Changes in interest rates can have a significant impact on optimal charitable giving structures. Some techniques are most effective in lower interest rate environments,¹ while others are more compelling when rates are elevated. Investors seeking to tax-efficiently diversify a highly appreciated, concentrated position while also accomplishing philanthropic objectives in today’s higher interest rate environment may wish to consider a Charitable Remainder Trust (CRT).

CRTs provide an income stream to one or more noncharitable beneficiaries during the term of the trust, and assets remaining in the trust at termination pass to charity. Capital gains generated from the sale of the concentrated position inside a CRT are deferred until they are distributed to the noncharitable beneficiary.

For illustrative purposes only.

The donor receives a significant charitable income tax deduction in the year of the transfer that is proportional to the actuarially computed value of the charity’s remainder interest. The value of the income stream to the noncharitable beneficiary varies inversely with the Section 7520 rate,²  so all else being equal, a higher Section 7520 rate reduces the value attributed to the noncharitable annuity and increases the value ascribed to the charitable remainder interest. That, in turn, increases the amount of the charitable deduction and overall effectiveness of the strategy.³

To ensure that a CRT is respected by the IRS as a legitimate charitable giving vehicle, the value of the remainder interest must equal at least 10% of the assets transferred to the trust. Increases in interest rates have provided increased flexibility to meet this requirement, and CRTs have become more accessible.

How changes in interest rates can impact CRTs:

As interest rates have recently soared, so has the Section 7520 rate. Between January 2021 and September 2023, the Section 7520 rate skyrocketed from 0.6% to 5.0%,⁴ enhancing the efficacy of CRTs as tax-efficient divestment and philanthropic devices.

There are multiple flavors and varieties of CRTs.⁵  One of the most common types of CRT is the Charitable Remainder Unitrust (CRUT), in which the annual payout to the noncharitable beneficiary is based on a fixed percentage of the value of the trust assets determined annually.

In CRUTs as Tools for Advanced Risk Management, we analyze in detail the circumstances in which CRUTs can provide superior wealth outcomes and their utility across two dimensions: the magnitude of the concentrated risk exposure and the investor’s level of charitable intent. We note that utilizing a CRUT may enhance the combined after-tax wealth of the noncharitable beneficiary and the charity over a wide range of market conditions and for a broad spectrum of charitable inclinations. CRUTs are most effective when there is some level of charitable intent; however, the charitable inclination threshold needed to utilize a CRUT may be significantly lower than many advisors presume (and decreases further as interest rates rise). In limited circumstances, a CRUT may even be beneficial if the donor has zero charitable intent.

Investors with some level of charitable utility who are seeking to immediately diversify the idiosyncratic risk of a concentrated position should carefully consider the potential benefits of a CRT structure relative to other strategies. CRTs are most advantageous when interest rates are high, so recent rate increases may present a favorable entry point for investors.

Send questions or comments to aperio.blog@blackrock.com.

¹ For example, Charitable Lead Annuity Trusts (CLATs) become more advantageous as interest rates decline.

² See Internal Revenue Code Section 7520. The Section 7520 rate, which is updated monthly and announced by the IRS in Revenue Rulings, fluctuates based on the yields of certain government debt obligations. It is used to calculate the present value of an annuity, life estate, term of years, remainder, or reversionary interest. The Section 7520 rate is 120% of the mid-term Applicable Federal Rate (AFR). The donor can select from three different Section 7520 rates: the rate for the month the trust was funded or the Section 7520 rate from either of the two months prior to the transfer.

³ Changes in interest rates have a larger impact on the size of the charitable deduction for Charitable Remainder Annuity Trusts (CRATs) than for Charitable Remainder Unitrusts (CRUTs).

⁴ See Rev. Rul. 2021-1 and Rev. Rul. 2023-16.

⁵ The varieties of CRTs include CRATs, CRUTs, NIOCRUTs, NIMCRUTs and FLIPCRUTs.
 

Important notes

Aperio Group, LLC, provides this material for informational purposes only and for the sole use of the recipient. The information contained herein is provided with the understanding that we are not engaged in rendering legal, accounting, or tax services. We recommend that all investors seek out the services of competent professionals in these areas. The strategies and/or investments referenced may not be suitable for all investors, because the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. None of the examples should be considered advice tailored to the needs of any specific investor or a recommendation to buy or sell any securities. The fees and expenses Aperio charges may be higher than the fees and expenses of other investment advisors and may offset profits. Additional information about the firm, and our fees and expenses, is included in our Form ADV.

Investing involves risk, including possible loss of principal. Asset allocation and diversification may not protect against market risk, loss of principal or volatility of returns. There is no guarantee that any investment strategy discussed herein will work under all market conditions. Many factors affect performance, including changes in market conditions and interest rates, as well as other economic, political, or financial developments.

You should not assume that investment decisions we make in the future will be profitable or will equal the investment performance of the past. With respect to the description of any investment strategies, simulations, or investment recommendations, we cannot provide any assurances that they will perform as expected and as described in our materials. Past performance is not indicative of future results.

Any tax information provided herein is for illustrative purposes only and does not constitute the provision of tax advice by Aperio. Due to the complexity of tax law, not every single taxpayer will face the situations described herein exactly as calculated or stated, i.e., the examples and calculations are intended to be representative of some, but not all, taxpayers. Since each investor’s situation may be different in terms of income tax, estate tax, and asset allocation, there may be situations in which the calculations would not apply. Please discuss any individual situation with tax and investment advisors first before proceeding. For those clients using tax advantaged indexing, taxpayers paying lower tax rates than those assumed, or without taxable income, would earn smaller tax benefits from tax-advantaged indexing (or even none at all) compared to those described.

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