medicare premium reduction strategies that it’s a year-by-year proposition given the fact that premiums are determined using your MAGI from two years prior to the current year. If your income in a particular year is projected to experience an unusual spike that’s attributable to a one-time or infrequent event that will otherwise optimize your projected after-tax retirement income for several years, it will usually make sense to pay the increased Medicare Part B and D premiums in that year. Examples include a sizable strategic or market-sensitive Roth IRA conversion or an unusual increase in a business owner’s income that will enable a larger qualified business income (QBI) deduction that will result in a large amount of income tax savings.

Strategy #4: Roth IRA Conversion Window of Opportunity

A multi-year, or staged, Roth IRA conversion strategy is a great example of a retirement income planning technique that should ideally be implemented beginning 20 years before retirement. A ten-year window of opportunity begins at age 62 for doing a Roth IRA conversion, creating a greater sense of urgency for implementing this strategy. This corresponds to the ten years prior to the age 72 commencement of lifetime annual required minimum distributions, or RMDs, from retirement plans.

Roth IRA conversions beginning at age 62 will reduce your annual RMDs for the rest of your life. This can, in turn, potentially reduce your annual taxable income, Medicare Part B and D premiums, taxable Social Security benefits, and net investment income tax. To the extent that this occurs, this will increase after-tax retirement income and contribute to the overall goal of optimizing asset longevity. Reduced RMDs also reduce the survivor’s exposure to the widow(er)’s income tax penalty for couples.

Reduced RMDs can also reduce the value of taxable retirement plan accounts at death and, in turn, reduce taxable income for non-spouse beneficiaries. Given the fact that most non-spouse beneficiaries are subject to a 10-year payout rule for taking distributions from retirement plans and IRA accounts, a reduction in the value of taxable accounts will often result in less tax liability for children and other non-spouse beneficiaries.

Per Strategy #3, taxable income from Roth IRA conversions needs to be balanced against potential higher Medicare Part B and D premiums beginning at age 63. The reduction in RMDs and associated lifetime income tax savings beginning at age 72 can more than offset increased Medicare Part B and D premiums between age 63 and 72 if done strategically.

Strategy #5: Lock in Sustainable and Potentially Tax-Favored Lifetime Income

The fifth strategy – locking in sustainable and potentially tax-favored lifetime income, has gained in popularity as a result of the virtual demise of corporate pension plans. Besides Social Security, opportunities for receiving a sustainable lifetime income stream with built-in longevity insurance to reduce the risks associated with the stock market have dwindled in the private sector.

Immediate and deferred fixed income annuities are a natural fit for filling this gap in a holistic retirement income plan beginning at any age. Purchase of fixed income annuities takes on more urgency at age 62 due to the fact that the income start date for the majority of fixed income annuities will occur by age 72, leaving less time for deferred growth and increased lifetime income. The income start date is subject to the RMD rules when purchases are made from qualified accounts and traditional IRAs.

Income optimization is the appropriate benchmark that should be used when evaluating fixed income annuities for inclusion in a retirement income plan. The goal is to design a comprehensive strategy that uses the least amount of assets to purchase the greatest amount of sustainable after-tax lifetime income that’s projected to pay for expenses not covered by Social Security, pensions, and distributions from investment and other assets.

Fixed income annuities come in three flavors: single premium immediate annuities (SPIAs), deferred income annuities (DIAs), and fixed index annuities (FIAs) with income riders. SPIAs and DIAs enjoy a unique income tax advantage when purchased in a nonqualified, or nonretirement account.

Unlike FIAs with income riders that distribute ordinary income that’s fully taxable, SPIAs and DIAs are annuitized. Periodic payments include income and a return of premium, or investment. When held in a nonqualified account, the return of premium portion of each payment, which can be 50% or greater, is nontaxable. Once 100% of one’s investment has been received, future payments are fully taxable.

Strategy #6: Achieve Sizable Tax Savings and Tax-Favored Lifetime Income When Selling Highly Appreciated Nonretirement Assets

The sixth strategy, although it can be used by anyone at any time, tends to be implemented by individuals in their 60’s. Generally speaking, they’re the ones with highly appreciated nonretirement assets who are looking for a tax-favored lifetime income exit plan. This includes real estate, investment securities, and businesses.

