Blog Charitable Remainder Trusts for Individual Beneficiaries of Two (or more) Generations

By Cowles Liipfert

This article will not go into the ABCs of Charitable Remainder Trusts (CRT’s).  We will assume that the readers are already somewhat familiar with CRTs, and the pros and cons of using CRTs in their personal planning.

Most of the time CRTs are created for an individual or married couple to make planned gifts to charitable organizations, whereby the trusts terminate upon the death of the Trust’s Settlor or Grantor (hereinafter called the “Grantor”) and/or, if applicable, the Grantor’s spouse.  The immediate benefits to the Grantor include (1) a charitable deduction for income tax purposes in the year of the gift to the CRT, (2) the assets can be diversified and reinvested by the trust without immediate income tax consequences on all the capital gains realized if the assets are sold, and (3) there is no gift or estate tax consequence for a gift to the Grantor’s spouse, because of the gift and estate tax marital deduction.

Any charitable deduction would not be for the full value of the assets transferred to the CRT, but would be reduced by the likely value of the retained life interest of the Grantor (and the spouse, if applicable), using federal actuarial tables to determine their life expectancies along with other factors, such as prevailing interest rates (Applicable Federal Rate or AFR), the percentage payout during their lifetimes, and the frequency of distributions – whether monthly, quarterly, semi-annually or annually.

The ages of the life beneficiaries and the applicable payout percentage set forth in the trust agreement (it must be at least 5%), in addition to the value of the assets transferred to the trust, are the primary factors in determining the value of the charitable remainder, i.e., the amount of the Grantor’s charitable deduction upon the transfer of assets to the CRT, 

Although not done often, it is also possible to name others (other than the Grantor and the Grantor’s spouse) as CRT beneficiaries prior to the ultimate charitable distribution, but there are a specific set of rules which must be strictly complied with, if the trust is to qualify as a CRT, most notably “The 10% Test,” which requires that the actuarial value of the charitable remainder be at least 10% at the time when the trust is created.

That is, the Grantor will not get the tax benefits described above if the CRT does not meet The 10% Test.

If a grandparent wanted to name a 5-year-old grandchild as a successor life beneficiary after the death of the Grantor and Grantor’s spouse, the trust would not pass The 10% Test, because that grandchild would have a 70-plus year life expectancy, and a CRT is generally required to distribute at least 5% per year to the individual beneficiaries prior to the termination of the CRT.  Taking those factors into consideration, the trust would not pass The 10% Test. Consequently, it is not possible to use a 5-year-old grandchild as a measuring life for the term of a CRT.

The 10% Test prevents many people from using the lifetimes of their children and/or grandchildren as measuring lives for the term of a CRT.  At the time this article is written, the Applicable Federal Rate (AFR) is still low by historical standards, but with inflation surging, the AFR is likely to go up as a percentage, which will affect the actuarial value of a charitable remainder interest.  In May 2022, a new CRT for a married couple and their three children, using their five lives to measure the term of the CRT, would not meet the 10% Test unless the children were in their mid-forties, or older.

If someone wants to create a CRT for beneficiaries who are much younger than the Grantor, a CRT could possibly be created for a term of 20 years or less, instead of being created for the lifetimes of the young beneficiaries.  In that case, a CRT for a term for a maximum of 20 years could meet The 10% Test.

Another possibility would be to create a CRT which used the lifetimes of older individuals as the measuring lives for the CRT term, but which named younger beneficiaries to receive the distributions.  An example would be to create a CRT for a term ending with the death of the Grantors’ last living child, assuming that such trust term would satisfy the 10% Test, but would name the Grantors’ grandchildren as beneficiaries or successor beneficiariues during the lifetimes of the children whose lives were the measuring lives for the CRT. That way, the grandchildren might receive distributions for perhaps 20 or 30 years, but not for their lifetimes.

A good practical example of how a trust could benefit grandchildren would be: Suppose the Grantor had two children and created a CRT for the joint lifetimes of the Grantor and the two children, to terminate upon the last death of the three of them – and suppose that the Grantor and one child died, but that the surviving child lived for a number of additional years.  The CRT could continue in effect until the second child’s death, but during the remaining trust term, the trust agreement could provide that the trust distributions would be one-half to the surviving child and one-half to the Grantor’s grandchildren by the deceased child.  That way, the deceased child’s children would continue to receive distributions until the death of the Grantor’s second child.

Even when The 10% Test is met, there are other tax drawbacks to naming younger beneficiaries as non-spousal beneficiaries of a CRT: (i) the charitable deduction would be smaller at the time the trust is created; and (ii) the gift tax value of any individual beneficiaries other than the spouse, would use up part of the Grantors’ lifetime gift tax exemption or exemptions, and later, the estate tax exemption at the Grantors’ deaths.  Notwithstanding those tax drawbacks, it might be worthwhile for someone to consider such a CRT. If you would like to consider the possibility of creating a CRT including other beneficiaries than you and your spouse prior to termination of the trust, please call our firm at (336) 725-2900 to arrange a planning conference with one of our attorneys.