“What’s a CRAT?”: Estate Planning Is More than Alphabet Soup

As many know by now, everyone has an estate plan. Even if you’ve never drafted a will or a trust, your state of residence has a convenient, one-size-fits-all plan for how your assets should be divided up upon your passing—and, if you have dependent children, who should take care of them until they reach majority. This all-encompassing plan is enshrined in your state’s probate laws, which are applied in the event of the death of anyone who doesn’t have a pre-existing will or other estate planning direction: in other words, those who die intestate.

This uncomfortable fact is what motivates many people to, at a very minimum, have a will drawn up, and even better, to also obtain other basic documents such as a legal power of attorney and a healthcare proxy.

But for some individuals, even these basics are not sufficient. Larger estates, and especially those with complex assets such as real estate, business interests, and other holdings that are relatively illiquid often find that it is important to use some more sophisticated estate planning tools to ensure that their wishes for their assets—and their heirs—are carried out in the most efficient way.

In this article we’ll present the basics of five such instruments, all of which are often called by acronyms: charitable remainder annuity trusts (CRATs), charitable remainder unitrusts (CRUTs), grantor-retained annuity trusts (GRATs), grantor-retained income trusts (GRITs), and grantor-retained unitrusts (GRUTs). Does this sound like alphabet soup, so far? Keep reading, and things will become clearer.

Charitable Remainder Annuity Trusts (CRATs)

A CRAT is a type of gift transaction in which a donor contributes assets to a charitable trust that then pays a fixed amount of income to a designated noncharitable beneficiary, such as the donor. CRATs are irrevocable, which means that once they are established, they can’t be changed. Assets placed in the trust become the property of the charitable trust, which generates a charitable deduction for the donor. The assets can be sold by the trust without triggering capital gains tax and the proceeds can then be re-invested to provide ongoing income for the donor and the trust. The annual payments (annuity) paid to the donor or other non-charitable recipient are typically taxable as ordinary income. By transferring assets to the trust, donors may reduce the size of their taxable estate while also assuring themselves of an ongoing income.

Charitable Remainder Unitrusts (CRUTs)

CRUTs operate similarly to CRATs, except that the income paid from the trust, rather than being a fixed amount, is pegged to a specified percentage of the trust’s assets. The income may be paid either for a fixed term of years or for the life of the recipient (typically, the donor). Assets remaining after the donor’s death of the end of the specified term become the property of the charity.

Grantor-Retained Annuity Trusts (GRATs)

A GRAT can allow donors to shift the benefits of assets to their heirs while potentially reducing estate tax exposure by “freezing” the value of the assets and shifting future appreciation to the trust’s beneficiaries with no tax burden. Over the term of the trust, the initial value of the gift that funds the trust is returned to the grantor (the person who establishes and funds the trust), with interest. At the conclusion of the term, any remaining assets in the trust pass to the heirs. This tool can potentially help grantors provide assets to their heirs without using much or any of their lifetime gift/estate tax exclusion and still retain an income from the assets.

Grantor-Retained Income Trusts (GRITs)

GRITs, like GRATs, can permit the transfer of assets to heirs while still retaining income for the grantor. Like all the trusts discussed in this article, they are irrevocable; once established and funded, they cannot be changed. As the name implies, a GRIT allows the grantor to transfer assets to the trust for the benefit of heirs, but retain the income generated by the trust’s assets. The grantor may also set a specific date or condition for the beneficiary to receive the assets held in the trust.

Grantor-Retained Unitrusts (GRUTs)

With a GRUT, as with a CRUT, the grantor receives an income stream based on a specified percentage of the trust’s assets. Assets placed in the trust are removed from the grantor’s estate for estate tax purposes, but the grantor is still able to enjoy an income from the assets for a specified period. However, if the grantor dies before the trust terminates, the remaining assets in the trust are placed back into the grantor’s estate, rather than passing directly to the beneficiary.

Obviously, there are many more details involved with each of these instruments, and those considering their use should consult with a qualified estate planning professional. Each estate is different and has different needs and priorities with respect to income from the trust and the nature of the beneficiary (charitable or non-charitable, etc.). At Aspen Wealth Management, we work with clients to develop the gifting and other estate planning strategies that are right for their unique circumstances. To learn more, please visit our website.