The benefits of CRATs.

• Author: Fink, Philip R.
• Position: Charitable remainder annuity trusts

Why create a charitable remainder annuity trust (CRAT)? To provide an annuity for life, while making a gift to charity thereafter. A CRAT is on attractive way to diversify a retirement portfolio, generate income and hedge against outliving one's wealth. This article explains the benefits of CRAT creation.

Charitable remainder trusts (CRTs) offer many tax and financial advantages when a grantor is a life income beneficiary. A CRT is a tax-exempt trust that disburses all or a portion of its income to one or more individual beneficiaries for a specified term. At the end of the term, the remainder interest passes to a designated charity. CRTs allow a donor to make a charitable gift while not relinquishing the present income stream from a property. There are two types of CRTs--charitable remainder annuity trusts (CRATs) and charitable remainder unitrusts (CRUTs). This article explains the various tax and financial advantages of a CRAT when the grantor is the life income beneficiary, and indicates the conditions under which a CRAT is more advantageous than an outright charitable contribution or taking no action.

CRAT vs. CRUT

A CRAT annually distributes a fixed percentage of the initial value of assets transferred to the trust over the trust's term. Thus, a CRAT distributes to the grantor the same amount each year. In contrast, a CRUT distributes each year a fixed percentage of the underlying assets' fair market value (FMV) for the year in question; as the underlying assets' FMV increases or decreases, the distribution for that year will correspondingly fluctuate.

For individuals using a CRT to supplement their retirement income, establishing a CRAT has the advantage of predictability--a grantor knows how much he or she will receive from the trust each year. With a CRUT, distributions will vary according to the underlying assets' annual FMV. (1)

What is a CRAT?

CRATs are used to achieve various financial goals that cannot be accomplished by making an outright charitable contribution (or by not making a contribution at all). Establishing a CRAT is a great way of diversifying an investment portfolio. In addition, individuals can use it as a hedge against outliving their savings. Many charitable organizations are eager for individuals to create CRATs and will readily undertake the necessary administrative tasks.

How Is It Created?

A CRAT is created when a grantor transfers property to a trust and names an individual (including the grantor) to receive an income interest, and a charitable organization to receive the remainder. Such a transfer is reportable for gift tax purposes, but the remainder qualifies under Sec. 2522(a)(1) for a gift tax charitable deduction; thus, there is no gift tax liability unless someone other than the donor receives the annuity. Because the transfer is a gift, there is no grantor income tax liability on the transfer of appreciated property; the CRAT takes a carryover basis in the property under Sec. 1015(b).

Typically, the grantor will receive an annuity for life; on his or her death, the remainder will go to a designated charity(ies). Alternatively, under Sec. 664(d)(1)(A), the grantor may receive an annuity from the trust for a specified number of years (not to exceed 20). The annual amount paid to the grantor must be at least 5%, but not more than 50%, of the trust assets' initial FMV. According to Sec. 664(d)(2)(D), the remainder interest's value must be at least 10% of the trust property's initial net FMV.

How Is It Taxed?

Under Sec. 664(c), a CRAT is generally not subject to income tax unless it has unrelated business taxable income. This...