This strategy is designed to reduce or eliminate income tax liability attributable to the capital gain that owners will realize from the sale of the highly appreciated asset by transferring a portion, or all, of the ownership of the asset from one or more individuals to a charitable remainder trust, or CRT, prior to the sale while providing tax-favored lifetime income. A CRT, which is a tax-exempt trust, is a long-standing IRS-blessed strategy when properly structured.

There are six benefits associated with a CRT:

The capital gain on the sale of assets owned by a CRT is exempt from taxation.
CRT funding creates a sizable income tax deduction equal to the projected remainder interest of the CRT that will eventually pass to one or more charities.
The proceeds from the sale of CRT assets can be reinvested to provide a lifetime income stream for the beneficiaries.
Most of a CRT’s annual income will be taxed at favorable long-term capital gains tax rates.
A CRT is an excellent philanthropic tool since the remainder interest of the assets will be distributed to one or more chosen charities following the death of the surviving lifetime income beneficiaries.
CRT assets avoid estate tax.

Six Proven Strategies

The six strategies that are highlighted in this article are proven strategies for creating and optimizing after-tax retirement income that can individually and collectively prolong the longevity of one’s assets in retirement. Each strategy can be implemented beginning at age 62 as part of a holistic retirement income plan.

Deferring Social Security start date (strategy #1) is a time-sensitive strategy. Once you start receiving Social Security, with some limited exceptions, it’s an irrevocable decision that, with the exception of potential cost of living adjustments, will lock in the amount of your periodic and lifetime payments and can also affect your spouse’s payments.

Gaining unrestricted access to home equity (strategy #2) through a HECM reverse mortgage should be implemented at age 62, the qualifying age, whenever possible to optimize the growth of, and after-tax distributions from, the credit line. Planning for reducing Medicare Part B and D premiums (strategy #3), which is an annual strategy, should be implemented beginning at age 62 since income from your federal income tax return beginning at age 63 will be used to determine your Medicare Part B and D premiums when you’re 65.

Roth IRA Conversions (strategy #4) and locking in sustainable and potentially tax-favored income (strategy #5) should be considered before age 62 whenever possible since there’s no restriction on the start date and earlier vs. later implementation can optimize after-tax lifetime income in retirement.

Achieving sizable tax savings and tax-favored lifetime income when selling highly appreciated nonretirement assets (strategy #6) is dependent upon (a) owning highly appreciated assets such as real estate, investment securities, or a business and (b) a desire to sell those assets.

Let the magic begin!

Charitable Remainder Trust Estate Planning Income Tax Planning

Reduce Capital Gains Tax on the Sale of Your Business

Post author By Robert Klein
Post date July 12, 2021

Businessmen making handshake with his partner in cafe - business etiquette, congratulation, merger and acquisition concepts

This article was originally published in, and has been reprinted with permission from, Retirement Daily.

Located at the end of President Biden’s American Families Plan released on April 28^th is the administration’s wealth redistribution plan titled “Tax Reform That Rewards Work – Not Wealth.” The section begins with the statement that the goal is to reverse provisions of the Tax Cuts and Jobs Act of 2017 and reform the tax code “…so that the wealthy have to play by the same rules as everyone else.”

Proposed Lifetime and Death Capital Gains Tax Rate of 43.4%

The American Families Plan would increase the top marginal income tax rate from 37% to 39.6%. In addition, the proposed top rate of 39.6% would replace the current long-term capital gains tax rate of 20% for households with income over $1 million. While income at this level is not the norm (539,000 income tax returns were filed in 2019 with 2018 adjusted gross income of more than $1 million, representing 0.4% of 141 million total returns filed), it is not unusual for business owners to cross the $1 million threshold when they sell a business.

Long-term capital gains tax rates for households with income over $1 million would almost double under President Biden’s plan, increasing 19.6% from 23.8% to 43.4% when you include the net investment income tax of 3.8%. Let us not forget about state income tax. Add on 13.3% if you live in California for a total marginal tax rate of 56.7% on all income, including long-term capital gains.

