What is a charitable annuity trust?

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Jeffrey Johnson is a legal writer with a focus on personal injury. He has worked on personal injury and sovereign immunity litigation in addition to experience in family, estate, and criminal law. He earned a J.D. from the University of Baltimore and has worked in legal offices and non-profits in Maryland, Texas, and North Carolina. He has also earned an MFA in screenwriting from Chapman Univer...

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UPDATED: Jul 16, 2021

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A charitable annuity trust is an option for making a charitable contribution while still allowing for payments to be made out of your estate, either to yourself or to a specified beneficiary. The structure of a charitable annuity trust allows for multiple benefits, such as particular tax breaks that may lead to a significant savings for people in certain situations. It can also be an excellent form of asset protection, since assets invested in a charitable annuity trust are generally unreachable by creditors in a variety of situations.

Understanding the Charitable Annuity Trust 

Charitable annuity trusts are generally offered by, and operated by, the charitable organizations themselves. The donor transfers assets to the charity, in other words, makes a donation to them. The charity is responsible for paying an annuity (regular annual payments) to the donor or to his specified beneficiary. The amount of the annuity that the charity pays depends on the value of the assets per year, and is calculated using an IRS formula based on federal interest rate.

The payments made to the donor or beneficiary may be used as a way for the donor to continue receiving income after retirement. A percentage of the payments made to the recipient will be considered taxable income by the IRS. The payments may be a way to pass on an estate to an heir while minimizing or avoiding estate taxes entirely. The rest that is not considered taxable income is considered a “return of assets” and thus the entire amount is not taxed.

Each year, the value of the annuity trust is calculated; should the value be smaller than the fair market value of the assets themselves, this means that the beneficiary is receiving a payment smaller than what the donation was worth; thus, he will receive a charitable deduction equivalent to the difference for use on that year’s taxes. Should the opposite be true and the value of the contract be greater than the fair market value of the assets, the excess will be considered a taxable gain and subject to various taxes by the IRS. The best case scenario is for the fair market value of the donation to exceed the contract value; in this case, the donor will receive immediate tax deductions that can be significant. Donors who wish to avoid a situation where things are reversed and they receive taxable gains may want to look into charitable remainder trusts, which operate in a similar fashion to a charitable annuity trust but do not include the possibility of such taxation.

Establishing a Charitable Annuity Trust

Setting up a charitable annuity trust is a fairly simple process; it will be largely a matter of working with the charity of your choice and completing the paperwork. However, you should discuss this situation carefully with an estate planning lawyer before you proceed, as there are complexities in finances may affect whether or not the use of such a trust is your best option. Your estate planning lawyer can advise you on whether a charitable annuity trust is the right option for your finances and can help to explain the benefits and risks of such an investment. 

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