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:
|Interest Rate Environment||Charitable Deduction||CRT|
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.
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