What Is a Charitable Remainder Annuity Trust (CRAT)?
A charitable remainder annuity trust (CRAT) is a type of gift transaction in which a donor (also known as a “grantor,” “trustor,” or “benefactor”) contributes assets to an irrevocable trust that then donates to one or more charities while also paying a fixed income to one or more designated noncharitable beneficiaries in the form of an annuity. The value of the annuity is calculated as a fixed percentage of the initial value of the trust’s assets, and that amount must be no less than 5% but no more than 50%.
Because it is irrevocable, the terms of the CRAT cannot be altered, and legal ownership of the assets belongs to the trust and not the donor. A CRAT lasts either until the donor dies or after a set period of no longer than 20 years, at which time any funds remaining in the trust are then donated to one or more previously selected charitable beneficiaries, which can be public charities or private foundations.
- A charitable remainder annuity trust (CRAT) is a type of gift transaction in which a donor contributes assets to a charitable trust that then pays a fixed income to a designated noncharitable beneficiary.
- Noncharitable beneficiaries receive their income in the form of an annuity, which is typically calculated as a fixed percentage of the initial value of trust assets.
- The annuity distribution value must be at least 5% but no more than 50%.
- When a CRAT’s term is up, any funds that remain in the trust are donated to one or more previously selected charitable beneficiaries.
How a CRAT Works
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, thanks to their autonomous legal structures. Not only can they not be changed by the grantor; additional contributions cannot be made to them.
To create a CRAT, a trustee, such as an accountant, a financial advisor, or an attorney, helps a donor design the terms of the entity. The assets in the trust that aren’t cash, which can include stocks, real estate, private business interests, and private company stock, 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 put into investments that are more suitable for generating income for donors.
Although the CRAT itself is a tax-exempt entity—and the donor gets an up-front tax deduction for the assets donated to the CRAT—the trust income distributed to noncharitable beneficiaries is in fact taxable as ordinary income. The grantor, however, by donating property in-kind to the CRAT, allows the tax-exempt sale of the property, which preserves its fair market value by avoiding paying capital gains taxes.
The SECURE 2.0 Act, part of the Consolidated Appropriations Act of 2023, which was signed into law by President Biden on Dec. 29, 2022, includes special provisions for making a one-time qualified charitable distribution from an IRA of no more than $50,000 to a charitable remainder annuity trust (CRAT), charitable remainder unitrust (CRUT) or charitable gift annuitys (CGA)]. Special rules apply to these donations so get advice from a tax expert.
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.
Example of a CRAT
Of the many forms of trusts available, CRATS are attractive because they offer a sense of reliability, in that their noncharitable beneficiaries enjoy a guaranteed income stream every year that never fluctuates. 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 whether the economic performance of the trust was good or poor.
CRAT vs. Charitable Remainder Unitrust Trust (CRUT)
While a CRAT provides the noncharitable beneficiary with the same income every year, a charitable remainder unitrust trust (CRUT) does not. This is because the value of the CRUT is recalculated annually, and the payout is based on a fixed percentage of that revaluation. In addition, a CRUT allows for additional contributions to be made during its term, which would also affect its annual value.
Pros and Cons of a CRAT
The chief pro of a CRAT is its tax savings. The trustor not only gets a partial tax deduction for their donation to the trust; they also can see a reduction in capital gains, gift, and estate taxes. Another advantage is that unlike with a charitable lead trust, a trustor or their designated noncharitable beneficiary can get a regular income stream from a CRAT while simultaneously donating money to charity from the trust. After death, the CRAT protects the money from creditors or greedy family members, passing it on instead to charity as directed by the trustor.
The greatest con of a CRAT is that it is irrevocable, giving the trustor no access to or control over the funds in the trust and making it difficult to impossible to alter the terms of the trust. Also, because it is a fixed annuity, the payment to the noncharitable beneficiary cannot grow if the CRAT’s investments do particularly well in any given year, as it can with a CRUT. A third disadvantage is that a CRAT is a complex construction whose creation and administration can be complicated and costly. It is important to run a thorough cost-benefit analysis to make sure that it is the best use for the assets you are planning to put into it.
What Is a Charitable Remainder Annuity Trust (CRAT)?
A CRAT is a “split-interest” giving vehicle that enables people to pursue philanthropic goals while still generating income. It pays a fixed annuity yearly to one more designated noncharitable beneficiaries while also donating funds to one or more designated charitable beneficiaries. When the term of the CRAT expires, the remaining assets go to the charitable beneficiaries.
Does the Amount of the Annuity Depend on the CRAT’s Investment Performance?
No. A CRAT always pays the same amount annually to its noncharitable beneficiaries regardless of its financial performance. The amount cannot go up when the fund does better or go down when it does poorly, as it does with a charitable remainder unitrust trust (CRUT), which revalues the trust’s assets annually.
What Are the Tax Implications of a CRAT?
The grantor gets a one-time tax deduction based on the value of assets they initially put in the CRAT. In addition, by donating property in-kind to the CRAT, a grantor can avoid capital gains taxes, as the trust, which is tax-exempt, sells the property, not the grantor. There are also gift and estate tax advantages for the grantor. However, any income generated by the CRAT for a noncharitable beneficiary will be taxed as ordinary income.
The Bottom Line
A charitable remainder annuity trust gives a donor the ability to receive a one-time tax deduction and ensure a consistent flow of income while donating to one or more charities. The rules for establishing a CRAT are complicated and require professional assistance.