An annuity trust is an irrevocable trust that pays a fixed dollar amount to one or more beneficiaries each year, based on the initial value of the assets placed into the trust. Unlike other trust structures where payouts fluctuate with investment performance, the annual payment from an annuity trust stays the same from start to finish. These trusts show up most often in two contexts: charitable giving (through a Charitable Remainder Annuity Trust, or CRAT) and estate planning (through a Grantor Retained Annuity Trust, or GRAT). Both use the same core mechanism of fixed annual payments, but they serve very different goals.
How the Fixed Payment Works
When you fund an annuity trust, the payout amount is locked in at the start. If you place $1 million into the trust and set the annuity rate at 6%, the trust pays $60,000 per year for the life of the trust, regardless of whether the underlying investments grow to $1.5 million or shrink to $700,000. That predictability is the defining feature of an annuity trust and what separates it from a unitrust, which recalculates its payout each year based on the trust’s current market value.
Because the payment never changes, you know exactly what income to expect. The downside is equally straightforward: inflation gradually erodes the purchasing power of that fixed payment. A $60,000 annual distribution buys noticeably less after 10 or 15 years of even moderate inflation. At a 3% annual inflation rate, that $60,000 has roughly the purchasing power of $44,000 in today’s dollars after a decade.
Charitable Remainder Annuity Trusts
A CRAT lets you donate assets to a trust, receive a fixed annual income stream, and eventually pass whatever remains in the trust to a qualified charity. You get an income tax deduction in the year you fund the trust, and the charity receives the remainder when the trust ends. It is a way to convert appreciated assets into steady income while supporting an organization you care about.
The IRS sets specific rules for CRATs. The annual payout must be at least 5% and no more than 50% of the trust’s initial value. The trust can run for a set term of up to 20 years or for the lifetime of one or more beneficiaries. And critically, the remainder that will eventually go to charity must be worth at least 10% of the initial net fair market value of the assets placed in the trust. That 10% floor is calculated at the time the trust is created using IRS actuarial tables, and if your proposed payout rate is too high relative to the trust term, you will not meet the threshold and the trust will not qualify.
The charitable deduction you receive is not equal to the full value of the donated assets. Instead, it equals the present value of the charity’s future remainder interest, which is the value of the donated property minus the present value of all the annuity payments you will receive over the trust’s lifetime. A longer trust term or higher payout rate means more goes to you and less to charity, which reduces your deduction.
Once a CRAT is funded, you cannot add more assets to it later. If you want to make additional contributions over time, a unitrust structure would be the alternative, since CRATs are locked at creation.
Grantor Retained Annuity Trusts
A GRAT works in the opposite direction from a CRAT. Instead of benefiting a charity, a GRAT is designed to transfer wealth to your heirs, typically children or grandchildren, while minimizing gift taxes. You place assets into the trust, receive fixed annuity payments back for a set number of years, and whatever is left in the trust at the end passes to your beneficiaries.
The tax benefit hinges on growth. When you create a GRAT, the IRS treats the transfer as a taxable gift, but the gift’s value is reduced by the present value of the annuity payments you are retaining. If you structure the annuity payments to nearly equal the value of the assets you put in (sometimes called a “zeroed-out GRAT”), the taxable gift can be close to zero. Meanwhile, if the trust’s investments outperform the IRS assumed interest rate used in the calculation, all of that excess growth passes to your beneficiaries free of gift and estate taxes.
Consider a simplified example: you transfer $10 million in assets into a GRAT, and those assets grow to $12 million over the trust term. You receive your annuity payments totaling roughly $10 million (plus the IRS assumed interest). The $2 million in appreciation passes to your heirs with little or no gift tax owed. GRATs are most useful for people with significant estates who hold assets they expect to appreciate, since the entire strategy depends on the trust’s investments outgrowing the IRS hurdle rate.
If the investments underperform or lose value, the trust simply returns your original assets through the annuity payments and your beneficiaries receive nothing. You have not lost money, but you have not transferred any wealth tax-free either.
How Annuity Trusts Are Taxed
Tax treatment depends on whether the trust is structured as a grantor trust or a non-grantor trust. In a grantor trust like a GRAT, you report all trust income on your personal tax return. The trust itself does not file a separate tax return with a tax liability. This is actually an additional benefit: by paying taxes on the trust’s income, you are effectively making a tax-free gift to the beneficiaries, since the trust assets grow without being reduced by tax payments.
Non-grantor trusts, including most CRATs and other irrevocable trusts, are taxed as separate entities when they retain income. The tax brackets for trusts are compressed compared to individual brackets. For 2026, trust income above $16,000 is taxed at 37%, the highest federal rate. Add the 3.8% net investment income tax that applies above that same threshold, and a trust retaining investment income can face a combined federal rate of 40.8% on ordinary income or 23.8% on long-term capital gains.
When a trust distributes income to beneficiaries, the beneficiaries generally pay income tax on those distributions at their own individual rates, which are often lower than the trust’s rates. This is one reason trusts are typically structured to distribute income rather than accumulate it. For CRATs specifically, the annuity payments you receive are taxed under a tiered system: ordinary income first, then capital gains, then tax-exempt income, then return of principal.
Who Benefits From an Annuity Trust
CRATs tend to work well for people who hold highly appreciated assets, such as stock or real estate, and want to convert them into income without triggering a large immediate capital gains tax. By transferring the asset into the trust, you avoid recognizing the gain at the time of the transfer. The trust can then sell the asset and reinvest the proceeds, spreading the tax impact across years of annuity payments. You also get the partial charitable deduction, which offsets other taxable income.
GRATs are primarily tools for high-net-worth individuals facing significant estate tax exposure. If your estate is well below the federal estate tax exemption, the complexity and legal costs of setting up a GRAT likely are not worth it. But for estates that would otherwise owe substantial taxes, a well-timed GRAT funded with assets poised for growth can transfer millions to the next generation at minimal tax cost.
Both types of annuity trust require an attorney experienced in trust and estate law to draft properly, and both involve irrevocable commitments. Once the assets are in the trust, you cannot take them back (outside of the scheduled annuity payments). The fixed payment structure also means you are locked into a set income amount regardless of your future financial needs, so these trusts work best as one component of a broader financial plan rather than your sole source of income or wealth transfer strategy.