Charitable Remainder Annuity Trust: Questions Donors Ask

Donors should consult with their professional advisors, as several choices are available regarding selecting the best trustee for their situation.

Typically, such a trust is invested in a balanced portfolio that is designed to produce both income and growth over the term of the trust. An annuity trust may also hold tax-free bonds.

Gifts of cash or appreciated property yield the same result for tax-deduction purposes. However, gifts of appreciated property have the added value of avoiding capital gains taxes.

Donors’ income will be taxed according to the type of investments and payout rate of the trust. You will usually pay tax at the ordinary income level on any ordinary income that is distributed, up to their full payment. The rest of their income will be taxed at the next lowest rate, usually as capital gains, then as tax-free return of principal.

A CRAT is a powerful tool that can save donors income, capital gains, estate, and inheritance taxes, depending on their circumstances and state of domicile. A qualified advisor is crucial to assist donors in maximizing these benefits.

The taxation of CRATs is prescribed by the Internal Revenue Code and accompanying U.S. Treasury regulations. The trust itself is a tax-exempt entity, but the trust distributions to an income beneficiary will be taxable to that beneficiary according to a four-tiered system. That system requires that the payments carry out ordinary income first, then capital gains, then tax-free income, and finally return of principal. The amount of the payment in each category depends on the trust’s overall investment performance, the nature of the assets that donors contribute to the trust, and any carryover of income from one year to the next.

Federal tax law does not set a specific minimum contribution required to establish a CRAT, but it’s common to see a minimum gift of $50,000 to establish a charitable remainder trust.

Setting up a CRAT is not difficult, but donors should be advised by an attorney with expertise in charitable trusts and estate planning. To save donors time and expense, be prepared to provide an initial draft of the trust agreement for review by donors and their attorneys. Once the trust agreement has been signed, you and the donor will simply transfer assets to the trustee to fund the trust.

No. Donors or their beneficiaries must begin receiving annuity payments as soon as the trust is created. If donors want to postpone the start date of payments, they can consider a flip charitable remainder unitrust or a deferred charitable gift annuity, both of which will allow them to select a future date on which payments will begin.

No. Because the annuity payments are fixed and must begin immediately, the assets used to fund the trust must be liquid. If donors want to create a life-income gift with illiquid assets such as real estate or business interests, the donor can create a flip charitable remainder unitrust that will begin making unitrust payments only after the property has been liquidated. In some cases, the donor can also create a charitable gift annuity with illiquid assets. Your organization will need to evaluate illiquid assets to be sure you can accept and liquidate them within a reasonable period.

Yes, if the trust continues to meet the 10% remainder, minimum 5% payment, and 5% probability of exhaustion rules (the likelihood that the body of the trust money will run out due to economic factors). Note that it is likely that naming multiple younger beneficiaries will cause the trust to fail the requirements. Note further that naming income beneficiaries other than a spouse will trigger gift-tax issues.

No. Federal law does not permit future additions to a CRAT. Future additions are, however, permitted to a charitable remainder unitrust.