The purpose of estate tax planning is to maximize the assets you pass on to future generations by minimizing gift and estate taxes. Estate-tax strategies revolve around the use of irrevocable trusts. This article discusses the most common types of irrevocable trusts that are used to minimize gift and estate […]
Many people understand that Charitable Remainder Trusts (CRTs) can help them sell and diversify appreciated assets while minimizing taxes on the sale. They might even know that there are different types of CRTs. But most people don’t understand the differences between Charitable Remainder Annuity Trusts (CRATs) and Charitable Remainder Unitrusts (CRUTs).
In fact, CRUTs are generally the better tax mitigation tool for people with appreciated assets who want to maximize their long-run returns. This article discusses the differences between CRATs and CRUTs, as well as some trade-offs between these two structures.
First, here are three things you need to know about Charitable Remainder Trusts generally (all of which apply to both CRATs and CRUTs):
The main difference is the structure of the annual distribution. It’s right there in their names: A CRAT is an Annuity Trust, while a CRUT is a Unitrust. CRATs distribute a fixed dollar amount (based on a percentage that is calculated when the trust is first funded), while CRUTs distribute a fixed percentage of trust assets every year (with the dollar amount increasing or decreasing along with the value of the trust assets). Assuming decent investment returns (say, better than 5% over the long run), the total amount distributed from a CRUT should exceed the total amount distributed from a CRAT.
What is an Annuity Trust?
An annuity is a fixed amount of money that a person receives for a specified period, usually in exchange for a lump-sum payment upfront. An Annuity Trust is a trust that provides a fixed income stream for the trust’s term — either a person’s lifetime or a specified period. That static income amount is based on the initial value of the assets placed into the trust. So, for example, if you put $1 million in startup equity into your Annuity Trust and had a 10% payout rate, you’d receive $100,000 per year, no matter how the trust performs — whether the equity grows 100x or not at all, you’re getting that $100,000 per year.
What is a Unitrust?
A Unitrust is a trust that pays out a fixed percentage of trust assets every year rather than a fixed amount. Since each distribution is tied to the fair market value of the trust’s assets in that particular year, the amount you receive from the trust will change yearly. For instance, if you put the $1 million in cryptocurrency into your Unitrust and had a 10% payout rate, you’d receive $100,000 in the first year. But if the trust’s investments doubled in value to $2 million the following year, you’d receive 10% of that new value, or $200,000. In other words, you get to share the upside or downside of your investments.
Other Differences
CRUTs have a few other key advantages over CRATs:
| CRAT | CRUT |
|---|---|
You prefer guaranteed annual payments rather than variable payments. | You want a higher ROI from the structure — that is, more total distributions. To check out the ROI of a CRUT, check out our online model here. |
You are pessimistic about your future investment returns. | You want more flexibility with the timing and amount of distributions. |
You want the trust to run for a more extended period. |
With a CRUT, you will receive distributions that are a percentage of trust assets in any given year. In some cases, the trust’s value and these payouts will grow over time; in other cases, they will go down.
With a CRAT, you’re signing up for a fixed payout every year, no matter how the trust does. This can bring welcome certainty. But your returns will probably be lower than with a CRUT since you won’t be able to share in the upside on the trust’s investments. Instead, most of those investment gains will remain in the trust and pass to the charitable beneficiary.
Erica is a 36-year-old New Yorker with a $1 million asset. That asset has a cost basis of zero (that is, she paid $0 for it). She wants to set up a 20-year term trust.
CRAT (Charitable Remainder Annuity Trust):
Standard CRUT: (Read more on the different CRUT structures.)
Why does a CRUT perform so much better on average?
No doubt you noticed the bottom line: The total payouts from Erica’s CRUT are significantly higher than from a CRAT. Why is that so? It’s simple: A CRUT’s annual distributions are defined as a percentage of the trust’s assets, measured that year, whereas a CRAT’s annual distributions are a fixed percentage of the trust’s starting value. Assuming that the trust grows in value over time — a fair assumption for most people, most of whom will aim to match historical market returns — then the distributions will be much larger if they’re tied to the trust’s growing value rather than its original value.
Charitable Remainder Trusts are robust tax planning structures. While CRATs and CRUTs are similar, the crucial difference in how the annual distributions are calculated has massive implications. If you are willing to give up more significant distributions and are focused on a short timeline, you may prefer the certainty and consistency of a CRAT. On the other hand, you may choose a CRUT if you wish for the Charitable Remainder Trust to run for a more extended time or value more flexibility with the timing and amount of distributions.
To learn more about CRUTs, check out our comprehensive guide, access our CRT calculator to evaluate the potential return given your situation, or schedule a meeting with us.
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From picking the best strategy to taking care of all the setup and ongoing overhead, we make things simple. The results are real: We have helped create more than $3 billion in additional wealth for our customers. If you would like to learn more, please feel free to explore our Learning Center. You can also see your potential tax savings with our online calculators or schedule a time to chat with us!
