Charitable Remainder Trusts vs. Charitable Lead Trusts: Options for Philanthropy in California

For many Californians, building a life of success is coupled with a deep desire to give back to the communities and causes that matter most. Philanthropy is more than just writing a check; it is about creating a lasting impact and weaving your values into a legacy that extends far beyond your lifetime. At the same time, you have a responsibility to manage your assets wisely and provide for your family’s future. These two goals—charitable giving and family wealth preservation—do not have to be in conflict. In fact, with careful planning, they can work together powerfully.

What Are Charitable Trusts and Why Use Them in California?

At its core, a charitable trust is a type of “split-interest” trust. This means it creates two distinct beneficiaries: a charitable beneficiary (a qualified non-profit organization) and a non-charitable beneficiary (typically the person creating the trust, their spouse, or their children). One beneficiary receives an interest in the trust for a set period, and the other receives the remaining assets at the end of that term.

These trusts are established as irrevocable, meaning that once you transfer assets into the trust, you generally cannot change the terms or take the assets back. While this requires a firm commitment, it is also the reason these trusts offer such significant benefits.

A well-structured charitable trust can help you accomplish several key objectives:

Support a Cause You Believe In: You can provide a substantial gift to a public charity or even a private foundation, creating a meaningful philanthropic legacy.
Generate an Income Stream: Depending on the structure, a charitable trust can provide regular payments to you or your loved ones for life or for a specified number of years.
Achieve Major Tax Advantages: Donors may receive an immediate charitable income tax deduction. Furthermore, funding a trust with highly appreciated assets, like stocks or real estate, can allow you to avoid paying capital gains tax on the sale of that asset.
Reduce Estate Taxes: The assets placed in a charitable trust are removed from your taxable estate, which can significantly lower or even eliminate federal estate taxes for your heirs.
Avoid the Probate Process: Like other trusts, assets held within a charitable trust are not subject to the public, costly, and time-consuming probate court process in California.

A Deeper Look at the Charitable Remainder Trust (CRT)

Think of a Charitable Remainder Trust, or CRT, as the “pay you first” trust. When you establish a CRT, you transfer assets into it, and the trust then makes regular payments to you or other designated non-charitable beneficiaries for a specific term. This term can be for the life of the beneficiaries or for a period of up to 20 years. At the end of this term, whatever assets are left—the “remainder”—are distributed to the charitable organization you named.

This structure is particularly popular for individuals who want to support a charity but need to retain an income stream from the assets they are donating.

What are the key benefits of a CRT?

You receive an immediate income tax deduction for the present value of the remainder interest that will eventually go to charity.
You or your chosen beneficiaries receive a potentially steady stream of income for a long duration.
It allows you to sell a highly appreciated asset, such as real estate or stocks, without immediately paying capital gains tax. The trust can sell the asset tax-free and reinvest the entire proceeds to generate income.
The value of the asset is removed from your taxable estate, reducing potential estate tax liability.

What are the types of Charitable Remainder Trusts?

There are two primary forms of CRTs, each with a different method for calculating payments.

Charitable Remainder Annuity Trust (CRAT): A CRAT pays out a fixed dollar amount to the income beneficiaries each year. This amount is determined when the trust is created and never changes, regardless of the trust’s investment performance.

Advantage: The income stream is predictable and stable, which is helpful for financial planning.
Disadvantage: Payments do not adjust for inflation, and you cannot make additional contributions to the trust after it is established.

Charitable Remainder Unitrust (CRUT): A CRUT pays out a fixed percentage of the trust’s value, which is recalculated annually. For example, the trust might pay out 5% of its value each year.

Advantage: If the trust’s investments perform well, the annual payments can increase over time, providing a hedge against inflation. You can also make additional contributions to a CRUT.
Disadvantage: If the trust’s value decreases due to market fluctuations, the payments will also decrease. The income stream is less predictable than with a CRAT.

Exploring the Charitable Lead Trust (CLT)

A Charitable Lead Trust, or CLT, operates in the reverse of a CRT. It is the “pay the charity first” trust. When you create a CLT, the trust makes payments to your chosen charity for a specified term. At the end of that term, the remaining assets are transferred to your non-charitable beneficiaries, typically your children or grandchildren.

