Legal Definitions - charitable remainder annuity trust

A Charitable Remainder Annuity Trust (CRAT) is a special type of irrevocable trust designed to provide a fixed income stream to one or more non-charitable beneficiaries for a specific period, after which the remaining assets are transferred to a designated charity.

Here's how a CRAT typically works:

• A donor (the "grantor") places assets, such as appreciated stock or real estate, into the trust.
• The trust then pays a fixed dollar amount, determined as a percentage of the initial value of the assets contributed to the trust, to the grantor or another chosen beneficiary (like a spouse or child) each year. This payment continues for a set number of years (up to 20) or for the lifetime of the beneficiary. Federal law requires this annual payout to be at least 5% of the initial trust value.
• Once the specified period ends, the remaining assets in the trust are distributed to one or more qualified charities chosen by the grantor.

CRATs offer several advantages to the grantor. They can receive an immediate income tax deduction for the charitable contribution portion of the trust and may defer or avoid capital gains taxes on appreciated assets transferred into the trust. This structure allows individuals to generate a predictable income stream for themselves or loved ones while simultaneously making a significant future gift to charity.

Key characteristics of a CRAT include its irrevocable nature, meaning it cannot be changed once established, and the inability to make additional contributions after its creation. The annual payout is fixed, regardless of how the trust's investments perform, providing stability for the income beneficiary.

Here are a few examples illustrating how a Charitable Remainder Annuity Trust might be used:

• Example 1: Retirement Income and Arts Philanthropy

  Mr. and Mrs. Chen, both in their late 60s, own a portfolio of highly appreciated tech stocks they've held for decades. They want to support their local symphony orchestra, but also need a reliable income stream during retirement. They decide to establish a CRAT, funding it with $1 million worth of their appreciated stock. The trust is structured to pay them a fixed annuity of 6% ($60,000) annually for the rest of their lives. Upon the death of the surviving spouse, the remaining assets in the trust will go to the symphony orchestra. This arrangement allows the Chens to avoid immediate capital gains taxes on the stock, receive a significant income tax deduction in the year they create the trust, and enjoy a predictable income while knowing they are securing a future gift for a cause they care about.

• Example 2: Supporting an Elderly Parent and Environmental Causes

  Sarah, a successful entrepreneur, wants to ensure her elderly mother, who relies on her for financial support, has a stable income for the remainder of her life. Sarah also has a deep commitment to environmental conservation and wishes to leave a legacy to a specific wildlife fund. She establishes a CRAT with $750,000 from the sale of a non-liquid asset (like a piece of investment property). The trust is designed to pay her mother a fixed annual amount of $45,000 (6% of the initial value) for her lifetime. After her mother passes away, the remaining funds will be distributed to the wildlife fund. Sarah benefits from an immediate charitable deduction, and her mother receives a secure, predictable income without Sarah having to manage ongoing payments directly from her personal finances.

• Example 3: Business Sale and University Endowment

  Dr. Lee, a medical practice owner, is selling his practice for $2 million. He anticipates a substantial capital gains tax liability from the sale. He also wants to make a significant contribution to his alma mater's medical research endowment. Dr. Lee decides to fund a CRAT with $1.5 million of the proceeds from the sale. The trust is set up to pay him a fixed annuity of 5% ($75,000) for 15 years. After 15 years, the remaining principal will be transferred to the university's endowment. By using the CRAT, Dr. Lee defers capital gains taxes on the assets transferred to the trust, receives an immediate income tax deduction, and secures a steady income stream for a defined period, all while fulfilling his philanthropic goals for his university.