Understanding the 5% Payout Rule in Charitable Remainder Trusts: A Smart Guide for Donors

Jul, 7 2025

Picture this: a person wants to give to charity but also needs income during retirement. There’s a clever way to balance both—set up a charitable remainder trust, or CRT. But here’s where it gets interesting: charities and the IRS won’t just let money sit and grow forever. There’s a rule to keep things moving called the "5% rule." What’s so special about this percentage, and why does it matter so much for CRTs? This seemingly small number can mean the difference between a tax-savvy plan and an IRS headache.

The Basics: What is the 5% Rule and How Does it Work?

The IRS says a charitable remainder trust must pay out a minimum of 5% of its initial value—and do this every year. The idea is simple: if you create a CRT, you (or someone you choose) get some money each year, and after a certain period or after the trust creators pass away, whatever’s left goes to charity. But the trust can’t just dribble out small, unpredictable amounts. The law draws a pretty clear line: that annual payout has to be at least 5%.

Let’s say you set up a trust with $1 million. That’s a $50,000 check (or a steady stream of payments) every year, no wavering. This rule stops someone from creating a trust, naming a charity, and then locking the funds away, never really benefiting anyone. The IRS wants that money in motion—benefiting either the giver or their loved ones, and eventually helping the charity.

There are two main types: Charitable Remainder Annuity Trust (CRAT) and Charitable Remainder Unitrust (CRUT). This rule applies to both. With a CRAT, the payout is a fixed dollar amount each year—you do the math once at the start, and that’s it. In a CRUT, the payout is a percentage (again, minimum 5%) of the trust’s value each year. The number fluctuates based on how well the investments do. Every year, the trust gets valued, and you set aside the new amount for that year’s payout. Both are wrapped up in the core requirement: don’t go below 5%.

Even though 5% is the minimum, people can choose a higher payout, but rarely does it make sense to set it too high. Why? The higher the annual payout, the less money will likely go to your chosen charity after all is said and done. There’s even a second test, hidden a bit deeper in the IRS rules. The trust must be set up in a way that, statistically, at least 10% of the original amount should be expected to go to the charity when the trust ends. So the 5% rule keeps the plan honest, making sure the charity—your actual goal—will get something meaningful.

All these rules aren’t just for the IRS’s amusement. They’re designed to make CRTs a win-win: donors get tax breaks and regular income, plus the chance to help a favorite cause. But without rules like this minimum payout, people could design schemes to dodge taxes or starve the charities of funds for decades. Nobody wants that.

Why the 5% Rule Exists and What It Means for Donors

Ever wonder why it’s exactly 5%? Not 3%, not 7%. This isn’t a number picked at random. The IRS studied how fast money would grow in different investments, then looked at ways to balance the needs of donors and charities. A lower number would have meant the trust could exist for ages, barely sending anything to the income beneficiaries, and possibly cheating the charity. A higher number might empty the trust too fast, leaving little or nothing for the charity.

Back in the 1960s and 70s, some people used CRTs as long-term tax shelters, letting the trust sit for generations. Congress put a stop to those loopholes by enforcing the minimum payout. So, if you’re looking at setting up a CRT now, you have to follow this rule to make it legit. Otherwise, the IRS could disallow the trust’s tax benefits, and that’s never good news.

This matters a lot when people plan their finances. A payout rate set at 5% is enough to make the trust last for a while (possibly decades), but there’s still a solid amount left for the chosen charity. If someone picks a 10% payout, the annual checks would be bigger but the trust would probably drain quicker, especially if investments hit a rough patch. Plus, if you go too high, charities might not receive their expected gift at the end, and the IRS could step in.

Another rarely mentioned point: the choice of 5% affects what kind of assets donors can contribute. For example, big pieces of real estate or shares in a business can create unpredictable returns. If the trust’s investments don’t keep up with the payouts, the principal can shrink, cutting future gifts to both donors and charity. This is why financial advisors encourage donors to carefully pick both the payout rate (never below 5%!) and the assets they place into these trusts. Practical tip: always run the numbers with a qualified planner who understands CRT rules. It's not the time to wing it.

Families often set up a CRT with relatives or themselves as income beneficiaries, but there’s a twist. If your spouse gets the payments, remember those payments are required every year. Some people worry, "What if the trust loses money in a bad investment year?" Too bad—the 5% payout still applies. It comes out of income, then principal if there’s not enough cash. This rule is like an automatic guardrail: no matter the year, someone has to receive the minimum distribution, and the remainder eventually lands with the charity.

Unlocking CRT Potential: Tips and Surprising Facts for Getting the Most from the 5% Rule

Once you start digging into CRTs, all sorts of details jump out. For example: did you know the IRS also has age rules tied to the 5% payout? If a donor is very young and wants a CRT with a single beneficiary, the trust might not fly with the IRS. Why? There’s a calculation called the “10% remainder test” that projects how much will realistically end up with the charity. Youthful donors might live long enough to empty the trust—leaving too little for the cause. So sometimes, even if you want to use 5%, you might be forced to go higher or make different payout arrangements.

Here’s another quirk: People can use the CRT 5% payout as a kind of flexible retirement income. For example, let’s say you sell a rental home. Instead of paying a giant tax bill right away, you toss the proceeds into a CRT. In return, you get that sweet 5% check every year, potentially for life. You defer the capital gains tax, shrink your taxable estate, and eventually send a solid gift to the charity. This isn’t just theory—there are plenty of well-documented stories of folks who turned a rental property headache into a win-win using CRTs and the 5% rule.

And if you’re curious, some creative families name their favorite charity as the backup choice—in case someone predeceases the expected payout term. If the donor or their chosen beneficiary passes away early, whatever is left goes immediately to the charity, which can be a significant and unexpected windfall for them. This adds a layer of meaning to the trust: it’s not just about money, but making your legacy felt sooner, not just “someday.”

Don’t forget about taxes. CRTs are beloved by financial planners for a reason. That 5% rule means predictable distributions, which can help with budgeting and withdrawals in retirement. The donor gets an immediate income tax deduction based on the actuarial value of the charity’s expected remainder. Bigger deduction, smaller taxes. Plus, the investments keep growing tax-free inside the trust until the annual payment goes out.

There’s another tip worth sharing: many people use CRTs to handle highly appreciated assets, like old stock from a tech employer or a family business. By transferring the asset to a CRT before selling, the donor avoids the big capital gains shock, enjoys a full deduction, and creates steady income. But—surprise—the 5% payout still applies, so it creates budget certainty as well as compliance with the law.

Pay special attention to administrative details. CRTs require annual valuations, IRS filings, and careful record-keeping. Any slip-ups, especially with calculating the 5% payout, could endanger the tax-exempt status. Financial planners—especially those who specialize in *charitable remainder trust* setups—hear horror stories all the time about trusts mishandled by amateur administrators. Pay close attention to the trust document’s wording. It should specify the 5% figure clearly and spell out how to value assets each year.

Finally, it’s easy to see why CRTs make for such an appealing tool. The magic of the 5% rule is that it stops abuse but keeps the system flexible enough for charities and donors to benefit together. I’ve seen a few friends in our neighborhood use CRTs after a windfall—from company buyouts to inheritance surprises. They liked that the trusts offered a way to help their favorite food banks, animal shelters, or scholarship funds. But the real win? They could count on income, protect their heirs, and watch their legacy unfold while keeping the IRS happy. The 5% rule made all that possible.