This structure is less about creating an income stream for the donor and more about making a significant philanthropic impact now while transferring assets to the next generation with potentially substantial tax savings. It is a powerful tool for legacy planning, particularly for families with large estates.

What are the primary goals of a CLT?

To make a significant and immediate philanthropic gift to a chosen charity over several years.
To transfer assets to heirs while minimizing or eliminating gift and estate taxes. The value of the gift to your heirs is calculated as the total value of the assets minus the value of the payments made to the charity. This can result in a large discount for tax purposes.

What are the types of Charitable Lead Trusts?

Similar to CRTs, CLTs come in two main varieties that determine how payments to the charity are calculated.

Charitable Lead Annuity Trust (CLAT): A CLAT pays a fixed dollar amount to the designated charity each year. This structure is particularly effective for wealth transfer when interest rates are low, as the fixed payments can leave a larger remainder for heirs if the trust’s assets outperform the IRS-assumed interest rate.
Charitable Lead Unitrust (CLUT): A CLUT pays the charity a fixed percentage of the trust’s assets, re-valued annually. This means the charity shares in the investment risk and reward alongside the eventual beneficiaries.

A further distinction exists between “grantor” and “non-grantor” lead trusts, which affects the tax treatment. A grantor trust provides the donor with an upfront income tax deduction but requires the donor to pay income tax on the trust’s earnings each year. A non-grantor trust offers no upfront deduction but provides a gift or estate tax deduction and shields the donor from paying tax on the trust’s income.

CRT vs. CLT: Which Is the Right Choice for Your Goals?

The decision between a Charitable Remainder Trust and a Charitable Lead Trust depends entirely on your primary objective. There is no one-size-fits-all answer, and the best choice is the one that aligns with your personal, financial, and philanthropic priorities.

Here is a simple breakdown to help distinguish their purposes:

A Charitable Remainder Trust (CRT) may be the right tool if your main goal is to:

Receive an income stream. If you wish to convert a non-income-producing asset into a source of cash flow for your retirement or for a loved one.
Diversify your portfolio tax-efficiently. If you hold a highly appreciated asset and want to sell it without incurring a large capital gains tax bill.
Obtain a significant, upfront income tax deduction. The deduction generated by a CRT can help offset high income in a particular year.
Make a charitable gift at the end of your life. Your philanthropic goal is fulfilled after your own financial needs are met.

A Charitable Lead Trust (CLT) may be a better fit if your main goal is to:

Transfer wealth to your heirs with minimal tax impact. This is a highly effective estate planning strategy for reducing gift and estate taxes.
Provide immediate and substantial support to a charity. The charity begins receiving payments as soon as the trust is funded.
Keep a valuable asset in the family. After the trust term ends, the asset itself passes to your children or grandchildren.
Reduce the size of your taxable estate. The value of the “lead” interest given to charity is removed from your estate.

What Types of Assets Can Be Used to Fund a Charitable Trust?

A key benefit of charitable trusts is their flexibility in the types of assets that can be used to fund them. While cash is always an option, the most significant tax advantages often come from donating appreciated assets.

Commonly used assets include:

Publicly Traded Securities: Stocks, bonds, and mutual funds that have grown in value are ideal for funding a charitable trust. Donating them avoids the capital gains tax you would have paid if you sold them yourself.
Real Estate: A personal residence, vacation home, or commercial property can be used. This requires an appraisal to determine the value and careful planning, especially if the property has a mortgage.
Closely Held Stock: Ownership interests in a private or family-owned business can be contributed, though this is a more complex transaction that requires careful valuation and legal structuring.
Cash: Simple and straightforward, cash is an easy way to fund a trust, though it does not offer the capital gains tax avoidance of appreciated assets.

Structure Your Philanthropic Legacy for a Lasting Impact

The decision to create a charitable trust is a momentous one that can shape your family’s future and the future of your community. The attorneys at Garmo & Garmo are prepared to help you explore your options, draft the necessary legal documents, and navigate the intricate landscape of California trust and tax law. We can help ensure your philanthropic vision is realized in a way that is both meaningful and financially sound.

Contact us at (619) 441-2500 for a consultation to discuss your specific needs and learn how you can structure your assets for a successful outcome and a lasting legacy.