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Charitable Remainder Trust

Recreate Stretch IRA with a Charitable Remainder Trust

As of January 1, 2020 new legislation called the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) became effective which 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.

The SECURE Act has eliminated the Stretch IRA strategy for non-spouse beneficiaries (think children or grandchildren) and now the entire IRA must be distributed by the 10th year after death of the original owner.  This forces the taxable distribution to occur in a compressed time period, often occurring around the time in a beneficiary’s life when they are in their highest earnings years thus exposed to a high marginal tax bracket.

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. 

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.

There is the risk your heirs may lose out if they prematurely pass away soon after the CRT is established.  A good 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.

To illustrate the potential benefits of a CRT compared to an Inherited IRA under the SECURE Act, we consider an 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 5.5% total return*.  The maximum calculated distribution rate allowed for the CRT in this example is 6.6% annually.  The couple is in a moderate tax bracket of 24% Federal and 6.37% NJ. 

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 $906,931 which has a present value today** of $840,725.  The CRT would distribute over her and her spouse’s lifetimes, estimated here at age 85, providing cumulative after-tax income of $1,319,029 over the 36 year period.  The present value of that would be $1,035,804.  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 $609,109 when the CRT terminates.

Charitable Remainder Trust

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 RegentAtlantic Wealth Advisor. 

*The return assumption above is shown for illustrative purpose only and is not indicative of the past or future investment returns of RegentAtlantic.

**Present value is the sum of each year’s after tax income discounted by an assumed risk free rate of 1.5% to account for the time value of money under each of the two illustrated strategies. 

Important disclosure information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.

Please remember to contact RegentAtlantic if there are any changes in your personal or financial situation or investment objectives for the purpose of reviewing our previous recommendations and services, or if you wish to impose, add, or modify any reasonable restrictions to our investment management services. A copy of our current written disclosure statement discussing our advisory services and fees is available for your review upon request.

This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.

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