Charitable Remainder Trusts

In 2008, Derek Sivers sold his company, CD Baby, for $22M. And he gave it all to charity.

That was the headline, at least. It made for a pretty story: A successful founder makes a lot of money and gives it all away. What most headlines didn’t cover, however, is the savvy method Derek used to donate to charity. 

So what did he do? Derek, as he writes about on his blog, used something called a Charitable Remainder Trust. With an amount like $22M, Derek may have saved something like $5M in capital gains tax upfront and may have secured a charitable tax deduction in the ballpark of ~$5M to 10M. Ultimately, Derek:

• Got a sizable tax deduction
• Receives payments each year from the trust
• Will, most likely, eventually contribute millions to the charity of his choosing

If you have a mind for philanthropy, Charitable Remainder Trusts can be a win-win: You could save money on taxes, get a yearly payment, and donate a significant amount of money to charity. If you are sitting on a sizable unrealized gain (say, startup equity you plan to sell soon) and find the idea of charitable donations and tax deductions interesting, this essay is for you.

Below, we’ll cover what you might need to know about Charitable Remainder Trusts. By the end, you should know more about how they work and whether you may want to learn more.

What does a Charitable Remainder Trust do?

When you transfer assets into a Charitable Remainder Trust (and then sell them), you’ll pick a charity to which you’d like those funds to go when the trust ends. That’s the real reason Charitable Remainder Trusts exist — to donate to charity. 

In the meantime, a Charitable Remainder Trust (also called a CRT) does three major things for you.

I: A CRT may let you defer taxes when you sell highly-appreciated assets. Imagine you’re about to liquidate a couple million dollars of shares you own at a company you’ve been working for. If you transfer this equity to a Charitable Remainder Trust before selling, the trust won’t pay any tax on the proceeds. While you will pay taxes on the income you receive from the trust, you are effectively deferring the larger tax burden you may otherwise have had to pay if you hadn’t transferred the assets to the trust.

II: You will receive income from the trust over its duration. You will receive payments from the trust, either as a percentage of the trust’s value or a fixed payment amount. These payments occur until the trust ends, which is either a set number of years or upon your death. You will have to pay income taxes on these payments. 

III: You may qualify for a tax deduction. Because you’re giving money to charity, you’ll get an immediately-applicable deduction you can apply to your regular taxes.

So, when you sell $1M in shares at that startup you’ve been working for, you may not pay a hefty tax bill to the IRS. You may not pay any taxes at all — and you get the immediate tax benefit of having given money to charity. There are more benefits, of course, which we’ll cover below. 

Here’s how Charitable Remainder Trusts actually work

“How is a Charitable Remainder Trust different from donating to charity in other ways?” you might be wondering, and reasonably so. 

Here’s how CRTs work:

1. You set up a Charitable Remainder Trust and transfer your highly-appreciated assets (like company equity) into the trust. Transferring requires lots of documentation & some legal work, and is best done with the help of a financial advisor and a lawyer. The trust then sells the asset with zero capital gains tax.

2. The trust, which might be managed by your financial advisor, invests those funds in accordance with your overall portfolio. Each year, you receive income — a percentage set by you — of the trust’s value. You pay income taxes on these payments.

3. When the trust ends (which you can choose to happen either when you die, or after a set duration of fewer than 20 years) the remaining portion is donated to a charity of your choosing. This amount donated should be at least 10% of the initial value. You typically select the charity when you create the trust.

How does it work in practice?

Imagine you’ve been working at a startup for a decade. It’s got an upcoming IPO, and your shares are worth somewhere in the ballpark of $10M. You’re looking to liquidate some of that. In this scenario, let’s say you’re planning to liquidate $1M.

So you set up the trust, transfer your shares, and sell them. Congratulations. The trust shouldn’t pay any capital gains tax — so instead of losing ~$330k to the IRS, all $1M is still in the trust. And, once it’s been sold, the trust can invest it: the stock market, real estate, art, whatever the trustee decides on. In most cases, your trust would invest the money in accordance with your overall portfolio asset allocation — unless you have a different objective for the assets in the trust.

