If you wish to leave a legacy for both your family and a charity of your choice, and receive an immediate tax deduction, a charitable remainder annuity trust may be a good option. To help you decide if it’s right for you, here’s some more information about this type of charitable gift.
Definition and Example of a Charitable Remainder Annuity Trust
A charitable remainder annuity trust (CRAT) is an option for estate planning. This type of trust is a financial arrangement that allows a trustee to hold assets for one or more beneficiaries. When you set up a charitable remainder annuity trust, you may be eligible for some personal tax deductions for your charitable gift.
Acronym: CRATAlternate name: Split-interest trust
For example, if you contribute $100,000 to a CRAT with a payout percentage of 5%, you and any income beneficiaries will receive $5,000 each year until the trust terminates. The remainder of the trust will be donated to charity.
How Charitable Remainder Annuity Trusts Work
Creating a charitable remainder annuity trust can help you leave a legacy behind and provide you with an income stream while alive. The amount you receive is either a stated dollar value or a certain percentage of your trust’s fair market value on the day that you established the trust. The payment amount can’t be less than 5% or greater than 50% of the CRAT’s initial value, according to the IRS. With a CRAT, your payment won’t change based on the value of the assets in the trust. Whether the account gains money or loses money, your payment remains the same. While it’s recommended you find a trusted financial planner to help you set up one, here’s a quick look at how CRATs work.
Choose the Charity
You can select a single charity or multiple charities when you set up the trust, and you may change this distinction at a later date.
Fund the Trust
The first step in the process is to fund your trust. You can use appreciated assets for this part; cash and securities are common options. You can’t contribute to this type of trust later on, so you’ll need to carefully consider the amount of your initial contribution. The goal is to ensure your trust has enough value to accomplish your financial goals.
Use it as an Income Source
During this step, you and any named beneficiaries will receive regular payments. You’ll set up the terms when you create the account, and payments will begin right away. Trusts with fixed terms can have payments for up to 20 years, but you also have the option of selecting lifetime payments in the event that you or your beneficiaries live longer than 20 years after you open the trust. Your beneficiaries can receive payments together with you, or you can set it up so that payments for certain beneficiaries (such as your children) start after the death of the immediate beneficiaries (such as you and your spouse). The present value of the charitable remainder in your trust must always be 10% of the assets you started with. When setting up your account, you may need to limit the number of beneficiaries or reduce the length of time they’ll receive payments to ensure the charitable amount meets the 10% requirement.
Give to Charity
When the payment term ends, the money left in the trust goes to the charity or charities of your choice, provided it is a public charity or a private foundation that meets IRS standards.
How Charitable Remainder Trusts Benefit You
During the setup phase, you reduce your tax burden because you get an income-tax deduction for part of your contribution. The deduction amount changes based on the terms of the trust. Also, you don’t pay capital gains tax on any appreciated assets you donate. For example, say you have stock in a tech company that you bought at $5 per share in 2010. Your shares are now worth $25. If you donate that stock to your CRAT, you won’t pay capital gains taxes on the $20 each share earned. The charitable remainder annuity trust provides a stable income for you and your beneficiary. This can bring peace of mind, knowing you and your loved ones are taken care of financially. You also have the opportunity to give generously. The money remaining in the trust after payment period ends goes to the charity you selected to help further its cause.
Charitable Remainder Annuity Trusts (CRATs) vs. Charitable Remainder Unitrusts (CRUTs)
There are two types of charitable remainder trusts: charitable remainder annuity trusts and charitable remainder unitrusts. Both CRATs and CRUTs allow you to give money to charity after your and your beneficiaries’ payments end. You also can’t modify many of the terms in the trusts once they’re set up. While they’re similar in many ways, there are some key differences between the two: Additionally, the funds in a CRUT are valued each year to assess its current worth. This means if the market is doing well and the trust fund has grown, your payments will be higher. But if the market is down, your payments will be lower. The amount of money you and your beneficiaries get each year depends on the unitrust. If you prefer predictable, fixed income, this one might not be a good option for you. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning!
