Although the charitable remainder trust offers considerable potential tax advantages that can reduce the effective cost of charitable giving, the fact remains that a portion of the donor's wealth will be going to charity and not to the donor's heirs. This represents an obviously significant dilemma for a charitably inclined individual making estate planning decisions. This dilemma is frequently solved by the use of life insurance to "replace" for the heirs the property that will pass to the charity upon the donor's death. If the insurance policy is owned by an irrevocable trust, the proceeds will not be included in the donor's gross estate.
Under such an arrangement, an insurance trust would be established (separately from the charitable remainder trust), and the trust would acquire and maintain an insurance policy on the life of the grantor. The trust provisions would spell out how the insurance proceeds are to be applied for the benefit of the grantor's heirs upon his or her death. The premiums for the life insurance policy are typically paid by the trust, using funds gifted each year by the grantor. Such insurance trusts are commonly utilized in tandem with charitable remainder trusts, and in this context are often referred to as "wealth replacement" insurance trusts. Planning for such tandem arrangements often includes utilizing a portion of the donor's projected income from the charitable remainder trust to pay the premiums on the insurance policy.
Such an arrangement works especially well in cases where the property transferred to the CRT was non-income-producing in the hands of the donor (e.g., unimproved land) or low yielding. Assuming that the CRT replaces this original property with income-producing securities, it will be able to make periodic distributions to the grantor, who in turn can make periodic gifts to the insurance trust for payment of policy premiums. In such a case the donor is able to "have his cake and eat it too." He makes a charitable gift, while still providing for his heirs--without any diminution of his current cash flow, since the insurance premiums are effectively funded by income now being derived from CRT assets which replaced (without capital gain tax) a previously non-income-producing or low yielding asset.