Charitable Remainder Annuity Trusts Explained: Purpose, Tax Savings & More

Summary:

Charitable Remainder Annuity Trusts (CRATs) offer fixed annual income to beneficiaries and leave remaining assets to a charity. They provide estate planning benefits, income tax breaks, and reduced capital gains exposure—but are irrevocable and inflexible.

• Provides fixed income during trust term (up to 20 years or lifetime)
• Remaining assets go to a designated charity
• Offers estate and income tax advantages
• Cannot be changed or added to once established
• Requires at least 10% of initial fair market asset value to remain for charity

Charitable remainder annuity trusts are a worthwhile option for individuals and families seeking to achieve a few key financial objectives.

In the big picture, this type of trust provides annuity income, structured as an annuity, to named beneficiaries for a period of time. After that term ends, the remaining assets in the trust (i.e., the charitable remainder) are donated to a previously named charitable beneficiary.

So, what sets charitable remainder annuity trusts apart from other trust options? What are the significant charitable remainder annuity trust taxation rules and potential benefits?

Keep reading to learn more about charitable remainder annuity trusts (CRATs).

What is a Charitable Remainder Annuity Trust? Foundational Information

Charitable remainder annuity trusts are a specific form of trust that guarantees annuity income to the named beneficiary or beneficiaries during the term of the trust. At the end of that term, the remaining assets in the trust are then donated to a charitable organization.

A trust itself is a legal structure that involves a grantor, trustee, and beneficiary or beneficiaries. The grantor places personal assets into the trust. The trustee manages the assets in the trust and has a fiduciary responsibility to act in the interests of the beneficiary. The beneficiary, who can be the grantor or another person or people, receives the assets from the trust.

This trust structure offers the same foundational benefits as some other types of trusts. These advantages include:

• Reducing the value of the grantor’s estate for tax purposes, as well as shielding those assets from legal actions such as civil lawsuits.
• Providing assets to a specific beneficiary or beneficiaries.
• Setting limits or conditions as to how and when beneficiaries can receive the assets.
• Tax benefits, including those that come from keeping assets in the trust and disbursing them over time.

Key Qualities of CRATs

Let’s take a closer look at charitable remainder annuity trust rules to better understand what sets this type of trust apart from many other types of trusts. Key qualities, rules, and limits of CRATs include:

• Irrevocability. CRATs are irrevocable. This means they cannot be revoked, dissolved, or otherwise changed after they are officially established. Irrevocable trusts offer reduced exposure to taxes that revocable trusts do not provide. However, this structure also disallows additional contributions to these trusts after they’re formed.
• Annuity structure. The income given to the beneficiary by the trust is paid out on a consistent basis for the term of the trust. As the IRS explains, a specific dollar amount, defined when the trust is formed as a fixed percentage between 5-50% of the initial value of assets in the trust, is paid out on a fixed basis.
• Variable term for beneficiary payouts. The length of payouts to the beneficiary can be set as either one of the beneficiary’s lifetimes or a defined term of years, specifically no more than 20 years, as Investopedia points out. The CRAT can provide income for life or for a shorter period of time.
• Tax exemptions. CRATs allow for various tax exemptions. Examples include a tax break for making a contribution to a CRAT from an IRA and avoiding tax on sales of certain assets by placing them in the trust before they are sold to generate income. However, the money received by beneficiaries is taxable.
• Supporting charitable causes. The remainder of the CRAT, after its disbursements to beneficiaries end, is donated to a charity or non-profit organization chosen by the grantor.

Here’s a charitable remainder annuity trust example: The grantor places $20 million in assets into the trust and names one beneficiary. The grantor sets the term at 10 years, with one payment each year, and the fixed percentage at 5%.

This means that, once a year, the beneficiary will receive $1 million in income for 10 years. Once the 10-year period is over, the remaining funds are donated to a qualified charity of the donor’s choosing.

Limits and Potential Drawbacks of Charitable Remainder Annuity Trusts

One notable limitation of CRATs is that they require at least 10% of the initial net fair market value of all assets placed in the trust to be donated once the trust’s term ends.

Their irrevocability is another important point to keep in mind, as assets can neither be added to the trust nor removed from it after it is established. Similarly, the terms and conditions of the trust are set in stone, so to speak. The named beneficiary or beneficiaries, the percentage of the total assets given as income, and other specifics cannot be altered once the trust is in place.

Tax Benefits of Charitable Remainder Annuity Trusts

Tax benefits offered by CRATs include:

• Assets placed into the trust are not taxable for the grantor when the assets are given to the trust, nor for the trust itself, as assets are sold to provide income to the beneficiary or the provision of the remainder to charity.
• A partial charitable deduction is available to grantors when they place assets into the trust.
• Estate taxes can be reduced or eliminated for the grantor by placing assets into the CRAT.
• Gift taxes can be avoided or reduced when the grantor and beneficiary are the same person, but gift taxes can apply when the beneficiary is another person besides the grantor or their spouse.

Knowledgeable, Experienced Support for CRATs from Dechtman Wealth Management

At Dechtman Wealth Management, our team of fiduciary financial advisors is bound by oath and by law to put our clients’ interests first. Supporting your financial stability and plans for the future is at the core of every action we take and decision we make.

As part of our holistic approach to financial planning and wealth management, our team can help you decide if a charitable remainder annuity trust is the right choice for your personal financial situation.