CRAT versus CRUT: Choosing the Best Charitable Remainder Trust
When Berkshire Hathaway announced in 2000 that it would buy paint manufacturer Benjamin Moore, financial advisor Penny Marlin had charity on her mind. One of Marlin’s older clients had long-held shares in the paint manufacturer, and—as a result of the transaction—he was about to get hit with a whopping tax bill.
After sizing up various financial strategies, Marlin recommended that her client gift the shares to a charitable remainder annuity trust (CRAT). The trust would provide a stable income stream to help fund the client’s retirement and enable him to avoid costly capital gains taxes. A charity wins, too; ultimately, an organization chosen by the client will receive the remaining value of the gifted assets.
“A CRT is a very powerful giving option because it allows you to address your current needs and also leave a legacy down the road,” says Marlin, who is based in Miami, Florida.
Sizing up Your Options
Charitable remainder trusts (CRTs) have long been popular giving vehicles for wealthy donors. Yet many donors are unaware that there are two distinct types of CRTs that operate in unique ways: the Charitable Remainder Annuity Trust and the Charitable Remainder Unitrust (CRUT). Sorting through this alphabet soup of trusts can be complex. Still, it’s imperative to understand your options so you can choose the vehicle that best suits your needs.
Each year, a Charitable Remainder Annuity Trust (CRAT) pays the donor a fixed percentage of the value of the donated assets at the time those assets are placed in the trust. In other words, the income stream is stable over the life of the trust. For example, a donor creating a 20-year CRAT worth $100,000 would receive an annual income of $5,000, assuming the minimum required yearly payout of 5 percent.
If you opt for a Charitable Remainder Unitrust (CRUT), you’ll also select a fixed annual payout ratio of at least 5 percent. However, the actual dollar amount you’ll receive each year will fluctuate instead of remaining consistent. That’s because the assets held in a CRUT are revalued at the beginning of each year. Depending on financial market performance and how well the assets in your CRUT are managed, you might earn more - or less - money each year.
Making the Right Choice
Neither option is inherently better than the other, of course. The best choice will depend on a variety of factors, including these:
* Your age. Donors age 65 or younger with life expectancies of 20 years or more often prefer CRUTs that provide the opportunity for growth. That’s because even modest inflation over long periods can significantly erode the value of fixed income payments—and eat away at your comfortable lifestyle. For example, a $10,000 annual payment will be worth just $4,420 in 20 years at a 4% inflation rate. “Younger donors, and that includes people just starting retirement, need growth to protect their purchasing power,” says Robert O’Dell, a principal financial advisor with LVM Capital Management in Wheaton, Illinois. By contrast, older donors generally favor the predictability that comes with a CRAT’s consistent income stream year after year.
* Your economic outlook. Do you foresee continued strong economic growth and a rising stock market, or are you worried that a recession accompanied by a weak stock market is around the corner? Bullish investors should feel more confident choosing a CRUT, which will generate higher annual payments if stocks and other investments perform well in the coming years. Those investors feeling bearish, however, may want to stick with a CRAT due to the guaranteed dollar amount paid each year.
* Your risk tolerance. Will you be highly dependent on the income from your CRT to fund current expenses? Do short-term swings in the value of your investments cause you to lose sleep at night? If you answer yes to either question, you probably won’t be able to tolerate significant fluctuations in your income each year and should thus lean toward a CRAT. More aggressive investors, however, should consider a CRUT.
* The type of asset you donate. Both types of CRTs can easily handle gifts of liquid assets such as cash or appreciated stock. But if you donate an illiquid asset that’s difficult to value immediately, such as a piece of real estate, you’ll need to select a CRUT. The trust will need to sell the land before payments can be made.
* Future contributions. You can make additional contributions to a unitrust and receive a charitable deduction each year you make a new gift. This makes the CRUT a popular option among investors such as corporate executives with large positions in a single stock that they want to sell over a period of years. An annuity trust, by contrast, cannot accept additional gifts.
Choosing the right charitable remainder trust depends greatly on your own unique situation. By choosing the type that best suits your specific needs, you’ll be sure that everyone involved—both yourself and your chosen charity—receives the full range of benefits that CRTs have to offer.
Mark Klimek is a freelance writer based in Portland, Maine.
Copyright CFA, 2004
Used with permission