Charitable remainder annuity trust: how a CRAT pays you and what the charity gets

A charitable remainder annuity trust, usually shortened to CRAT, is an irrevocable trust that pays a fixed dollar amount each year to you or to someone you name, and gives whatever is left to charity when the payments stop. The amount is set when the trust is funded and never changes. Under the rules in Internal Revenue Code section 664, it has to be at least 5% and no more than 50% of the value of the assets put in, the payments can run for one or more lifetimes or for a fixed term of up to 20 years, and the charity's share has to be worth at least 10% of what went in at the start.

That last requirement does most of the work in practice. It is the reason a CRAT set up for a young beneficiary at a high payout rate simply will not qualify, and the reason the arithmetic has to be run before the documents are drafted rather than after.

What a CRAT actually does

Three things happen at once when a CRAT is funded.

You give assets away irrevocably. The trust is not yours any more, and you cannot change your mind, take the assets back, or alter the payout later.

You keep an income stream. The trust owes a fixed annuity to the named beneficiary — you, your spouse, both of you in succession, or someone else entirely — for the agreed period.

You get a charitable income tax deduction now, based on the present value of the charity's future remainder interest rather than on the full value of what you contributed. The deduction is subject to the usual adjusted gross income percentage limits, which depend on the type of asset and the type of charity, with a carryforward for anything you cannot use in the year of the gift.

The trust itself is generally exempt from income tax. That is the feature people set these up for. If you contribute an appreciated asset you have held for years — concentrated stock, a rental property, a business interest — the trust can sell it without paying capital gains tax on the way out, and the full sale proceeds go to work funding your annuity. You do not escape the gain permanently; it comes back to you gradually through the payments, which is covered below.

The rules a CRAT has to satisfy

These are not drafting preferences. Fail one and the trust does not qualify.

Requirement	What it means
Fixed payout	A specific dollar amount, fixed at the outset, paid at least annually. It does not move with investment performance.
5% to 50%	The annuity must be at least 5% and no more than 50% of the initial net fair market value of the assets contributed.
10% remainder	The present value of the charity's remainder interest must be at least 10% of that same initial value.
Term limit	Lives of one or more individuals living when the trust is created, or a fixed term of no more than 20 years.
Single funding	A CRAT is funded once. Additional contributions are not permitted after it is created.

The single-funding rule is the main structural difference between a CRAT and its variable cousin, the charitable remainder unitrust (CRUT), which pays a percentage of assets revalued each year and can accept further contributions. If you expect to add to the trust over time, a CRAT is the wrong shape.

There is one further hurdle for lifetime CRATs. A trust that pays a fixed amount for someone's life can, in principle, run out of money before that person dies, leaving the charity with nothing. The IRS applies a probability test to that risk, and a trust that fails it does not qualify. The IRS has also published optional sample language that lets a trust address the same concern a different way, by ending early if the assets would otherwise be exhausted. Which route a particular trust takes is a drafting decision for the lawyer preparing it, but the underlying maths — payout rate, beneficiary age, and the valuation rate in force — is what decides whether either route is available at all.

Where the numbers come from

Two inputs set the deduction: the payout you choose, and the interest rate the IRS publishes each month for valuing split-interest gifts. A higher valuation rate assumes the trust assets grow faster, which leaves more for the charity and increases your deduction. A lower one does the opposite, and can push a marginal trust below the 10% remainder threshold.

Here is an illustrative structure, not a quote or a projection:

• Contribution: $1,000,000 of long-held appreciated stock
• Payout rate chosen: 5%
• Annual annuity: $50,000, fixed, for the life of a single beneficiary
• Remainder to charity: whatever the trust holds when the payments stop

The $50,000 does not change. If the trust earns more than it pays out, the charity's share grows. If it earns less, the trust erodes, and the annuity is paid out of principal until the assets run out. That is the trade the CRAT makes: certainty for the beneficiary, variability for the charity. A CRUT reverses it.

Whether that same structure produces a qualifying deduction depends entirely on the beneficiary's age and the valuation rate for the month of funding. These rates change monthly and the outcome changes with them, so treat every figure above as an example based on stated assumptions and have the actual numbers run before acting.

If you want a feel for how a fixed stream converts into a present value, the present value of annuity calculator does the same arithmetic the trust valuation uses, without the charitable overlay.

