When Only a CRAT Will Do

The charitable remainder unitrust (CRUT) is far more popular than the charitable remainder annuity trust (CRAT).  Annuity trusts make up only about 15% of all charitable remainder trusts in existence.  Nonetheless, there are donor situations where the CRAT can be an attractive option.  Although we usually think of the gift annuity when a donor desires fixed payments, here is a list of situations where the CRAT beats the gift annuity:

1. The charity does not have a gift annuity program,
2. The charity is not registered to issue gift annuities in the donor’s state of residence
3. The donor wants to make payments to more than two beneficiaries,
4. The donor wants more than one charity to benefit from the gift, or
5. The donor wants to name the trustee who will administer his gift or trustee it himself.

What’s the Problem with CRATs

If you have tried to model a CRAT lately, you may have run into a surprising obstacle. A one-life CRAT is unavailable for beneficiaries younger than their early 70s and two-life CRATS with beneficiaries must be even older. Otherwise, the CRAT fails the 5% probability of corpus exhaustion test – the IRS deems that there is a greater than 5% chance that the trust will run out of money before its last income beneficiary dies.  No charitable deduction is available if a CRAT fails this test and the trust is not exempt from income tax. 

The persistently low IRS discount rate over the past five years is the reason the CRAT does not work for beneficiaries well into acceptable planned giving ages.  The IRS discount rate is one of the variables in the calculation of the probability of a CRAT exhausting its principal.

IRS Provides a Solution

The IRS recently published Revenue Procedure 2016-42, which provides a solution for CRATs that would otherwise fail the 5% probability test.  The Revenue Procedure provides language for a “qualified contingency” that makes the 5% probability test inapplicable. The contingency states that the trust will terminate immediately prior to making its next payment if distributing that payment would cause the trust principal to fall below 10% of the original value of the trust, plus interest. The interest rate is the IRS discount rate used to compute the original deduction. The Revenue Procedure also states that an otherwise qualified CRAT instrument that contains “the precise language of the sample provision” will be a qualified CRAT, but that one that contains “a substantive provision similar but not identical to” the sample provision might or might not qualify.

A Welcome Development

The publication of Rev. Proc. 2016-42 should be a welcome development to gift planners. Although it is unlikely to lead to a stampede of CRAT donors, Rev. Proc. 2016-42 does provide a clear solution when the only impediment standing between a donor and a CRAT is the 5% probability of exhaustion test.

Review the list of situations above where only a CRAT will do.  Do you have donors who could benefit from a CRAT in place of a gift annuity? The IRS solution to the 5% rule gives you a new reason to talk to them about making a life income gift!