Would you like your estate plan to support your favorite charity and leave a legacy for your family? Two trust types can be used together to help achieve those goals: a charitable remainder trust (CRT) and a wealth replacement trust (WRT). One of these may be more familiar to you than the other. Let’s take a closer look at how each trust complements the other.

The CRT’s role

The CRT-WRT strategy begins with the CRT. You contribute securities or other assets to the CRT. Then the CRT pays you an income stream for life—a fixed percentage of the trust’s value. At the end of the trust’s term, the remaining assets are distributed to the charitable beneficiaries you named.

In addition to receiving periodic income payments, you can claim a charitable income tax deduction equal to the present value of the charitable beneficiaries’ remainder interests.

Even greater income tax savings may be available if you contribute appreciated property that would otherwise be subject to capital gains tax if sold. As a tax-exempt entity, the CRT can sell capital assets tax-free and reinvest the proceeds in income-producing assets (but you may be subject to income tax on a portion of the distributions you receive).

So where does the WRT come in? As the CRT’s income beneficiary, you use the regular income stream you receive to fund the WRT. The WRT then purchases a life insurance policy that will ultimately benefit the WRT beneficiaries you name.

When you die, the CRT’s assets pass to the charity you’ve selected. At the same time, the life insurance proceeds are paid to your WRT, which distributes them to your WRT beneficiaries based on the trust terms you established.

The WRT’s role

It’s possible to replace wealth with a stand-alone life insurance policy; however, setting up a WRT to hold your policy can offer benefits.

For one thing, if you own the policy under your name, the proceeds will be included in your taxable estate. If your estate is large enough that estate taxes are a concern, this may reduce the policy’s wealth replacement power.

By contrast, if your policy is owned by a properly structured WRT, the death benefit bypasses your estate—though contributions to the trust to cover premium payments generally will use up some of your lifetime gift tax exemption.

Also, using a WRT allows you to place conditions on distributions to your beneficiaries. For example, you might not want them to receive all the proceeds right away.

It is possible to transfer an existing life insurance policy to a WRT, but it can be risky, so unless you’re uninsurable, you’re likely better off making cash gifts to a WRT to buy a new policy.

An example

To get a better idea of how this strategy works, consider this example: Ken wants to donate $1 million to his alma mater, but he’s reluctant to deprive his children of the funds. Ken’s solution: He contributes $1 million to a CRT for the college’s benefit, which invests the money in conservative income-producing investments.

He also establishes a WRT, naming his children as beneficiaries. He makes cash gifts each year to the trust financed in large part by income from his CRT. The WRT’s trustee uses these gifts to purchase a $1 million insurance policy on Ken’s life. When he dies, the CRT distributes its assets to the college, and the insurance company pays the death benefit to the WRT. This money, which replaces the charitable donation, can then be used by the trustee to benefit Ken’s children.

Right strategy for you?

If you’re charitably inclined but don’t want to deprive your family of its inheritance, the combination of a CRT and WRT may be the answer. Contact us if you’re interested in this strategy. We can review your overall estate plan to determine if a CRT and a WRT will help you achieve your goals.

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