Feb 16, 2023
Recreate stretch IRA with a charitable remainder trust
As of January 1, 2020 new Federal legislation called the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) became effective1 which we believe profoundly impacts a favored strategy for beneficiaries who inherit IRA accounts. Prior to the SECURE Act, beneficiaries of Inherited IRAs were allowed to stretch the required minimum distributions over their lifetime. The younger the beneficiary, the more valuable the tax deferral benefits of the stretch.
Naming a Charitable Remainder Trust (CRT) as the primary beneficiary of an IRA can allow a donor to provide greater lifetime income to their heirs while also creating a charitable gift to be realized in the future. The CRT is a non-taxable account so that when it receives the IRA there is no tax liability and the full value can be used to generate income to the trust beneficiaries. The CRT will make annual payments to beneficiaries for life (1 or 2 lives), or for a specific term not to exceed 20 years, based on a specified payout rate applied either at the start of the trust or calculated each year.2
All earnings within the trust grow tax-deferred and only the distributions to the beneficiary are taxed as they are made each year. At the death of the last beneficiary or end of the specified term the remaining value in the trust will be paid outright to the named charity(ies). The donor’s estate will receive a charitable deduction based on the calculated present value of the charitable remainder interest, which must be at least 10% of the beginning account value. This requirement will be a factor in determining the maximum allowable annual distribution from the CRT.3
There is the risk your heirs may lose out if they prematurely pass away soon after the CRT is established. A way to hedge that is to name two individuals as successive income beneficiaries of the trust or to use a 20-year fixed term for the distributions. Additionally, sometimes life insurance is purchased on the second to die of the beneficiaries as a way to ensure value to their heirs.
A Hypothetical Example
| Distribution Term in Years | After-Tax Cumulative Income | Present Value of After-Tax Income | Charitable Remainder | |
|---|---|---|---|---|
| Inherited IRA | 10 | $926,079 | $817,951 | $- |
| Charitable Remainder Trust | 36 | $1,426,645 | $956,871 | $710,751 |
To illustrate the potential benefits of a CRT compared to an Inherited IRA under the SECURE Act, we consider a hypothetical individual who has died with a $1 million IRA. We assume the beneficiary daughter and her husband are both 50 years old, so the CRT will have an expected term of 36 years based on their joint life expectancy. In each instance, the hypothetical portfolio will be invested in a balanced manner, with 60% in stocks and 40% fixed income with an annual 6.0% total return*. The maximum calculated distribution rate allowed for the CRT in this example is 6.6% annually. The hypothetical couple is in a moderate tax bracket of 24% Federal and 6.37% NJ.
*The return assumption above is shown for illustrative purposes only and is not indicative of the past or future investment returns of CI Private Wealth.
If the beneficiary received this as an Inherited IRA, the required distribution would occur within a ten-year period and, if taken evenly over the period, her cumulative after-tax income would amount to $926,079 which has a present value today** of $817,951. The CRT would distribute over her and her spouse’s lifetimes, estimated here at age 85, providing cumulative after-tax income of $1,426,645 over the 36-year period. The present value of that would be $956,871. Even taking into consideration the longer distribution period for the CRT, there is significant additional value to the donor’s heirs compared to the Inherited IRA, plus the added bonus of leaving a charitable gift of $710,751 when the CRT terminates.
Structuring a Charitable Remainder Trust to inherit an IRA can be a powerful tool which may maximize lifetime, tax-efficient cash flow to your heirs while also creating a future gift to your favorite charity(ies). The trust may also provide the benefit of asset protection against creditors, liabilities and ex-spouses in a divorce. Be sure to include your entire financial, tax and legal advisory team as the tax law around CRTs is complicated.
If naming a Charitable Remainder Trust as the beneficiary of your IRA is of interest or you would like to discuss other charitable giving strategies, please contact your CI Private Wealth advisor.
**Present value is the sum of each year’s after tax income discounted by an assumed risk free rate of 2.5% to account for the time value of money under each of the two illustrated strategies.
1 https://www.congress.gov/bill/116th-congress/house-bill/1994/text
2 https://www.irs.gov/charities-non-profits/charitable-remainder-trusts
3 https://www.irs.gov/charities-non-profits/charitable-remainder-trusts
ABOUT THE AUTHOR
James Sonneborn, CFP, CFA, MBA
Jim has over 35 years of experience managing investment portfolios and providing financial advice to individuals, families and charitable organizations in the New York metropolitan region.
As a Wealth Advisor and Co-Chair of the Firm's Neighborhood Nonprofits Group, Jim works with a wide range of clients and has a particular specialty in philanthropic strategies. For donors, Jim works to construct strategies that align with the client's philanthropic goals. In the nonprofit sector, Jim focuses on helping organizations strengthen their financial position through endowment management and planned giving consulting. Jim currently serves on the boards of The Rippel Foundation and the Environmental Endowment of NJ.
Jim holds a BA in Business from Western Colorado University and an MBA in Finance from Drexel University, as well as the CERTIFIED FINANCIAL PLANNER, Chartered Financial Analyst and Certified Divorce Financial Analyst certifications.
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