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CRAT: What Is A Charitable Remainder Annuity Trust?

A CRAT is a Charitable Remainder Annuity Trust. This is a type of Charitable Remainder Trust that typically offers greater certainty but lower returns and distributions than its cousin, the Charitable Remainder Unitrust. In this guide, we’ll explain the basics of a CRAT and explore an example.

But before diving into the definitions, here are a few essentials on CRTs:

  • It is a tax-exempt irrevocable trust designed to reduce individuals’ taxable income.
  • It distributes income to the trust beneficiaries at least annually for a specified period — up to 20 years or for your lifetime — and, when that period is over, donates the remainder — everything that hasn’t been distributed yet — to your chosen charity.
  • It allows you to stash your assets in the trust, receive an up-front tax deduction, defer your taxes on any gains you realize inside the trust (for example, when you sell appreciated assets), put the trust’s income to use for yourself, and then donate a portion of the assets to charity at the end of the trust’s term.

What is a Charitable Remainder Annuity Trust (CRAT)?

Let’s recap on what is the meaning of a CRAT. A CRT Annuity Trust (or CRAT) is a tax-exempt structure. In exchange for donating some of the money in the trust to a charity at the end, you are allowed to defer the associated taxes when selling assets inside the CRAT trust, you recieve an immediate charitable income tax deduction to reduce your taxes and you receive set identical payments at least annually for the length of the trust.

CRATs are a form of tax-deferred account, like an IRA, that are designed to incentivize charitable giving in exchange for significant tax benefits: tax deferral and the ability to lower your tax rate via income smoothing and an upfront charitable deduction.

How Does A CRAT Work?

First, choose an asset. You, the individual setting up the trust, choose an appreciated asset that you’d like to contribute to a trust. This could be any asset that has appreciated or is likely to appreciate significantly. Followed by a designated beneficiary. You’ll designate an income beneficiary — the person who will receive payments from the trust every year.

Second, you’ll transfer assets and get a deduction. You transfer your chosen assets to the trust, and you get an immediate charitable remainder tax deduction, usually equal to about 10% of the value of the asset you put in. Therefore, you’ll be able to sell your asset tax free inside the trust, allowing you to reinvest those tax savings to create more wealth.

And third, you’ll take your annual withdrawal. Every year you get a set distribution no matter how the investments in the trust performed. Plus, you’ll leave the remainder to charity. Whatever is left in the trust at the end of the trust’s term — is donated to a charitable organization.

What Is Unique About Charitable Remainder Annuity Trusts (CRATs)?

An annuity is, essentially, a fixed amount of money that a person receives for a specified period of time, usually in exchange for a lump-sum payment up front. Similarly, an Annuity Trust is a trust that provides a fixed income stream for the trust’s term — either a person’s lifetime or a specified period of time. That fixed income amount is based on the initial value of the assets that are placed into the trust when it is set up.

So, if you put $1 million in startup equity into your CRAT with a 5% payout rate, you’d receive $50,000 per year, no matter how the trust performs — whether the trust assets grow to $10 million or not at all, you are receiving $50,000 per year. Some unique aspects of CRATs are:

  • Limited Term Length: Charitable Remainder Annuity Trusts can’t be set up for as long as CRUTs unfortunately, as an example a lifetime CRAT can only be set up for individuals 58 or older while lifetime CRUTs can be setup for individuals 26 or older. And the longer a Charitable Remainder Trust is set up for, typically the higher the expected returns are for the simple reason that assets that are tax exempt grow faster than taxable assets.
    • From another framing, CRATs will have a lower annual payout rate for the same trust length as a CRUT due to IRS rules.
  • After the set up, assets cannot be added to a CRAT trust.
CRAT
How assets move between the beneficiary (you), a Charitable Remainder Unitrust and the Charitable Beneficiary

Pros Of A CRAT

  1. Financial certainty: Set your self up with a set distributions for the length of the trust
  2. Lower effective tax rates: you can effectively smooth out your income and avoid spiking it in any individual year, which typically results in an overall effective tax rate. In exchange for donating some of the money in the trust to a charity of your choice at the end of the term, you also get an immediate charitable income tax deduction from the government.

So, now that you have a good idea of why most people choose to set up a CRAT, let’s dive into the key decision you will have to make: Should you use a “lifetime” or “term” trust?