The proposed legislation would also eliminate the step-up in basis on unrealized gains exceeding $1 million at death. The step-up in basis allows individuals with appreciated assets to avoid income taxation on the appreciated value when they die. Unrealized gains exceeding $1 million at death would be taxed at a 43.4% rate unless the appreciated assets are donated to charity.

Eliminate Capital Gains on Business Sales with a CRT

Lifetime charitable giving has historically benefited individuals with highly appreciated non retirement assets such as real estate, investment portfolios, and businesses. Many savvy business owners who are planning on selling their business and want to reduce or eliminate income tax liability attributable to the capital gain that they will realize from the sale can use a long-standing IRS-blessed strategy called a charitable remainder trust, or CRT. A properly designed and administered CRT managed by an experienced investment advisor who specializes in CRTS and is familiar with their four-tier payout scheme can be used as the cornerstone of a successful business owner’s retirement income plan.

A CRT is a tax-exempt trust. The initial and one of the most important benefits of a CRT is that the gain on the sale of assets owned by a CRT is exempt from taxation. This includes ownership of a business interest.

Tax Proposal Creates Sense of Urgency for Implementation of CRT Business Sale Strategy

The proposed long-term capital gain tax rate increase of 19.6% has created a sense of urgency for business owners who are thinking about selling their businesses in the near future. The CRT strategy will increase in popularity with the proposed tax law changes. It will likely result in the acceleration of the sale of many businesses to avoid the increased tax liability attributable to long-term capital gains exceeding $1 million from the sale if the proposed changes are enacted.

It is important to keep in mind that the proposed tax legislation that’s part of the American Families Plan is in its early stages. The long-term capital gains tax rate increase of 19.6% and elimination of the step-up in basis at death are major departures from long-term fixtures of the income tax law, and, as such, are controversial and subject to modification.

Having said this, given the reality that one of the overriding goals of the current administration is redistribution of wealth as evidenced by the fact that the American Families Plan was released on the 98^th day of the new administration, successful business owners have a lot at stake and need to act quickly before the proposed legislation or some form of it is enacted. Furthermore, business owners and others adversely affected by the proposed legislation need to keep in mind that any tax legislation that is enacted, whether it is in 2021 or 2022, could have an effective date as of the date of enactment or even a retroactive date.

CRT Funding Creates a Current Income Tax Deduction

When the CRT income beneficiary(ies) die, the remainder interest in the CRT is transferred to one or more charitable organizations specified in the CRT document. This creates a second income tax benefit to the business owner, i.e., a charitable contribution deduction, that can be used to offset otherwise taxable income.

The deduction, which is taken in the year that the business interest is transferred to the CRT, is the present value of the projected remainder interest of the CRT that will pass to one or more charities. The amount of the deduction can be hundreds of thousands of dollars or more depending upon the value of the business interest being transferred to the CRT and the age of the business owner and spouse if married. The allowable charitable deduction is limited to 30% of adjusted gross income, with excess amounts carried forward for five years.

CRT Lifetime Income Stream is Tax-Favored

The third income tax benefit enjoyed by a business owner who sells part or all of his/her business interest using a CRT is favorable taxation of CRT income. The net proceeds from the sale of a business interest owned by a CRT are reinvested by the CRT to provide a lifetime income stream to a designated beneficiary who is generally the business owner and his/her spouse if married.

The periodic income payment is calculated using either a fixed dollar amount if it is a charitable remainder annuity trust (CRAT) or a fixed percentage of the annually redetermined net fair market value of trust assets for a charitable remainder unitrust (CRUT). The taxation of CRT income, which is reported annually on Schedule K-1, is driven by the character of the income being distributed, taxed in the following order under a four-tier payout scheme: ordinary income, capital gains, tax free income, and principal.

Most of a CRT’s annual income will be taxed as long-term capital gains at a current top federal tax rate of 23.8% since the origin of a CRT from the sale of a business is untaxed long-term capital gains. CRT income classified as long-term capital gains will continue to enjoy favorable tax treatment if President Biden’s proposal is enacted provided that total taxable income in a given year is less than $1 million.

