While there may be some debate on the origin of the phrase, “Don’t put all your eggs in one basket,” the reality is that when it comes to investing, having too much of one stock can be hazardous to your portfolio.
Last week we looked at the use of charitable gift annuities to help diversify a concentrated stock position and generate income. This week, we highlight another philanthropic strategy to accomplish the same goal: the charitable remainder trust.
What is a Charitable Remainder Trust?
A charitable remainder trust (“CRT”) is an arrangement that provides for a specific amount of income to be paid to one or more income beneficiaries. The trust is funded using cash, securities, real estate, or other assets. After the income period ends, the trust terminates and the assets remaining in the trust are distributed to one or more charities.
The CRT allows for much greater design flexibility than the gift annuity: the donor can choose the percentage of the trust assets to be paid as income; the donor can choose, within certain limits, how long the trust will last; the donor can choose the charities receiving the remaining assets and can even reserve the right to change the charitable recipients of the trust.
The CRT requires greater expense and administration than the gift annuity (which doesn’t cost the donor anything). An attorney is needed to draft the CRT document, and a CPA / third-party administrator who specializes in charitable trusts is needed to ensure all tax forms are filed properly. An investment advisor is needed to manage the trust assets and ensure the income beneficiaries are paid as dictated by the trust.
Despite the added effort, a CRT can work effectively to diversity a single stock position or several concentrated positions in an investor’s portfolio.
Case Study – Charitable Remainder Trust
Here’s how the CRT can be used to diversify a concentrated position:
Assume John Donor, age 75, owns 5,000 shares of Company Y that he bought at $10 per share many years ago. Shares are now selling for $200 – a $190/share profit. John’s portfolio, valued at $5 million, otherwise consists of a broad range of mutual funds, but he holds Company Y because he doesn’t want to pay the tax on the gain. Company Y makes up 20% of his portfolio – a highly concentrated position. Company Y’s dividend yield is 2%.
John decides to establish a charitable remainder trust and fund the CRT with his Company Y shares. He hires an attorney to draft the trust and delivers the shares electronically to a brokerage account registered to the trust. John serves as trustee of the CRT.
Once inside the CRT, the concentrated position is sold without incurring capital gains and reinvested in a diversified portfolio of stocks and bonds. Once that happens, John no longer has a concentrated position.
John decides to have the CRT pay 7% of the trust’s value, as revalued each year, annually to him and his wife, age 73, for their joint lives. John and his wife will receive $1,000,000 x 7% = $70,000 in the first year, and a varying amount in subsequent years (depending on the trust’s investment performance), as long as either is alive – more than he was receiving from the Company Y dividend.
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With a CRT, capital gains that would normally have been due upon the sale of a security are deferred and instead are paid out in installments with each trust payment until the entire gain has been distributed. CRTs have a complex taxation structure, but suffice to say that the annual income will be taxed partly as ordinary income, to the extent the trust investments generate income, and partly as capital gains – including the gains from the sale of the concentrated position.
John also gets a charitable deduction of $361,630 (assumes 2.4% AFR) which he can use to offset his income this year. To the extent that he can’t absorb the entire deduction, the unused amount gets carried forward for up to five additional years.
And, John and his wife choose to divide the remainder interest among three charities – a local animal shelter, the area hospital on whose Board John sits, and their church as the third.
The end result is similar to that of the gift annuity: the removal of the concentrated stock position, increased income, deferred capital gains, a charitable deduction, and a major gift to charity.
Consider a charitable remainder trust to help diversify a concentrated position if:
- You are charitably inclined;
- You desire flexibility in the design of the diversification strategy;
- Your stock position is significant enough to justify the additional expense necessary to establish and administer a CRT;
- You are relying on income from the concentrated position.
Whether a gift annuity or a remainder trust – for those who are philanthropic, there is no excuse for keeping a concentrated stock position in your investment portfolio.