The chart below is a hypothetical example  projecting 10 years of a potential Charitable Remainder Trust situation with the following assumptions:

• You transfer $1M of highly-appreciated assets to the trust.
• Each year, you get 5% of the trust’s total value*. You can change this percentage, but it can’t be too high (for trusts with long durations, usually anything above 8 or 9%) or it’ll deplete the fund.
• The value of the trust goes up 10%, on average, yearly. This return is simply a figure we’re using for the purposes of illustration. For reference, the average annual return from the S&P 500 return over the past 30 years is roughly 9.89%.

*Note: There are two main types of Charitable Remainder Trusts: CRUTs and CRATs. If you decide a CRT may be a good fit for your situation, you’ll want to consult with your financial advisor & lawyer on the benefits and drawbacks of each. In general, CRUTs are a popular choice — they pay you based on the value of the fund, while CRATs have a fixed payout for the fund’s entire duration.

If you decided to sell your highly-appreciated assets without a CRT (or any similar trust), you’d be on the hook for capital gains tax. With a CRT, the trust sells the asset and you receive payments in smaller chunks over time. This means you may be able to lower your effective capital gains tax rate on these payments. Instead of 20%, you might be at 15%, or even 10%. So you’re not just deferring the taxes, you’re also potentially lowering the amount you pay in total. 

You will have to pay income taxes on the distributions you receive from the trust. It is worth noting, however, that you may be able to use your charitable tax deduction to offset capital gains taxes on payouts from your trust. 

Finally, if you take a look at the chart above, you’ll notice the payout structure is similar to what would happen if you wanted to invest a big chunk of money, retire, and live off the profits. Except if you’d just taken the $1M as cash, you’d have started with a significantly lower initial investment. 

What’s the catch?

The only catch is the obvious one: you don’t get to access all of your money at once, and you’ll never get access to all of the money in the trust — the point is that a lot of it goes to charity.

How much you end up eventually receiving from a CRT depends on a number of factors:

• How well your trust’s investments are performing
• How high you set your payout (a payout too high may deplete the trust)
• Your personal tax situation 

For some people, CRTs are one of the best ways to give to charity

Setting up a Charitable Remainder Trust means making a huge impact on a cause you care about. And the money that goes to charity hasn’t been taxed at any step of the way, which makes a CRT arguably the most direct, impactful way to donate to a charity; to do some good in the world, and to save lots on your own taxes while you do it.

If you’re wondering whether a CRT is the right decision for you, you might be interested in what we do at Compound. We help people in tech (at companies like Stripe, Discord, and OpenAI) navigate complex financial situations — so they don’t have to worry about their finances. Head here to learn more about Compound.

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Disclaimer: Compound Advisers, Inc. ("Compound") is an investment adviser registered with the Securities and Exchange Commission (“SEC”). An adviser’s status does not represent any endorsement of the SEC or any expertise simply by having the status as a registered investment adviser. 

This educational write-up is provided for informational purposes only and is not intended to be investment advice or a recommendation to buy, sell, or hold any securities or investments. This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer, or solicitation to buy or sell any securities or to adopt any investment strategy. The information provided herein is based on sources believed to be reliable, but Compound Advisors makes no representation or warranty as to its accuracy, completeness, or reliability.

Charitable Remainder Trusts (CRTs) are complex estate planning strategies and should only be considered by sophisticated investors who have a thorough understanding of the tax and legal implications of CRTs. Any investment in a CRT involves risks and uncertainties, and investors should carefully consider their financial objectives, risk tolerance, and investment experience before making any investment decisions.

This write-up is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country, or other jurisdiction where such distribution, publication, availability, or use would be contrary to law or regulation or which would subject Compound Advisors to any registration or licensing requirement within such jurisdiction.

Past performance is not indicative of future results, and the value of investments may fluctuate and be worth more or less than their original cost. Any investment owned by a CRT might be speculative, and investors may lose part or all of their investment.

This write-up is not an offer to sell securities, nor a solicitation of an offer to buy securities, in any jurisdiction where such offer or sale is not permitted. Before investing in any CRT or other securities, potential investors should carefully review the applicable offering materials and consult with their own legal, tax, and financial advisers to determine whether an investment in such securities is appropriate for them.

Compound Advisors is a registered investment adviser with the Securities and Exchange Commission. Registration with the SEC does not imply any level of skill or training. Please visit our website at withcompund.com for more information about our firm and the services we provide.