Potential CRT Income Tax Savings – Current Income Tax Law

In summary, income tax savings attributable to establishing and funding a CRT in connection with the sale of business includes three components: elimination of the capital gain from the sale of the business, a sizable charitable contribution deduction, and favorable income tax treatment of CRT lifetime income distributions.

The latter benefit is threatened if the administration’s tax proposal is enacted and taxable income in a particular year exceeds $1 million. When this occurs, it generally happens in the year of sale. It could extend to future years if the business is sold on an installment sale basis depending upon the selling price and the amounts received in subsequent years.

The easiest way to illustrate the initial and ongoing income tax savings from a CRT is with an example. The example applies current income tax law and includes the following eight assumptions:

Sale of business on June 30, 2021 with long-term capital gain of $5 million
Reinvestment of net proceeds of business if sold outright with a return of 5% split 50/50 between qualified and nonqualified dividend income
Reinvestment of net proceeds of business if sold by CRT with annual distributions of 5% of prior year’s December 31^st CRT value split 75/25 between long term capital gains and dividend income, with the latter split 50/50 between qualified and nonqualified dividend income
Other ordinary income of $200,000
Standard deduction with outright sale
Married filing joint tax status
Ages 63 and 59
California resident

Cases #1 and #2 – Outright Sale of Business

The purpose of Case #1 is to calculate the income tax liability attributable to the long-term capital gain of $5 million from the sale of the business. Per the illustration, federal income tax would be $1.143 million, or 22.86% of the gain. California tax would be $623,000, or 12.46% of the gain, for total income tax liability of $1.766 million, or 35.32% of the gain.

Case #2 includes investment income of $81,000 and other ordinary income of $200,000, increasing taxable income from $4.975 million to $5.256 million. Total income tax liability increases from $1.766 million to $1.908 million, or 36.13% of total adjusted gross income.

Case #3 – Sale of 100% of Business by CRT

Case #3 assumes that 100% of the ownership of the business is transferred to a CRT prior to the June 30, 2021 assumed closing date. This would result in the following:

Long-term capital gain of $0
Charitable contribution deduction of $1.422 million with allowable deduction of $97,500 in 2021, $135,000 in 2022, and the balance of $1,189,500 carried forward for four years
Total projected 2021 income tax liability of $52,000 or $1.856 million less than Case #2 tax liability of $1.908 million
Reinvestable net after-tax proceeds of $4.9 million, or $1.8 million greater than Case #2 of $3.1 million.
Annual investment income of 5% of the CRT value of $5 million, or $250,000, which is $88,000 greater than the projected annual investment income of $162,000 from the net after-tax proceeds from an outright sale
$218,750, or 87.5%, of CRT investment income of $250,000 taxed at a 23.8% capital gains tax rate vs. $80,846, or 50%, of non-CRT investment income of $162,000 taxed at a 23.8% capital gains tax rate
Total projected 2022 income tax liability of $75,000, or $18,000 less than Case #2 projected liability of $93,000

Enactment of the American Families Plan would result in additional federal income tax liability of 19.6% of $5 million, or $980,000, for an outright sale. Without a CRT, reinvestable net after-tax proceeds of $3.1 million would be reduced to $2.1 million, or 42.2%, of the long-term capital gain of $5 million.

CRT Assets Avoid Estate Taxation

Did I mention that there is another tax bill that Senator Bernie Sanders and the White House formally proposed on March 25^th called the “For the 99.5% Act?” This proposal would reduce the federal gift and estate tax exemption of $11.7 million per individual to $3.5 million effective January 1, 2022. The “For the 99.5% Act” would also increase the estate tax rate from 40% to 45% on taxable estates exceeding $3.5 million, 50% on estates above $10 million, and 65% for estates over $1 billion.

A CRT is an excellent estate planning strategy for reducing estate tax. CRT assets avoid estate tax since the remainder of the CRT passes to charity at death, and, as such, it is excludable from one’s taxable estate. In the preceding example, the remainder value of the $5 million of assets transferred to the CRT would be excluded from the husband and wife’s estate.

