What about my heirs with a CRT?

When you (and your spouse) are gone, the CRT assets go then to the charity(ies) you have named and not to your heirs. You may not like that, and your heirs especially may not like that. However, there are two alternative ways to solve the problem, so it will actually “pay to give away”:

The first way is for you to invest outside the CRT your tax savings from the income tax deduction. Under the example above, the IRS rules provide that $35,120 in taxes is saved on a $300,000 CRT. You would also then personally save and invest the extra cash flow you receive because of having the CRT as opposed to a sale by you. In other words, you would still spend the $12,125 per year you would have had after taxes if you had sold the $300,000 asset and paid the income tax on the capital gain.

Therefore, under the example above you would save a minimum of $3,547 in extra cash each year. With the assumptions above, these amounts you invest outside of the CRT would compound and grow to $278,614 at the end of a 65-year old’s life expectancy. This is $72,304 more than the mere $206, 310 as you would have had left for your heirs if you had sold and then spent the same $12,125 per year in cash.

However, the risk in the first alternative is you may pass away before the end of your life expectancy. If you die early, you will not have had time to save and invest the extra cash flow, and so it will not have grown to equal the $206,310 from a straight sale.

This then leads to the second alternative. The tool makes sure that your heirs receive at least as much as or more than what they would have received if you had not transferred the property to the CRT. Instead of investing tax savings and the $3,547 in extra cash flow each year yourself, you would instead give such amounts to the trustee of yet another trust, a life insurance trust – many times called a “wealth replacement trust”. The trustee of the insurance trust, usually a child or sibling of yours, would take out a life insurance policy on your life. The trustee uses the cash from the tax savings and the extra cash flow from the CRT each year to pay insurance premiums. Typically, those amounts will buy a life insurance policy that pays as much or even more when you are gone (the $278, 614 under our example).

On your death the policy proceeds are paid to the insurance trust and then distributed to the insurance trust beneficiaries. There are then two great tax advantages of the insurance. First, proceeds are free from income tax. Second, and even more dramatically, the proceeds go to your heirs free from the estate tax. This happens because the life insurance trust, and not you, owns the policy. Therefore, the life insurance trust can transfer a substantial amount (life insurance proceeds) to your heirs without being subject to estate tax.

The result is even more spectacular when you consider what would have happened to the $206,310 left after a sale by you, without the CRT. That amount would be taxed by the estate tax. Therefore, your heirs would have been left with only $121,723 after estate tax ($206,310 minus $84,587, assuming $1,000,000 in other assets), compared to at least $278,614 in that case of a CRT with a life insurance trust.

Please note that if you find you are uninsurable, the odds are still good with the first alternative that your heirs will be at least as well off as in a sale.

The combined effect of the above is you receive the same income as if you had sold the asset, and your heirs receive at least as much or probably more when you are gone. It may pay to give away.