How the payments are taxed when you receive them

The trust pays no tax. You do. The character of what reaches you is decided by a four-tier ordering rule that empties the trust's most heavily taxed pockets first:

1. Ordinary income — current year first, then any accumulated from prior years
2. Capital gain — again, current year, then accumulated
3. Other income, including tax-exempt income
4. Return of principal, which is not taxable

This is why the capital gains benefit is deferral rather than elimination. When the trust sells your appreciated stock, the gain is not taxed at trust level, but it sits in tier two and is fed back to you through the annuity payments over the years that follow, taxed at your rates as it arrives. Stretched across a long payout period, that can be worth a great deal. It is not the same as the gain disappearing, and any adviser who describes it that way is describing something else.

Note also that a CRAT with any unrelated business taxable income in a year faces a punitive excise charge on that income, which is one reason trustees are cautious about holding operating business interests or debt-financed property inside one.

CRAT, CRUT and charitable gift annuity compared

These three are regularly confused because all three pay an income stream and end with a gift.

	CRAT	CRUT	Charitable gift annuity
What you get	Fixed dollar amount	Percentage of assets, revalued yearly	Fixed dollar amount
Who owes it	The trust, from its own assets	The trust, from its own assets	The charity, from its general assets
Inflation	No protection	Payments rise if assets grow	No protection
Extra contributions	Not allowed	Allowed	Each gift is a separate contract
Cost and complexity	Trust document, trustee, annual return	Same, slightly more admin	Simple contract, no trust
Risk if assets fall	Payments continue until funds exhausted	Payments fall with the assets	Charity's full credit stands behind it

The practical dividing line is size and motive. A charitable gift annuity is a contract with a single charity and works at modest amounts because there is no trust to run. A CRAT justifies its setup and administration costs at larger values, keeps you free to name more than one charity and to change the charities later if the document allows, and can hold assets a charity would not want to take directly.

When a CRAT is the wrong tool

It is irrevocable, and that is the whole of the risk. If your circumstances change, the annuity is what it is. A beneficiary in their sixties funding a CRAT with most of their liquid wealth has converted flexible capital into a fixed stream and a deduction, and there is no undo.

It also assumes you actually want the charity to receive the remainder. If the real objective is income for yourself and capital for your children, a CRAT is the wrong structure — the remainder has to go to charity, and there is no version of it that quietly returns to the family.

A few other situations argue against it. If you need inflation protection, the fixed payment will disappoint over a 25-year horizon in a way a inflation-adjusted annuity or a CRUT would not. If your giving is annual and modest, a donor-advised fund or a qualified charitable distribution from an IRA achieves the charitable purpose with none of the machinery. And if someone is pitching a CRAT primarily as a way to make capital gains vanish, be careful — the IRS has publicly warned about promoted CRAT arrangements built on aggressive basis claims, and the four-tier rule above is the reason those claims do not work as advertised.

Administration is a real ongoing cost too. A CRAT files an annual information return, needs a trustee willing to serve, and requires the annuity to be paid on time every year regardless of what markets have done. Where the trust holds an annuity contract as an investment rather than being one, the additional issues in annuity in a trust apply on top.

This article is educational and not personal financial, tax or legal advice. Charitable trust rules are detailed, the valuation rates change monthly, and the outcome depends on facts specific to you; confirm the current position with the IRS or a qualified professional before acting.

Charitable Remainder Annuity Trust: Frequently Asked Questions

Can I be the trustee of my own CRAT?

Often yes, though many people choose not to be. Serving as trustee means taking responsibility for valuing the assets, investing them, making the annuity payment on schedule, and filing the trust's annual return. Where the trust holds hard-to-value assets, a trustee who is also the annuity beneficiary is in an awkward position, and a corporate or charity trustee removes the conflict. The charity that will eventually receive the remainder will sometimes serve without charge.

What happens if the trust runs out of money?

The payments stop and the charity receives nothing. That is the structural risk of a fixed annuity paid from a finite pool, and it is exactly what the IRS probability test is designed to prevent at the outset. A trust that starts at a 5% payout and is invested conservatively has a good deal of headroom; one that starts near the 50% ceiling for a long term has almost none.

Can I change the charity after the trust is set up?

Only if the trust document reserved that power when it was drafted. Many CRATs are written to let the donor or trustee substitute one qualified charity for another, and that flexibility costs nothing at the drafting stage. If the document names a single charity with no substitution power and that charity later ceases to exist, sorting it out becomes a court matter.

Does a CRAT reduce my estate tax?

Generally yes, because the assets leave your estate when the trust is funded and are not brought back. Where the annuity continues to a surviving spouse, the value of that continuing interest is typically handled through the marital deduction. Where it continues to someone else — a child, for example — that interest has gift or estate tax consequences that have to be dealt with at the time the trust is created, not afterwards.