Annuities can be complex financial instruments with many moving parts. One of the luxuries that annuities provide is their ability to be tailored to fit the desires of the annuitant. Given the numerous different types of annuities, it is important for potential annuitants to understand all of their options. In addition to a variety of traditional annuities, there are multiple types of planned giving annuities. Continue reading to learn about a form of planned giving that is structured as an annuity, a charitable remainder annuity trust.
What is a Charitable Remainder Annuity Trust?
Charitable remainder annuity trusts (CRATs) are a form of planned giving in which the donor gives assets to a charitable trust, and subsequent fixed payouts are made to either the donor for the rest of his or her life or a beneficiary designated by the donor. Once the donor passes away, any funds that remain in the trust are donated to a preselected charity.
It is more common for the donor to opt to receive the annuity payouts themself, but if the donor chooses to allocate the payouts to a beneficiary, the beneficiary can be other family members or even a university or non-profit organization.
CRATs can be funded with several types of assets, including cash, securities and real estate. However, it is best to use cash or readily marketable assets to fund an annuity trust.
How does a Charitable Remainder Annuity Trust Work?
First, the donor must make a donation in the form of cash, stocks, or non-publicly traded assets such as real estate. The donation makes the donor eligible for a partial income tax deduction. The partial income tax deduction is based on the type of trust, the term of the trust, IRS interest rates that assume a particular growth rate of the trust’s assets, and the expected income payments.
Once the donation has been made, the donor or his or her chosen beneficiaries receive an income stream. The frequency of annuity income payments is specified in the terms of the contract per the decision of the donor. Payouts can be made annually, semi-annually, quarterly or monthly. The IRS requires that the annual payout rate stated in the trust cannot be less than 5% or more than 50% of the initial fair market value of the trust’s assets. The payouts from the CRAT will be fixed, meaning the payouts are made according to an interest rate that never changes; the payouts that the beneficiary receives are always the same amount. The fixed annuity payouts will continue either until the death of the last income beneficiary or for a period of time that is specified in the contract.
After the specified timespan of annuity payouts or the death of the last income beneficiary, the remaining CRT assets are distributed to the designated charitable beneficiaries. The donor can specify multiple charities to receive the remainder of the assets, or choose just one organization.
CRATs are similar to other charitable annuities, with one vital difference: CRATs are structured as a separate trust fund, which shields them from incurring any liability. CRATs offer a dependable and guaranteed stream of income to their beneficiaries every year, and the amount received never fluctuates regardless of the trusts’ investment performance. For instance, a CRAT with an initial value of $3,000,000 and a 5% payout would pay $150,000 annually to the income beneficiary, regardless of the returns of the underlying assets and the economic climate.
Advantages of Owning a Charitable Remainder Annuity Trust
Disadvantages of Charitable Remainder Annuity Trusts
The Bottom Line
Donors who are considering opening a charitable remainder annuity trust should consider all aspects of the decision, and talk to a financial advisor about if a CRAT is a good fit for them. CRATs can be a great option for those who are looking to balance their financial planning with charitable goals.
Special thanks in preparing this summary of “What is a Charitable Remainder Annuity Trust?” goes to Bob Carlson, leader of the Retirement Watch advisory service and chairman of the Board of Trustees of Virginia’s Fairfax County Employees’ Retirement System with more than $4 billion in assets.