A term-of-years CRAT worked from the annuity factor: the charitable deduction, the 10 per cent remainder test, the maximum payout and what the family gives up.
A charitable remainder annuity trust (CRAT) pays the donor a fixed annuity for life or up to 20 years and leaves what is left to charity. The donor's income tax deduction is the contribution minus the present value of the annuity at the section 7520 rate. Illustratively, 10,000,000 of stock paying 500,000 a year for 20 years at a 5.0 per cent rate gives an annuity worth 6,231,105 and a deduction of 3,768,895, or 37.69 per cent of the gift, comfortably above the 10 per cent minimum the remainder must meet.
Worked in full in The Family Office Professional by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Family offices use a CRAT for one problem above all: a large, low-basis position the family wants to diversify without paying the capital gains tax up front, combined with a charitable intent that is real. The trust is tax-exempt, so it can sell the stock and reinvest the whole proceeds. The family gives up the remainder; in exchange it gets a fixed income stream, a deduction now and tax spread over the payments. The arithmetic decides whether that exchange is good.
| Input | Value |
|---|---|
| Stock contributed, fair market value | 10,000,000 |
| Tax basis | 1,000,000 |
| Term | 20 years |
| Annuity, 5.0% of initial value, paid at each year end | 500,000 |
| Section 7520 rate (illustrative) | 5.0% |
| Combined capital gains rate (illustrative) | 23.8% |
| Trust's net investment return (illustrative) | 6.0% |
The rules that frame the design: the annuity must be between 5 and 50 per cent of the initial value, a term of years cannot exceed 20, and the remainder must be worth at least 10 per cent at funding. The donor may use the 7520 rate for the month of the gift or either of the two months before.
Annuity factor = (1 − (1 + i)−n) ÷ i = (1 − 1.05−20) ÷ 0.05 = 12.4622
PV of annuity = 500,000 × 12.4622 = 6,231,105
In Excel: =PV(5%,20,-500000)
Remainder = contribution − PV of annuity = 10,000,000 − 6,231,105 = 3,768,895, or 37.69%. The 10% test passes.
Maximum annuity that passes: (10,000,000 − 1,000,000) ÷ 12.4622 = 722,183 a year, a payout of 7.22%.
Deduction: 3,768,895. At an illustrative 37% marginal rate it is worth 1,394,491, subject to the percentage-of-income limits for gifts of appreciated property, with a five-year carryforward.
Sold outright, the stock would realise a gain of 9,000,000 and a tax of 2,142,000, leaving 7,858,000 to reinvest. Inside the trust the sale is not taxed, so all 10,000,000 is reinvested and the 500,000 annuity is 1.273 times the income the same payout rate would give on the after-tax amount. The tax has not disappeared: the payments carry the trust's income and gains out to the donor under the tier rules, ordinary income first, then capital gains, so the 9,000,000 gain is taxed slowly, as it is paid out.
If the trust earns 6.0 per cent net, after 20 years and 10,000,000 of payments it holds 13,678,559 for the charity: 32,071,355 of growth on the original 10,000,000 less 18,392,796 for the payments compounded. Had the family instead sold, paid the tax and drawn the same 500,000 a year from 7,858,000, it would have 6,808,875 left, before the income tax on returns and payments that both routes carry differently. That is the price: 6,808,875 in 20 years forgone by the family, against a deduction worth 1,394,491 today, a deferral of 2,142,000 of tax and a gift to charity more than twice as large.
| 7520 rate | Payout 5% | Payout 6% | Payout 7% | Payout 8% |
|---|---|---|---|---|
| 3.0% | 25.6% | 10.7% | −4.1% | −19.0% |
| 4.0% | 32.0% | 18.5% | 4.9% | −8.7% |
| 5.0% | 37.7% | 25.2% | 12.8% | 0.3% |
| 6.0% | 42.7% | 31.2% | 19.7% | 8.2% |
Shortening the term raises the remainder: at a 5 per cent payout and a 5.0 per cent rate, 10 years leaves 61.4 per cent (factor 7.7217) and 15 years 48.1 per cent (factor 10.3797). And the trust's actual return decides what the charity receives, not the deduction: at 4 per cent net the charity gets 7,022,192, at 3 per cent 4,625,925. A fixed annuity paid out of a portfolio that underperforms eats into capital; a CRAT measured on a life rather than a term must also pass a test that the trust has no more than a 5 per cent probability of running out.
The common mistake is to carry over the intuition from a GRAT, where a low 7520 rate is good for the family. In a CRAT the deduction is the charity's share, so a higher rate is better: it discounts the annuity more and leaves a larger remainder. In a low-rate month a 7 per cent payout fails the 10 per cent test outright and a 6 per cent payout barely passes, as the table shows, and the choice between the current month's rate and the two prior months is worth checking every time.
Value the annuity at the 7520 rate, subtract it from the gift, and check the 10 per cent floor; then compare what the family gives up at the end of the term with the deduction and the deferral it gets now. A CRAT is a charitable vehicle that happens to defer tax, not a tax shelter that happens to involve a charity. For the mirror-image trust that passes growth to heirs, see how a GRAT works; the office cost model and the working documents for this book are on the free companion page for this case.
As the value contributed minus the present value of the annuity, discounted at the section 7520 rate for the term. For 10,000,000 paying 500,000 at each year end for 20 years at an illustrative 5.0 per cent, the annuity factor is 12.4622, the annuity is worth 6,231,105 and the deduction is 3,768,895.
The value of the charity's remainder at funding must be at least 10 per cent of the contribution. On 10,000,000 for 20 years at a 5.0 per cent rate, the annuity can be at most 9,000,000 divided by 12.4622, which is 722,183 a year, 7.22 per cent. At a 3.0 per cent rate a 6 per cent payout leaves 10.7 per cent, barely passing.
It helps, the opposite of a GRAT. A higher rate discounts the annuity more heavily, so the charity's remainder and the deduction are larger. At a 5 per cent payout for 20 years, the remainder is 25.6 per cent of the gift at a 3.0 per cent rate and 42.7 per cent at 6.0 per cent.
This article is one calculation from The Family Office Professional. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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