What is a Charitable Remainder Annuity Trust

A Charitable Remainder Annuity Trust (CRAT) is a type of gift transaction in which a donor contributes assets to a charitable trust which subsequently pays a fixed income to a designated beneficiary, in the form of an annuity. The value of the annuity is calculated as a fixed percentage of the initial value of trust's assets, but that amount must be no less than 5%.

A CRAT lasts until the donor passes away, at which time any funds remaining in the trust are then donated to a charity pre-chosen by the donor.

Key Takeaways

  • A Charitable Remainder Annuity Trust (CRAT) is a type of gift transaction in which a donor contributes assets to a charitable trust which subsequently pays a fixed income to a designated beneficiary, which can be a non-profit entity, a university, or another such party.
  • Beneficiaries receive a fixed income from the CRAT in the form of an annuity, which is typically calculated as a fixed percentage of the initial value of trust assets. 
  • The minimum annuity distribution value is 5%. 
  • CRATs last until the donor passes away, at which time any funds that remain in the trust are then donated to a charity pre-chosen.

CRATS offer a sense of reliability, in that their beneficiaries enjoy a guaranteed income stream every year, where the amount received never fluctuates--regardless of the trusts' investment performance. For example, a CRAT with an initial value of $4,000,000 and a 5% payout would pay $200,000 annually to the income beneficiary, regardless of the returns of the underlying assets and economic conditions.

CRATs are similar to other charitable annuities, with one chief difference: CRATs are structured as a separate trust fund, which consequently shields them from incurring any liability, due to their autonomous legal structures.

Note: although the trust itself is a tax-exempt entity, the trust income distributed to beneficiaries is in fact taxable, according to terms dictated by the U.S. Internal Revenue Code and accompanying U.S. Treasury regulations.

BREAKING DOWN Charitable Remainder Annuity Trust

To create a CRAT, a trustee, such as an accountant, financial advisor, or attorney helps donors design the terms of the entity. The assets in the trust are then sold, without triggering a taxable event, which consequently increases the assets’ income potential. The proceeds of the sale of the underlying assets are then reinvested into investments that are more suitable to generating income for donors.

While these trusts typically last for a term that equals the lives of an individual or the combined lives of a couple, the terms can also be determined not to exceed 20 years, or they can be calculated as a combination of a certain number of lives plus a certain number of years.

Income tax consequences for the donor can be complex, depending on the individual situation. All or some of the income from the trust may be taxed at ordinary income rates, but part may be taxed at lower capital gains tax rates, or may even be tax-free, for some years.

[Important: Because the annuity payments doled out by CRATS are fixed and must immediately begin after the creation of the trust, the underlying assets within the structure must be kept highly liquid.]