Retirement Income Planning Essential When Evaluating CRT Strategy

A CRT is a powerful planning strategy that can be used as the cornerstone of a successful business owner’s retirement income plan. It offers the opportunity for sizable initial and ongoing income tax savings, increased sustainable lifetime tax-favored income, elimination of estate tax on CRT assets, and, last, but not least, a philanthropic/legacy component, i.e., the distribution of the remainder of the CRT to one or more chosen charities.

There are many situations where individuals who have used this strategy have accumulated a larger estate that has been distributed to their heirs than they would have without a CRT. This can occur when a CRT is combined with an irrevocable life insurance trust that purchases life insurance on the life of the business owner and his/her spouse if married using a portion of the income tax savings from implementing the CRT.

The CRT strategy, while it offers several significant benefits for business owners considering selling a business and for their families, is not for everyone. The implementation of a CRT generally should not be an all or nothing situation whereby 100% of the ownership of a business is transferred to a CRT.

It is important to strike a balance between CRT vs. individual ownership, weighing the pluses and minuses of each in a particular situation within the context of a holistic retirement income plan. Paying some income tax is not necessarily a bad thing – especially if you can do so at a federal tax rate of 23.8% vs. 43.4%.

Charitable Remainder Trust Income Tax Planning Retirement Income Planning

How to Avoid Tax and Receive Tax-Favored Lifetime Income on the Sale of a Rental Property

Post author By Robert Klein
Post date October 2, 2018

A popular strategy for individuals who want to sell a rental property that has appreciated in value while deferring income tax on the gain is a 1031 exchange. Named after the IRS code section that authorizes this tactic, you can defer tax on the gain by purchasing a replacement property whose purchase price and loan amount are the same or greater than the property being sold provided various timing and other rules are met.

Suppose, however, that you no longer want to manage or own rental properties, you don’t want to pay income tax on the gain if you sell your property, and you need ongoing income. You can accomplish this using a long-standing strategy recognized by IRS provided that there’s either no mortgage on the property or one that can be paid off.

Enter the Charitable Remainder Trust

A charitable remainder trust, or CRT, can be a great solution for someone in this situation. It has been used by numerous families since 1969 to increase income, save taxes, and benefit charities. Its appeal as a retirement income planning strategy is compelling given the scarcity of traditional pension plans and ongoing concern about the financial stability of Social Security.

A CRT is an irrevocable trust created under the authority of Internal Revenue Code Section 664. When you transfer title of property to a CRT, your CRT becomes the legal owner. You, and potentially your children, receive lifetime income from your CRT. When you pass away, the remaining assets are distributed to one or more charities of your choice.

A CRT offers the following five benefits when used for highly appreciated assets such as rental properties:

Sizable charitable contribution deduction
Avoidance of capital gain tax on the sale of property
Conversion of highly appreciated asset into tax-favored lifetime income
Removal of current asset value and future appreciation from estate
Helps charities that are important to you

Sizable Charitable Contribution Deduction

When you transfer title of property to a CRT, you transfer ownership to a separate legal entity, the ultimate beneficiary of which will be one or more charitable organizations of your choice. This entitles you to a charitable contribution deduction, the amount of which is equal to the “present value of the remainder interest” that will go to charity.

The calculation of the present value of the remainder interest takes into consideration several factors. These include the value of the property transferred to the CRT, the age and sex of the individuals receiving income from the CRT, and the CRT income distribution percentage.

Generally speaking, the older the income beneficiaries, the greater will be the charitable contribution deduction since income will be paid by the CRT to the income beneficiaries for a shorter period of time. As an example, a 76-year old woman who transfers rental property to a CRT valued at $900,000 who will be the sole income beneficiary of the trust is entitled to a charitable contribution deduction of approximately $335,000.

The amount of federal and state income tax savings associated with the charitable contribution deduction is dependent upon your federal and state marginal tax brackets and your ability to use the deduction. The deduction is limited to 30% of adjusted gross income, with the unused portion carried forward for five additional years. Income tax planning, including analysis of the timing of the transfer of a rental property to a CRT, is critical.

