The Ins and Outs of Charitable Remainder Annuity Trusts

• Fixed revenue stream that is paid out to you and your spouse for as long as both of you are living.
• The charity that you select can be your favorite one. It can even be your own private foundation.
• A tax deduction based on the value of the charitable contribution is available.
• You can use a CRAT to sell a highly appreciated asset to avoid paying taxes on capital gains.
• The trust lets the charity avoid estate and income taxes upon the death of you and your spouse.
• Investment decisions are easier because under a CRAT, investments are managed within a trust that’s exempt from income taxes.

A CRAT offers a steady stream of income for the remainder of your life while giving you a way to donate to your favorite charity. A trustee will manage the assets of the trust, and you or other people that you’ve selected will receive a fixed income for life or for a predetermined number of years. When the CRAT terminates, the remaining funds will go to the charity. The typical donor of this type of trust:

• Requires income for a specified duration
• Wants a fixed income
• Will not be making additional donations to the charity
• Is from 55 years old to 80 years old

Years ago, William Frederickson bought appreciated securities for $30,000. Today, his wise investment is worth $100,000. William's investment advisor has been encouraging him to diversify. Frederickson has been hesitating to act on this since he may lose some of the funds to capital gains taxes along with the future earnings he would have enjoyed on the amount that went to taxes.

Frederickson believes in supporting charities. In fact, he has considered donating to his favorite charity for some time, but he isn’t comfortable giving a large gift while he’s still alive and in need of a steady income to get by. However, he is interested in making a donation upon his death.

After reviewing his options, William decides that a planning method called a charitable remainder annuity trust will let him complete his life goals. This planning option will allow him to avoid paying taxes on his capital gains. It will also give him a lifetime income, produce a deduction for income taxes, let him avoid estate taxes and help him ensure that his preferred charity receives a large donation when he dies.

A CRAT is a unique and permanent investment option. It's one that is mutually beneficial since both the donor and the charity benefit through its split interest setup. To determine its fixed income feature, the value of the investment is multiplied by a specified percentage. You will receive this amount for the remainder of your life or for a set number of years, which is not to exceed 20.

You can also set this type of trust up to go into effect upon your death. In this case, you would select a beneficiary. Most people select their spouse as the income beneficiary, but you can choose another person such as your child or a sibling. When a child or a sibling is the beneficiary of a CRAT, he or she may run into issues regarding gift and estate taxes. Because of this, most people select a CRAT when they intend for themselves or a spouse to be the beneficiary.

If you’re a little wishy-washy about the charity, be sure to include an addendum that lets you change where your donation goes after the creation of the trust. To qualify for a good annual income as well as for favorable estate and gift taxes, your CRAT must meet several technical requirements. For instance, the percentage used to determine the annual income cannot be less than 5 percent or higher than 50 percent of the amount. In addition, the charity’s interest must be at least 10 percent while the total trust amount will need to pass a 5 percent exhaustion test to ensure its stability. Also, the charity that you select for the CRAT must be a qualifying one under the federal tax law.

When it comes to tax deductions, you’ll benefit from having a CRAT in place. The amount that you’ll claim is the contribution’s actuarially computed value. This type of deduction falls under the federal regulations statute that oversees charitable gifts, so you may face limitations according to your adjusted gross income. In this deduction category, the type of asset that you transferred may affect the amount that you owe in taxes as could the kind of charity.

In most cases, the trust is relieved from federal income tax, so this is a major benefit of contributing through a CRAT. You will likely owe income tax on the trust distributions, but this will be based on the nature of the income. It will also depend on the rules regarding the timing of the transfer.

A major area of consideration involves sufficient assets. When you set up a CRAT, it will pay you a fixed annuity. However, it can only do this as long as it has sufficient assets. Because of this, it’s important that the trust's invested assets are managed judiciously. These types of trusts are usually funded with assets that are able to generate a substantial and consistent flow of income.

Keep in mind that under a CRAT, you can only make one contribution. If you want to increase the amount that is going to the charity, you would need to create a second one. Instead of setting up a CRAT, you could select a charitable remainder unitrust. With this type of trust in place, you would be able to make additional contributions.

CRATs offer benefits in the form of income tax deductions and the avoidance of estate and capital gains taxes. By establishing a charitable remainder annuity trust, you’ll not only work to maintain your own personal income, but you’ll also provide support for a charity that inspires you.