2019 seems like a long time ago, and in many ways it was! But some of your clients may be living in the past when it comes to inherited IRAs. How so? You may recall that the tax laws used to permit clients to withdraw money they inherited in their parents’ IRAs over the course of their lifetimes. This was useful because clients could defer the income tax for as long as possible. Known as the “stretch IRA,” this option was largely eliminated by the SECURE Act of 2019, which requires most non-spouse beneficiaries to withdraw the entire inherited IRA via annual distributions within 10 years, rather than stretching withdrawals over their lifetime.
What’s going on here is that the stretch IRA disappeared for 2020 and subsequent tax years, but many of your clients might not have gotten the message that the rules changed. So, not only is it a good idea to watch for these scenarios as you work on your clients’ estate, financial, and tax plans, but it’s also important to explore a potential alternative for certain clients who are charitably inclined.
Here’s what to watch for:
- Your client owns an IRA.
- Your client is philanthropic, and charities are prioritized in their estate plan even where the client has children or other heirs.
- Your client has identified an heir to whom the client would like to leave a legacy gift.
- This heir is likely to be in a high-income tax bracket in the years ahead and wants to defer income tax wherever possible.
The concept, oversimplified for illustrative purposes, goes something like this:
- Instead of naming the heir directly as the beneficiary of the IRA, your client would instead name as the beneficiary a charitable remainder unitrust, referred to as a CRT, or even a “NIMCRUT” (net-income makeup charitable remainder unitrust), of which the heir is the income beneficiary.
- The CRT would receive the IRA proceeds upon your client’s death.
- The tax result of this structure somewhat mimics the old stretch IRA because, as a charitable entity, a CRT is generally not subject to income tax at the trust level on the income from IRA assets.
- According to the terms of the CRT, the assets can be distributed annually over the heir’s lifetime (or for a fixed period of up to 20 years) and, similar to what would have happened with the old stretch IRA, the heir will pay income taxes on distributions from the trust as they are received.
So why doesn’t everyone do this? Here are three reasons:
- It’s actually possible for an heir to be too young for this technique to work well. The IRS requires that a CRT’s payout rate result in a present value of the future gift to charity of at least 10% of the value of the initial gift. This means that the payout rate could be too low to justify the expense and complexity of the transaction where the CRT’s income beneficiary is very young.
- There is always a risk that the heir will die prematurely, sending the entire remainder interest to the charity with nothing remaining to pass to the heir’s own heirs.
- Even when compared with the 10-year rule, it can take a very long time for the CRT’s tax benefits (i.e., more wealth) to outweigh the projected “loss” of the assets that will ultimately go to charity.
What’s the bottom line here? If your client is truly charitable, they may be better able to fulfill their charitable goals by naming a charity, such as the client’s fund at the Community Foundation, as the beneficiary of the client’s IRA, leaving other assets eligible for a step-up in basis to fund the estate gifts for heirs.
Remember, it doesn’t have to be complex. Even just talking about philanthropy in the simplest terms with your clients can help strengthen your relationships and grow your practice.
As always, the team at the Community Foundation is here to help! Please reach out anytime.
This material is intended for informational/educational purposes only and should not be construed as investment, tax, or legal advice. Please contact your financial, tax, and legal professionals for more information specific to your situation.
The Community Foundation team is happy to help you structure charitable giving tools and plans to achieve your clients’ philanthropic goals—whether through beneficiary designations or any other type of charitable giving vehicle. This email address is being protected from spambots. You need JavaScript enabled to view it.!
Questions?