Avoidance of Capital Gain Tax on the Sale of Property

When you sell highly appreciated rental property, the capital gain and associated income tax liability can be significant. The gain can be sheltered to the extent that you have “suspended passive losses.” Suspended passive losses arise when a property has expenses that exceed its income, income from all sources exceeds a specified threshold, and the property owner isn’t a real estate professional. They are nondeductible in the year in which they occur.

Suspended passive losses for a specific property can be used in their entirety when the property is sold. A CRT should be considered whenever there are no suspended passive losses or the losses won’t substantially reduce projected income tax liability on the sale of the property. One important caveat, as mentioned earlier, is that there can be no mortgage on the property or it can be paid off prior to transferring title to the CRT.

Continuing the earlier example, assume that the 76-year old woman sold her highly-appreciated rental property for $900,000. The property has no mortgage, no suspended passive losses, and a low cost basis. Her projected federal and state income tax liability attributable to the sale would be $330,000. This would leave her with net sales proceeds of $534,000 after assumed closing costs of $36,000.

Let’s assume instead that title of the property is transferred from this individual to a CRT and is subsequently sold by the CRT for $900,000. Since the property is sold by a CRT, there would be no capital gain tax. The CRT would net $900,000 less closing costs of $36,000, or $864,000 from the sale.

Conversion of Highly Appreciated Asset into Tax-Favored Lifetime Income

Assuming that replacement of rental property income is a goal, the CRT in our example could be designed to distribute 5% or more of its net income each year for the remainder of the income beneficiary’s life. The net proceeds from the sale of the rental property would generally be invested in a professionally managed investment portfolio and other types of appropriate investments. A portion of the portfolio would be liquidated each quarter to pay income distributions, investment management fees, and trust administration fees.

Using a distribution rate of 5%, the distribution to the CRT income beneficiary in the first year in our example would be $864,000 x 5%, or $43,200. Since the origin of the CRT investment portfolio is a long-term capital gain, the income would be reported by the CRT as a long-term capital gain on the income beneficiary’s K-1. This would continue until such time as 100% of the long-term capital gain from the sale of the property has been reported as income.

Unlike rental property net income that’s often less than CRT distributions and is taxable as ordinary income at an individual’s highest tax rate, CRT income in this situation would receive favorable long-term capital gain tax treatment. This could result in minimal income tax liability attributable to the CRT income depending upon the individual’s other income sources and amounts.

Removal of Current Asset Value and Future Appreciation from Estate

Since a CRT is a separate legal entity with one or more charitable organizations as the remainder beneficiary, the transfer of property to a CRT removes the current value and future appreciation of the property from one’s estate. As such, a CRT can be used to reduce estate tax liability for individuals with a high net worth who will be subject to estate tax. This currently applies to an estate value in excess of $5.6 million for single individuals and $11.2 million for married couples.

Even if estate tax liability isn’t a concern, estate preservation often is. Going back to our example, the sale of the rental property by a CRT would result in net proceeds of $864,000, or $330,000 greater than the net proceeds of $534,000 if sold individually.

There are various strategies that can be used by a CRT to preserve one’s estate in this situation. They include the following three, a discussion of which is beyond the scope of this blog post:

Reinvest income tax savings and annual CRT distributions in excess of former rental property income to offset the loss of one’s estate resulting from transferring property to a CRT.
Provide for continuation of lifetime income payments to children upon the death of the initial income beneficiary.
Use income tax savings to fund a “wealth replacement trust” that purchases life insurance to replace the value of the rental property that’s transferred to a CRT.

Helps Charities That are Important to You

As previously stated, the ultimate beneficiary of a CRT is one or more charities of your choice. After you, and potentially your children, receive lifetime income from a CRT, the remaining value at death is distributed to one or more charitable organizations. The knowledge that this will occur can be very rewarding depending upon one’s charitable inclinations and legacy goals.

A Powerful Retirement Income Planning Strategy

Anyone considering the sale of highly-appreciated unencumbered rental property, the gain from which won’t be significantly sheltered by suspended passive losses, is a potential candidate for a charitable remainder trust, or CRT. The various benefits of a CRT, including substantial income tax savings and tax-favored lifetime income for one or more generations, can provide creative planning opportunities. It’s especially powerful when used as a retirement income planning strategy.