What are the differences and trade-offs of lifetime vs term CRATs?

The length of a CRAT trust plays a large role in determining how they will make distributions to the beneficiaries. They can be setup for the length of people’s lives or a specified period of years (Between 1 and 20 years).

In lifetime trusts, you have your whole life if they are 58 or older (or the length of the lives of all the beneficiaries) to withdraw the trust’s assets.

In a term trust, instead, withdrawals from the trust’s assets are for a pre established number of years (usually 20), and there is one main reasons why you might decide to use this approach:

  • It is easier to leave the right to future distributions to another beneficiary (such as a family member) if something happens to you before the trust term is over

CRAT Example

Here is a specific example comparing the returns of a Charitable Remainder Trust Annuity and Charitable Remainder Unitrust for the same scenario:

Erica is a 36-year-old New Yorker with a $3m asset that has no cost basis (that is, she paid $0 for it). She wants to set up a 20-year term trust.

CRAT (Charitable Remainder Annuity Trust):

  • Payout Rate: Given the trust length and the IRS’s discount rate, she is entitled to receive 5.39% of the trust’s initial value every year.
  • Annual Payments: The trust was originally worth $3 million, so Erica will receive $161,700, or 5.39%, every year.
  • Up-front Charitable Annuity Trust Deduction: $300,000
  • Total Payouts After Donating Charitable Remainder: $3,234,000

Standard CRUT:

  • Payout Rate: Erica is entitled to receive 11.04% of the trust’s assets annually for 20 years
    • Reminder: CRUTs will have a higher annual payout rate than a CRT annuity for the equivalent trust timeline due to IRS rules.
  • Annual Payments: In year 1, Erica would receive $353,226 (assuming the assets are valued at the end of the year, after they’ve had a chance to grow a bit); because her payout rate of 11.04% exceeds the asset growth rate of 8%, the trust’s value and payments will decrease over time.
  • Up-front Charitable Deduction: $300,000
  • Total Payouts After Donating Charitable Remainder: $4,450,200

Why do Charitable Remainder Annuity Trusts perform worse on average?

No doubt you noticed the bottom line: The total payouts from Erica’s CRUT are significantly higher than the payouts from a CRAT trust. Why is that so? It’s simple: Because a CRUT’s annual distributions are defined as a percentage of the trust’s assets, as measured that year, whereas a CRAT’s annual distributions are a fixed percentage of the trust’s starting value. Assuming that the trust grows in value over time — a fair assumption for our users, most of whom will be aiming to at least match historical market returns — the distributions will be much larger if they are keyed to the trust’s growing value, rather than to how much the assets were worth on day 1. However, you can have more confidence in the size of your distributions as with a CRAT your distributions are not at risk based on the trusts investment performance.

Are distributions from a CRAT taxable?

Distributions from the Charitable Remainder Annuity Trust are taxable. When you receive distributions from the CRAT they are taxed according to the type of income they were realized as inside the trust, or in other words the taxes on income realized in the trust are being deferred until you receive the income as distributions. If there are multiple types of income inside the trust such as long and short term capital gains, the income is distributed according to the four tier accounting system. It is important to note, you aren’t taxed on the income realized inside the CRAT, so the investments can grow tax free.

Next Steps

A Charitable Annuity Trust is powerful tax planning structure. While CRATs and CRUTs are very similar, their key difference around how distributions are calculated has massive implications. If you are willing to give up larger distributions and are focused on financial consistency you may prefer a CRAT. Why? Because you want certainty with your annual payments from the trust.

On the other hand, you may prefer a CRUT if you want the Charitable Remainder Trust to run for a longer time period, or value more flexibility with the timing and amount of distributions and/or want a higher ROI from the structure — that is, more total distributions. So, check out why are CRATs different from CRUTs, access our calculator for tax saving to evaluate the potential return on investment given your situation. And if you have any questions, schedule a meeting with our experienced team.

About Valur

We have built a platform to give everyone access to the tax planning tools of the ultra-rich like Mark Zuckerberg (Facebook founder), Phil Knight (Nike founder) and others. Valur makes it simple and seamless for our customers to utilize the tax advantaged structures that are otherwise expensive and inaccessible to build their wealth more efficiently. From picking the best strategy to taking care of all the setup and ongoing overhead, we make take care of it and make it easy.