How do Charitable Remainder Annuity Trusts (CRATs) work?

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Key Takeaways
  • A Charitable Remainder Annuity Trust (CRAT) is a type of transaction in which a donor contributes assets to a charitable trust which subsequently pays a fixed distribution to a designated beneficiary, which is typically an individual.
  • Beneficiaries receive income from the CRAT in the form of an annuity, which is typically calculated as a fixed percentage of the initial value of trust assets.
  • The minimum annuity distribution value is 5%.
  • CRATs last until the end of the trust term, which could be a term of years or your life, at which time any funds that remain in the trust are then donated to the donor’s chosen charity.

People look at Charitable Remainder Trusts (CRTs) for a variety of reasons: they may want to sell and diversify away from an appreciated asset, create a reliable income stream, or donate to charity. There are two categories of Charitable Remainder Trust: Charitable Remainder Annuity Trusts (CRATs) and Charitable Remainder Unitrusts (CRUTs).

We spend most of our time writing and talking about Charitable Remainder Unitrusts (CRUTs) because they are the right fit for most of our users — CRUTs provide more income and a higher return on investment. Still, many people come to us under the impression that a CRAT is the right fit, so we thought it important to describe how CRATs work and when they are a good choice — and when they are not.

What Is A Charitable Remainder Trust?

A Charitable Remainder Trust (CRT) is a split-interest irrevocable trust that typically has two beneficiaries: the donor and a charity. What this means is the trust has two beneficiaries i.e. split interest and is irrevocable in that once it is setup or assets are contributed those elements are permanent. When the donor puts assets into the CRT, he or she receives an immediate tax deduction and an income stream for a term of years or for life, and the named charity receives the trust assets that remain at the end of the trust term.

What Is A Charitable Remainder Annuity Trust?

A Charitable Remainder Annuity Trust (CRAT) is a type of gift transaction in which a donor contributes assets to a charitable trust that subsequently pays a fixed amount to a designated beneficiary 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, but that amount must be no less than 5% of the trust assets. A CRAT may last for a term of years or for the donor’s life, and when that term is over, any funds remaining in the trust are then donated to a charity the donor chooses (often a Donor Advised Fund or foundation controlled by the donor).

Critically, CRATs are tax exempt, meaning that you will pay no taxes on most gains realized inside the trust. This is why people often use them to sell highly appreciated assets — it allows for long-term tax deferral.

What does a CRAT look like in real life (CRAT example)?

John is a 36-year-old Californian with $1m of Chime equity that he acquired at almost no cost. If he set up a CRAT for 20 years, he would receive:

  • A $100,000 charitable deduction up front (10% of the value of the assets he gifted)
  • Annual Payments: The trust was originally worth $1 million, so Erica will receive $53,900, or 5.39% of the original trust value every year.
  • Total Payouts After Donating Charitable Remainder: $647,268

There are a few relatively simple reasons why most people with appreciated assets choose Charitable Remainder Trusts and specifically CRATs.

  • CRTs: Sell and diversify an appreciated asset and take advantage of the tax deferred nature of a Charitable Remainder Trust.
  • CRATs: Wanting consistent, locked-in payments, in exchange for less upside
  • Receive an upfront charitable deduction

Now let's dive into how CRATs and CRUTs compare to help you understand what is a better fit for your situation.

How do CRUTs vs. CRATs compare?

There’s not actually all that much to differentiate the structures, but one main difference can significantly affect your returns. This key difference comes down to how much is distributed from the trust annually, and it’s encapsulated in the trusts’ labels: A CRAT is an Annuity Trust, and a CRUT is a Unitrust.

What does that mean?

  • 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, for example, if you put $1 million in startup equity into your Annuity Trust and chose a 10% payout rate, you’d receive $100,000 per year, no matter how the trust performs — whether the equity grows 100x or not at all, you’re getting that $100,000 per year.
  • A Unitrust, by contrast, is a trust that pays out a fixed percentage of trust assets every year, rather than a fixed amount. Since the fair-market value of the trust’s assets is measured every year, the amount that you receive from the trust will change every year. For instance, if you put the $1 million in cryptocurrency into your Unitrust and chose a 10% payout rate, you’d receive $100,000 in the first year. But if your investments do very well and the trust grows to $2 million the next year, you’d receive 10% of that new value, or $200,000.

Why are CRUTs “particularly suited for appreciated property”?

With a Charitable Remainder Unitrust, you will receive distributions that are a percentage of trust assets. In some cases, the trust’s value and these payouts will grow over time; in other circumstances, they will go down. (You are entitled to distributions equal to a fixed percentage of trust assets every year, though we offer a variety of distribution methods to suit your needs, including Standard CRUTs, Flip CRUTs, and NIMCRUTs.

With a Charitable Remainder Annuity Trust, you’re signing up for a fixed payout every year, no matter how the trust does. This can bring welcome certainty, but your returns are likely to be lower than with a CRUT, since your assets are likely to grow over time and much of those gains will be stuck in the trust and will revert to the charitable beneficiary at the end of the term.

An example will be helpful.

The differences of CRUTs v. CRATs in real life

Erica is a 36-year-old New Yorker with a $1m 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 $1 million, so Erica will receive $53,900, or 5.39%, every year.
  • Up-front Charitable Deduction: $100,000
  • Total Payouts After Donating Charitable Remainder: $647,268

Standard CRUT: (More on the different CRUT structures)

  • Payout Rate: Erica is entitled to receive 11.04% of the trust’s assets annually for 20 years.
  • Annual Payments: In year 1, Erica would receive $117,742 (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: $100,000
  • Total Payouts After Donating Charitable Remainder: $1,483,400

Why does a CRUT perform so much better 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. 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.

Another benefit, is you can add additional assets to a CRUT whenever you’d like. Say you added $1m of stock in year 1 and then had another $1m of stock in year 5 you wanted to defer taxes on, with a CRUT you have the flexibility to continue contributing those assets. CRAT’s don’t offer the same benefit.

Conclusion

There are a few relatively simple reasons why most people with appreciated assets choose Charitable Remainder Trusts and, specifically CRATs and CRUTs.

  • CRTs: Sell and diversify an appreciated asset and take advantage of the tax deferred nature of a Charitable Remainder Trust.
  • CRATs: The primary reason to choose an annuity trust is because you want certainty with your annual payments from the trust.
  • CRUTs: You want the trust to run for a longer time period, want more flexibility with the timing and amount of distributions and/or want a higher ROI from the structure — that is, more total distributions. To check out the ROI of a CRUT check out our online model here.

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