While a charitable remainder trust (CRT) can be an excellent tool for charitable giving and estate planning, a wealth replacement trust is sometimes a better option. When you establish a charitable remainder trust, you transfer appreciated property to an irrevocable trust and designate a charity as the beneficiary. A portion (or all) of the assets within the trust are then sold and reinvested to provide income to the person donating the assets. At the death of the donor, or after a specified number of years, the trust expires and the property remaining within the trust is transferred to the charity.
Though it can provide income and reduce the size of your estate and thus the potential federal estate tax, one of the major drawbacks to a CRT alone is that none of the money in it can be left to heirs. However, if you’d like similar estate tax benefits, but would like to leave your heirs an inheritance, consider using a wealth replacement trust.
Wealth Replacement Trust
A wealth replacement trust is a planning tool in which a donor uses the income or tax savings from establishing a life-income gift, such as a gift annuity or charitable remainder trust, to buy life insurance to replace the assets that he or she is giving away. For example, if a donor puts $200,000 into a charitable remainder trust to be given to her local church, but still wants to leave money to her grandchildren, she could use a wealth replacement trust to accomplish this. To do so, she would use income proceeds from the charitable remainder trust to purchase a $200,000 life policy. When she dies, the money in the trust goes to her church, and the life proceeds go to her grandkids.
Because the life insurance would have been held in an irrevocable insurance trust, it is not included in the value of the estate, and the death benefit passes to heirs free from estate taxes. And since it passes as a death benefit from a life insurance policy, the proceeds are also tax-free to heirs.
Is This the Right Strategy?
Whether this financial strategy is right for you or someone in your family depends on several factors:
The cornerstone to this strategy is the use of life insurance. Typically, the donor is someone older, usually over 65 years of age. Since the cost of life insurance increases dramatically with age and health problems, it is ideal that the donor be healthy. If you are sick or have multiple health issues, you would not be able to get your life insured – or you would have to pay a restrictively high premium to do so.
If you are below the age of 65, you may not be ready to look into this type of financial strategy because you probably have many years left to work and gather more assets. Nevertheless, if you are involved with charitable causes and are building up a good-sized nest egg, it may be prudent for you to investigate a trust like this now. The younger you are, the less expensive the life policy will be, and you may not have to worry about qualifying for the life policy.
Trusts of all types require working with trained professionals. Most attorneys will consult you for free as to which type of trust may be suitable, but there are fees to set it up. Furthermore, there are administrative fees for the management of the trusts, and there are also the costs of the life insurance premiums.
The fees for wealth replacement and charitable remainder trusts vary too greatly to provide an average range. Much depends on the state you live in, the size of the assets to be placed in your trust, and the complexity of the trust setup. Premiums for the life insurance depend on age, health, the size of the death benefit, any riders, and the state in which you reside.
When a WRT Is Appropriate
To set up a WRT, you need to first set up a CRT. Because of the costs of setting up these two types of trusts, you want to have assets that amount to at least $100,000 to contribute. If the assets you want to contribute amount to less than $100,000, the time, expense, and complexity of a CRT and a WRT make them unsuitable as a strategy for you.
In addition, if income is going to be derived from the CRT, an age of 70 years or older is optimal. Of course, there are exceptions for those with truly large multimillion-dollar estates.
Another key item to be aware of is health. If the donor wants to use life insurance as a vehicle to leave heirs money, then the donor needs to be in good enough health to qualify for the life insurance policy. If there are health issues, the donor would need to use an annuity as the funding vehicle, which would require a larger portion of the assets to be diverted from the charity and into the purchase of the annuity to leave to heirs.
There are few things in life more rewarding than helping others. As you reach the golden years of life, knowing that you can leave a legacy, however small, is something that has brought comfort to many.
If you are inclined to work for and donate to charitable causes and organizations, these types of strategies allow you to give in more effective ways. A WRT provides a pathway to leaving money to a charity without casting aside family members who would otherwise inherit. Plus, it allows you to leave money to heirs in a way that relieves them of the tax liability otherwise associated with inheriting the assets left to them.
Have you set up a wealth replacement trust? Would you recommend it to others?