This post explores the two types of Charitable Remainder Trusts or CRTs: The Charitable Remainder Annuity Trust or CRAT and the Charitable Remainder Unitrust or CRUT. In another video, I discuss CRTs in general. Let’s start with a brief review of CRTs and then turn to CRATs and CRUTs.
I. Charitable Remainder Trusts
A charitable remainder trust or CRT starts when a donor transfers assets into the trust. The trust makes specific distributions, at least annually, to one or more noncharitable beneficiaries for the beneficiaries’ lives or for a specific number of years. The grantor – along with the grantor’s spouse – can be and often is the beneficiary. At the end of the term, the assets remaining in the trust go to one or more charities. The charity is called the remainder beneficiary.
The two main variations of Charitable Remainder Trusts are the CRAT and the CRUT. Those are not just four-letter words. The CRAT pays a fixed dollar amount or a fixed percentage of its initial value to the noncharitable beneficiaries at least annually. The CRUT pays a variable amount to the noncharitable beneficiaries each year, which is a percentage of the net fair market value of the CRUT as valued annually.
With a CRAT, the noncharitable beneficiary receives an annuity. An annuity is a specified percentage of the value of the assets first contributed to the trust. This amount does not change from year to year but remains the same throughout the term of the trust.
II. Charitable Remainder Annuity Trusts
A CRAT provides a steady, reliable source of income to the noncharitable beneficiaries – who are often the donors or grantors. Each year, they can count on receiving the same specified amount. Because only the initial value of the CRAT matters, its assets are valued only once, when the CRAT is first funded. A CRAT ensures payouts to the noncharitable beneficiaries remain steady even if assets in the trust go down in value. A CRAT does have some limits. It can be funded once and only once, so no additional contributions can be made. Distributions to noncharitable beneficiaries cannot be delayed with a CRAT. Therefore, the income from a CRAT cannot be deferred and it works best for liquid assets. Because the payouts to the noncharitable beneficiaries are fixed, a CRAT does not provide a hedge against inflation. In general, a CRAT is less flexible than a CRUT.
III. Charitable Remainder Unitrusts
A Charitable Remainder Unitrust or CRUT is more flexible in part because it comes in several different variations.
The Charitable Remainder Unitrust or CRUT pays a variable amount to the non-charitable beneficiaries, which is a percentage of the net fair market value of the CRUT as valued annually. Yes, this means that the assets in the CRUT must be valued annually. This can be costly for assets that are difficult to value, including business interests. The CRUT comes in several variations, including: the Standard CRUT or S-CRUT; the NICRUT or Net Income Charitable Remainder Unitrust; the NIMCRUT or Net Income Unitrust with Make-Up Provisions; and the FLIPCRUT or Flip Unitrust.
The S-CRUT works well for donors who want to receive payouts from the trust each year. The payout to the noncharitable beneficiaries of an S-CRUT is always the same percentage of the trust principal. Because the value of the principal differs each year, however, that payout changes. The assets can be valued on any day of the year, but they must be valued on the same day each year. Usually, the trust is valued on the first day of each taxable year. When assets in the S-CRUT appreciate, the payouts to the noncharitable beneficiaries increase. The annual payments from an S-CRUT cannot be deferred; they must start when the trust is founded. Therefore, the S-CRUT does not work well for assets like real estate, businesses, or boats, which must be converted to cash to make payments.
The NICRUT uses the net income method to calculate payouts to the noncharitable beneficiaries. Under the net income method, the annual payout is the lesser of a fixed percentage of the net fair market value of the trust assets valued annually or the amount of trust income for that year. If the NICRUT has no income, the noncharitable beneficiaries receive no payouts. The NICRUT works well for difficult to sell assets like valuable art. If the art were placed in an S-CRUT, the trust would have to sell the art immediately to start payments to the beneficiaries. The NICRUT also maximizes the value received by the charitable beneficiary. On the other hand, the noncharitable beneficiaries’ annual payments will be less predictable and often less than would be paid from an S-CRUT.
A NIMCRUT starts with the same payout to the noncharitable beneficiaries in a NICRUT – that is, that is, the lesser of a fixed percentage or the trust income. A NIMCRUT differs because it also has an IOU make-up account. The IOU account is the sum of amounts that would have been paid under the fixed percentage in previous years if the percentage were less than the trust’s income. The main advantage of the NIMCRUT is the ability to defer income for the noncharitable beneficiary into future years when the makeup payments are made. On the other hand, this can lead to a large payment in one future year, which may have adverse tax consequences on the noncharitable beneficiary.
The NIMCRUT is best explained by an example. Charlie funds a NIMCRUT with $100,000. The annual unitrust amount payable to the noncharitable beneficiary, which is also Charlie, is the lesser of the NIMCRUT’s annual income or 5% of its value. In the first year, the trust’s assets are valued at $100,000 and the trust has $4,000 net income. The distribution to Charlie will be $4,000 because the net income of $4,000 is less than $5,000, which is 5% of the trust’s value. Because the income is $1,000 less than the unitrust percentage amount, the IOU account owing to Charlie is $1,000. In Year 2, the trust is worth $120,000 and has $8,000 in net income. 5% of the trust’s value is $6,000, which is less than the net income of $8,000. The NIMCRUT distributes to Charlie $6,000 for Year 2 plus the $1,000 owing from the IOU account, for a total distribution of $7,000 in Year 2.
The Flip Unitrust or FLIPCRUT is the final variation of the CRUT. A FLIPCRUT starts as a NICRUT or NIMCRUT. Upon a certain date or a triggering event specified in the trust, the FLIPCRUT flips or changes to an S-CRUT. Then regular payments of a percentage of the annual value of the assets to the noncharitable beneficiaries begin. This is an excellent retirement planning strategy. During their high-income-earning years, the donors establish the FLIPCRUT and claim an income tax deduction. When the donors retire, the trust flips to an S-CRUT and becomes a regular source of income for them. The IOU account from a NIMCRUT disappears upon the flip. But if the donors wish to collect from the IOU account, they can arrange to do so in the year before the flip. This makes the FLICRUT an extremely flexible planning tool for obtaining tax advantages, preparing for retirement, and supporting charity.
As you can see, charitable planning is extremely complicated. If you would like to discuss your options for charitable planning, contact us to schedule a no-charge consultation.