How Much Income Can You Take From a Charitable Remainder Trust?

A charitable remainder trust (CRT) is a financial instrument designed to balance personal income needs with philanthropic goals. It provides a steady stream of income to designated beneficiaries for a specified period. Afterward, the remaining assets are dedicated to one or more charitable organizations. This structure allows assets to support both individual financial well-being and charitable causes.

Understanding Charitable Remainder Trusts

A Charitable Remainder Trust is an irrevocable trust arrangement where a donor transfers assets into the trust. The donor cannot reclaim the assets once they are placed into the trust. The trust holds these assets, which can include cash, securities, or other property. A designated trustee manages the trust, investing the assets and making distributions.

The trust benefits two parties: a non-charitable income beneficiary and a charitable remainder beneficiary. The income beneficiary, who can be the donor or another individual, receives payments from the trust for a defined period. After this period, the remaining principal is distributed to the specified charitable organization or organizations. This mechanism allows for the conversion of appreciated assets into an income stream while supporting philanthropy.

Types of Charitable Remainder Trusts

The mechanism for determining income distributions from a Charitable Remainder Trust varies depending on the type of trust established. The two primary structures are the Charitable Remainder Annuity Trust (CRAT) and the Charitable Remainder Unitrust (CRUT). Each type dictates a distinct method for calculating the annual payout to the income beneficiary. Understanding these differences is fundamental to comprehending how much income a beneficiary can receive.

A Charitable Remainder Annuity Trust (CRAT) provides a fixed annuity amount each year to the non-charitable beneficiaries. This amount is determined at the time the trust is established and represents a fixed percentage of the initial fair market value of the assets contributed. Once this percentage is set, the dollar amount of the annual payment does not change, regardless of how the trust’s investments perform. CRATs do not permit additional contributions after their initial funding.

Conversely, a Charitable Remainder Unitrust (CRUT) offers a variable income stream. Beneficiaries of a CRUT receive a fixed percentage of the trust’s fair market value, which is revalued annually. This means the dollar amount of the payment can fluctuate year to year, increasing if the trust’s assets grow in value and decreasing if they decline. Unlike CRATs, CRUTs allow for additional contributions after inception.

Income Distribution Rules

The amount of income that can be taken from a Charitable Remainder Trust is subject to specific IRS regulations. These rules ensure that the trust serves its dual purpose of providing income to beneficiaries and ultimately benefiting charity. For both CRATs and CRUTs, there are minimum and maximum payout rates. The annual payout to the non-charitable beneficiary must be at least 5% and cannot exceed 50% of the trust’s value.

For a Charitable Remainder Annuity Trust (CRAT), the fixed payment is calculated based on the initial fair market value of the assets transferred into the trust. For instance, if a CRAT is funded with $100,000 and the chosen payout rate is 5%, the annual payment to the beneficiary will be $5,000 ($100,000 x 0.05) every year. This payment remains constant throughout the trust’s term, providing a predictable income stream.

In contrast, the payment from a Charitable Remainder Unitrust (CRUT) is recalculated annually. The unitrust amount is determined by applying the fixed percentage payout rate to the trust’s fair market value as revalued on a specific date each year. For example, if a CRUT begins with $100,000 and has a 5% payout rate, the first year’s payment would be $5,000. If the trust’s value increases to $110,000 in the second year, the payment for that year would become $5,500 ($110,000 x 0.05). Conversely, if the value decreased, the payment would also decrease.

Payments from a CRT can be structured to last for the lifetime of one or more non-charitable beneficiaries, or for a term of years. The maximum term permitted by IRS regulations is 20 years. The valuation of assets for income calculation, particularly for CRUTs, occurs on a designated annual valuation date. The investment performance of the trust assets directly influences the income received by beneficiaries.

Taxation of Charitable Remainder Trust Distributions

The tax treatment of distributions from a Charitable Remainder Trust is important for beneficiaries to assess their net income. Distributions from CRTs are subject to a four-tier taxation system, often referred to as ordering rules. This system dictates how each portion of the distribution is characterized for tax purposes, based on the trust’s accumulated income and gains. Different types of income are taxed at different rates.

The first tier consists of ordinary income, including interest, dividends, and other income earned by the trust. Current or accumulated ordinary income is distributed first and taxed at ordinary income tax rates. Once exhausted, the trust moves to the second tier.

The second tier comprises capital gains from the sale of appreciated assets within the trust. These gains can be from current sales or accumulated from prior years. Distributions from this tier are taxed to the beneficiary at capital gains rates, which are lower than ordinary income tax rates for long-term capital gains. After ordinary income and capital gains are exhausted, distributions move to the third tier.

The third tier consists of tax-exempt income, such as interest from municipal bonds, which the trust may have earned. Distributions characterized as tax-exempt income are not subject to federal income tax for the beneficiary. If distributions exceed the amounts available in the first three tiers, the remaining portion is considered a return of principal. This fourth tier represents a return of the original assets contributed to the trust and is received by the beneficiary tax-free.

Beneficiaries of a CRT receive a Schedule K-1 (Form 1041), which details the character of their distributions according to this four-tier system. This document is for accurate tax reporting.