What Is the 5% Rule for Charitable Remainder Trusts?

When you set up a charitable remainder trust (CRT), you’re not just giving money to charity-you’re creating a financial lifeline for yourself or your loved ones, while still supporting a cause you care about. But there’s a catch. The IRS doesn’t let you just pick any amount to pay yourself each year. There’s a hard limit: the 5% rule. This rule is the backbone of how CRTs work, and if you ignore it, your trust could lose its tax benefits overnight.

What Exactly Is the 5% Rule?

The 5% rule says that every year, a charitable remainder trust must pay out at least 5% of its net fair market value to the non-charitable beneficiaries-usually the person who created the trust (the donor) or someone they name. That’s the minimum. You can pay out more, but never less. And here’s the kicker: the payout has to be recalculated every year based on the trust’s current value, not the original amount you put in.

For example, if you fund a CRT with $1 million in stocks in 2025, and the trust is worth $1.05 million by the end of the year, you must pay out at least $52,500 in 2026 (5% of $1.05 million). If the value drops to $950,000 next year, your payout drops to $47,500. It’s not fixed. It moves with the market.

This rule exists because the IRS wants to make sure the charity gets something real in the end. If you took out 10% or 15% every year, the trust could be drained before the donor dies, leaving nothing for the charity. The 5% floor ensures the charity still gets a meaningful gift after the donor’s lifetime.

Why Does the 5% Rule Exist?

The IRS created the 5% rule to balance two competing goals: helping donors get income now, and making sure charities aren’t shortchanged later. It’s not just about fairness-it’s about tax law integrity.

Charitable remainder trusts get special tax treatment. When you put assets into a CRT, you get an immediate income tax deduction based on the estimated value the charity will receive. That deduction can be huge-sometimes tens or even hundreds of thousands of dollars. But the IRS doesn’t give that break to people who are just using the trust as a tax loophole to avoid paying capital gains tax while taking out nearly all the money.

The 5% rule acts as a guardrail. If the payout rate were too high, the present value of the charity’s future gift would be too small to qualify for the deduction. The IRS uses actuarial tables to calculate the charity’s expected share. If that share is less than 10% of the original trust value, the trust fails the test-and the tax deduction vanishes.

That’s why most CRTs stick close to 5%. It’s the sweet spot: enough income for the donor, enough left over for the charity, and full compliance with the IRS.

How Does the 5% Rule Compare to Other Payout Options?

There are two main types of charitable remainder trusts: unitrusts and annuity trusts. The 5% rule applies to both, but they work differently.

• Charitable Remainder Unitrust (CRUT): Pays a fixed percentage (at least 5%) of the trust’s value each year. The amount changes as the trust’s investments rise or fall. This is the most common type, and it’s the one where the 5% rule matters most.
• Charitable Remainder Annuity Trust (CRAT): Pays a fixed dollar amount every year, based on the initial value of the trust. The payout doesn’t change, even if the trust grows or shrinks.

Here’s the problem with CRATs: if you set a payout of $50,000 a year from a $1 million trust, that’s 5%. But if the trust grows to $2 million over time, you’re still only taking out $50,000-so you’re getting only 2.5% of the value. The IRS doesn’t care about that. As long as the initial payout rate was at least 5%, you’re fine.

But with CRUTs, you can’t get lazy. If the trust value drops to $600,000, your 5% payout becomes $30,000. That’s still legal. But if you accidentally paid only $25,000 because you forgot to recalculate, the IRS could disqualify the entire trust. That means you lose your tax deduction, owe back taxes, and pay capital gains on the assets you sold to fund the trust.

What Happens If You Break the 5% Rule?

Breaking the 5% rule isn’t a small mistake. It’s a trust-killer.

If you pay out less than 5% in any year, the trust loses its status as a charitable remainder trust. That means:

• Your original income tax deduction is revoked.
• You owe income tax on the full amount of capital gains from assets sold inside the trust.
• Future earnings in the trust are taxed as regular income.
• The charity may not receive the gift you intended.

