How does a charitable remainder trust work for tax and estate planning, and what are the two main types?

A charitable remainder trust (CRT) is an irrevocable trust that provides income to the donor (or other beneficiaries) for a specified period, after which the remaining assets pass to a designated charity. It offers a unique combination of income, tax deductions, and philanthropic impact.\n\nHow It Works:\n\n1. Donor transfers appreciated assets to the CRT\n2. CRT sells assets -- no immediate capital gains tax (the trust is tax-exempt)\n3. Full proceeds are reinvested\n4. Trust pays income to the donor for life or a term of up to 20 years\n5. At termination, remaining assets go to the designated charity\n6. Donor receives an upfront charitable income tax deduction equal to the PV of the remainder interest\n\nTwo Types:\n\n| Feature | CRAT (Annuity Trust) | CRUT (Unitrust) |\n|---|---|---|\n| Payout | Fixed dollar amount | Fixed % of trust value (revalued annually) |\n| Inflation protection | None | Yes (if trust grows) |\n| Additional contributions | Not allowed | Allowed |\n| Income variability | None (fixed) | Fluctuates with trust value |\n| Best for | Donors wanting predictable income | Donors wanting growth participation |\n\nWorked Example:\n\nWealth advisor Constance recommends a CRT for client Pemberton, age 60, who holds $2,000,000 in highly appreciated stock (cost basis $300,000).\n\nWithout CRT:\n- Sell stock: capital gains tax on $1,700,000 at 23.8% = $404,600\n- Net proceeds: $1,595,400\n- Invest at 6% = $95,724/year income\n\nWith CRUT (5% payout rate):\n- Transfer $2,000,000 to CRUT\n- No immediate capital gains tax (trust sells tax-free)\n- Full $2,000,000 invested\n- Year 1 income: 5% x $2,000,000 = $100,000\n- Charitable deduction (PV of remainder): approximately $540,000\n- Tax savings from deduction (37% bracket): $540,000 x 0.37 = $199,800\n- If trust grows at 8%, Year 10 income: 5% x $2,000,000 x 1.08^10 x (adjusted) = approximately $125,000+\n\nTotal benefit: higher initial income ($100K vs $95.7K), $199,800 tax savings, and growing income stream.\n\nTrade-offs:\n- Assets are irrevocably transferred (cannot be reclaimed)\n- Heirs receive nothing from the trust (though the tax savings can fund a wealth replacement trust with life insurance)\n- Minimum payout rates and maximum term apply (IRS rules require the charity's remainder interest to be at least 10% of initial contribution)\n- Income from the trust is taxable to the beneficiary\n\nCRAT vs CRUT Decision:\nChoose CRAT when the donor prioritizes stable, predictable income (similar to a bond). Choose CRUT when the donor wants income that grows with the portfolio and may wish to make additional contributions over time.\n\nLearn more about estate and wealth planning in our CFA Level III course.