What Is a Charitable Remainder Trust?

A charitable remainder trust (CRT) is an irrevocable trust to which a donor transfers cash, securities or other assets. In return, the donor and/or other designated individuals receive a payment stream for a term of up to 20 years, or for the lifetime of the donor and/or other individuals. Upon termination of the trust, the assets remaining in the CRT are transferred to a charity selected by the donor.

How Is a Charitable Remainder Trust Created?

The donor first drafts the trust with his or her attorney and appoints the trustee. Because the trust is irrevocable, the terms cannot be changed once it is established. During the term of the trust, payments of a fixed dollar amount or a fixed percentage are made to the individual beneficiaries at least annually. At the termination of the trust, the remaining property is transferred to a charitable beneficiary or beneficiaries selected by the donor.

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A CRT can be structured as an annuity trust or as a unitrust:

Charitable Remainder Annuity Trust (CRAT)

A CRAT pays a fixed dollar amount — determined by the donor when the trust is structured — to the donor and/or other non-charitable beneficiaries. 

For example, the beneficiary of a $1 million lifetime CRAT with a 5% payout rate will receive distributions of 5% of the original gift amount, equal to $50,000 annually. 

If assets in the CRAT were to generate an annual income of less than $50,000, the deficit would be paid from the trust principal. If assets in the CRAT were to generate an annual income in excess of $50,000, the excess income would be retained in the CRAT. The non-charitable beneficiaries are unaffected by fluctuations in the value of the trust's underlying assets.

Charitable Remainder Unitrust (CRUT)

A CRUT pays a fixed percentage of the trust's current value —determined annually — to the donor and/or other non-charitable beneficiaries. 

For example, the beneficiary of a $1 million lifetime CRUT with a 5% payout per year will receive a distribution equal to 5% of the original gift amount the first year. One year later, if the CRUT assets are only worth $900,000, the beneficiary will receive $45,000 for the upcoming year (5% of $900,000). 

However, if the CRUT assets are worth $1.1 million, the donor will receive $55,000 for that year (5% of $1.1 million). A new payment amount will be calculated each year based on the fair market value of the trust. As a result, the non-charitable beneficiaries benefit if the trust's assets appreciate. They also suffer if the trust's assets lose value. 

Additional Considerations

To thwart abusive CRTs, the law stipulates that the annuity or unitrust interest at the front end of the CRT cannot exceed 50% of the value of the trust assets. In addition, the law requires that the charitable remainder at the back end of the CRT must be at least 10% of the initial value of the trust assets. This may preclude setting up a CRT for a very young beneficiary or choosing a high payout rate, which could erode the trust principal.

What Are the Benefits?

A CRT allows the donor to satisfy charitable goals while retaining a current income stream.

The donor of a CRT receives an income tax and gift tax charitable deduction (or an estate tax deduction if the trust is funded by a transfer at death) equal to the present value of the charity's remainder interest in assets transferred to the trust.

Additionally, assets contributed to a CRT typically are excluded from the donor's gross estate, although any of the income stream that has been accumulated, rather than spent, during life is included in the beneficiaries' estates at their deaths.

Furthermore, a CRT also can be a useful tool to convert highly appreciated, low-yielding assets into a consistent stream of income without immediately recognizing the capital gain. Any taxable gain on the sale of appreciated assets by a CRT generally is deferred, because it is passed through to the beneficiaries over future years. This allows reinvestment of full, pre-tax proceeds within the trust.

Case Study

A donor, age 60 and in the top income bracket, owns $1 million worth of stock which originally cost him $10,000. He would like more income because the stock dividend is yielding only 1.5% ($15,000 per year). If he sells the stock, however, he will have to pay tax on the entire capital gain that year. 

By contributing to a 5% CRAT, this individual can increase his income from $15,000 a year to $50,000. In the process, he will defer his capital gains tax over future years, and he also may reduce his portfolio risk through diversification. Finally, he will receive a $526,435 income tax deduction, which can be used to lower his income tax liability for the next five years. The table in Exhibit 2 illustrates this example.

By contributing to a 5% CRUT, this donor can increase his income in the first year from $15,000 a year to $50,000. In future years, his income may be higher or lower than $50,000, depending upon the value of the trust. In the process, he will defer capital gains taxes, may reduce his portfolio risk through diversification, and will receive approximately a $380,220 income tax deduction, which can be used to lower his income tax liability for the next five years.

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    This material is provided for illustrative/educational purposes only. This material is not intended to constitute legal, tax, investment or financial advice. Effort has been made to ensure that the material presented herein is accurate at the time of publication. However, this material is not intended to be a full and exhaustive explanation of the law in any area or of all of the tax, investment or financial options available. The information discussed herein may not be applicable to or appropriate for every investor and should be used only after consultation with professionals who have reviewed your specific situation.BNY Mellon Wealth Management conducts business through various operating subsidiaries of The Bank of New York Mellon Corporation.

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