There’s no grace period. The IRS doesn’t send a warning. They just audit, disqualify, and bill you. In one real case from 2023, a donor in Florida set up a CRUT with a 4.8% payout because he thought “close enough” would work. The IRS caught it during a routine audit. He ended up owing $187,000 in back taxes and penalties.

That’s why most financial advisors and attorneys who handle CRTs use automated tracking systems. They don’t rely on human memory. They set up quarterly valuations and automated payout calculations to avoid any risk.

Can You Pay More Than 5%?

Yes-and many people do. There’s no upper limit, but there’s a practical one.

If you set the payout at 10%, you’ll get more income each year. But here’s what happens: the IRS’s actuarial tables now assume the charity will get a smaller share. If that share drops below 10% of the original trust value, the trust fails the 10% test-and you lose your tax deduction.

So while you can pay 8%, 9%, or even 9.9%, you’re walking a tightrope. The higher the payout, the lower the charity’s projected share. Most experts recommend staying between 5% and 7%. That gives you solid income without risking the tax benefits.

For example: if you put $500,000 into a CRUT and set the payout at 7%, the charity’s projected share is still above 10%-so you’re safe. But if you go to 8.5%, and the trust has low-growth assets like bonds, the charity’s share might dip below 10%. That’s when you need an actuary.

Who Should Use a Charitable Remainder Trust?

A CRT isn’t for everyone. It’s best for people who:

• Own highly appreciated assets (like stocks, real estate, or private business shares) and want to avoid capital gains tax when selling them.
• Need steady income in retirement but don’t want to give away everything now.
• Have a charity they want to support long-term, like a university, hospital, or religious organization.
• Are in a high tax bracket and can use a large upfront deduction to reduce current taxes.

If you’re younger, have limited assets, or don’t plan to leave anything to charity, a CRT isn’t right for you. The setup costs are high-usually $5,000 to $15,000 in legal and administrative fees. You also need to manage the trust for years, if not decades.

But for someone with $1 million in appreciated stock who wants to retire at 65 and give $300,000 to their church in 20 years? A CRT with a 6% payout could be perfect.

Common Mistakes People Make With CRTs

Even smart people mess up CRTs. Here are the top three errors:

1. Forgetting to recalculate the 5% payout annually. Many assume the payout is fixed. It’s not. You need a new valuation every year.
2. Using the wrong asset type. CRTs work best with stocks, real estate, or private equity. Don’t fund one with cash unless you have a specific reason. Cash doesn’t grow tax-free inside the trust the way appreciated assets do.
3. Choosing the wrong charity. The charity must be a qualified 501(c)(3). Don’t assume your local food bank qualifies-check with the IRS’s Tax Exempt Organization Search tool. If it doesn’t, your trust fails.

Also, don’t name your own business as the beneficiary. That’s a red flag for the IRS. The charity must be independent.

How to Set Up a CRT the Right Way

If you’re serious about a CRT, follow these steps:

1. Consult a tax attorney or CPA who specializes in charitable trusts. Don’t use a generalist.
2. Choose a qualified charity and confirm its status with the IRS.
3. Decide between a CRUT or CRAT. Most people choose CRUT for flexibility.
4. Pick a payout rate between 5% and 7%. Use an actuarial calculator to ensure the charity’s share stays above 10%.
5. Fund the trust with appreciated assets-not cash or retirement accounts.
6. Set up annual valuation and payout procedures. Automate them if possible.
7. File Form 5227 every year with your tax return to report trust activity.

And never, ever skip the annual valuation. That’s where most CRTs fail.

Final Thought: It’s Not Just About Money

The 5% rule isn’t a restriction-it’s a guarantee. It ensures that when you create a charitable remainder trust, you’re not just helping yourself. You’re also honoring your commitment to the future. The trust lasts for your lifetime, and then the charity gets what’s left. That’s powerful. But only if you follow the rules.

Get it right, and you’ll have income, tax savings, and the satisfaction of knowing your legacy will keep giving. Get it wrong, and you’ll pay the price-financially and morally.