Which CRUT Shall It Be?
The charitable remainder unitrust (CRUT) comes in five flavors, each of which can be useful in certain donor situations. The donor’s goals should dictate which of the five will work best for them.
A standard CRUT pays a fixed percentage of its value as revalued each year, regardless of its income. For example, a 5% standard CRUT will distribute 5% of its value each year. A standard CRUT makes sense for a donor who wants the beneficiaries to receive significant income from the trust every year.
Net income CRUT
A net income CRUT (NICRUT) pays a fixed percentage of its value as revalued each year, or its net income for the year, whichever is less. For example, a 5% NICRUT will distribute 5% of its value in a year it earns net income of 5% or more, but just its net income in a year when that income is less than 5%. A NICRUT makes sense for a charitably-minded donor who wants to provide income to beneficiaries so long as it does not erode the principal that will go to the charity at the end.
Net income with makeup CRUT
A net income with makeup CRUT (NIMCRUT) is a variation on the NICRUT. It keeps a running total of the shortfalls in years when its net income is less than its payout percentage. If in a later year the NIMCRUT earns more net income than its payout percentage, it can distribute all its net income so long as its net shortfall remains above $0. For example, when a 5% NIMCRUT earns net income of 3%, it will distribute 3% of its value and add 2% of its value to its shortfall total. If the NIMCRUT earns 6% net income the next year, it will distribute all its net income that year and reduce its shortfall total by 1% of the trust’s value. If it earns 7% net income the following year, it will distribute only 6% of its value: the 5% unitrust amount plus the remaining 1% shortfall from prior years. A NIMCRUT can make sense for a donor who wants to fund the trust with an illiquid asset and preserve principal for the charity. The net income provision gives the trustee time to find a buyer without the need to distribute more than the available net income. Once the asset is sold, the trustee can invest to generate income, thereby increasing distributions, while the net income provision continues to protect against erosion of the remainder that will go to the charity. Should the unitrust have excess net income at some point, for example by realizing post-contribution capital gain, which has been defined in the trust document as distributable income, the income beneficiaries will get the benefit of that excess net income to the extent shortfalls have accumulated in prior years.
A flip CRUT starts as a NICRUT, then becomes a standard CRUT in the year after a specified triggering event occurs. The triggering event can be the sale of an “unmarketable” asset, a specific date, or any other event outside the donor’s control. The flip CRUT is often used when the funding asset is real estate or some other asset that may take time to sell. Like a NICRUT, the trustee has time to find a buyer without the need to distribute more than the net income available. Once the funding asset is sold, the trust can flip to a standard CRUT. The trustee can then invest to maximize total return, knowing the trust will distribute its unitrust percentage each year regardless of its net income. The Flip CRUT makes sense for a donor who wants the trust to distribute its unitrust percentage every year once the funding asset is sold, even if it must dip into principal some years to do it. The Flip CRUT can also be used as a supplemental retirement plan: the donor makes her expected retirement date the flip triggering event. Distributions will be limited to net income before retirement and switch to standard unitrust amounts thereafter.
Flip with makeup CRUT
A Flip with makeup CRUT is similar to a Flip CRUT, but allows income shortfalls to be made up later during the pre-flip period. In instances where the triggering event is the sale of an unmarketable asset, the makeup provision is unlikely to come into play. In the case where the triggering event is a specific date, the makeup provision is more likely to increase the amounts distributed, especially if post-contribution capital gain has been defined in the trust document as distributable income.
Want to learn more?
Register for our “What Color Is Your CRT?” webinar on June 24 to learn about the role of each CRUT option in more detail.