Using A Charitable Remainder Trust to “Stretch Out”

Distributions from an IRA & Create a Charitable Gift

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Since Congress passed the Tax Reform Act of 1969, Charitable Remainder Trusts have played a substantial role in reducing income taxes and creating charitable gifts.  A more recent Congressional act, the SECURE Act (January 2020), has spawned new interest in CRTs as a better way to leave an IRA to heirs and create a charitable legacy.

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A Charitable Remainder Trust (CRT) is a trust that can provide a lifetime income stream to heirs, or for a term of up to 20 years, with the remaining balance going to charity.  The benefits of a CRT derive from the ability to defer income taxes—traditionally capital gains taxes incurred on the sale of an appreciated asset—but, as discussed below, a CRT can also help defer ordinary income taxes due on an inherited IRA.  The IRA to CRT Strategy can generate a lifetime income stream for heirs and, ultimately, a significant charitable gift.

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The SECURE Act changed the rules regarding distributions to beneficiaries from inherited IRAs.  A surviving spouse can still take distributions from an inherited, or rollover, IRA based on the surviving spouse’s life expectancy.  However, with some exceptions, a non-spouse beneficiary must withdraw the entire balance of the IRA within 10 years of the IRA owner’s death.  For most adult children who inherit a parent’s IRA, these accelerated distributions—and the ordinary income taxes due on those distributions—is likely to occur during the child’s highest income-earning and tax-paying years.

    

By naming a CRT as the beneficiary of an IRA, distributions to beneficiaries, including children and, possibly grandchildren, could be stretched out for much longer than 10 years, allowing the assets to continue to grow tax-deferred.  At the end of the CRT’s term, the remaining balance is distributed to one or more charitable beneficiaries—which traditionally include public charities, foundations, churches and educational institutions—but could include a family donor-advised fund or even a family foundation, creating a lasting philanthropic legacy.

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Implementing the IRA to CRT Strategy starts with the establishment of a “testamentary” CRT—that’s a trust created during the IRA owner’s lifetime, but nothing is transferred to the trust until the IRA owner’s death (or the death of the IRA owner’s spouse, if married). Because a properly drafted CRT is recognized by the IRS as a tax-exempt entity, no taxes are due when the IRA is transferred to the CRT.  When IRA assets are distributed to the individuals named as income beneficiaries of the CRT, the distributions are taxed to the recipients.  Those distributions must be at least 5% of the value of the CRT determined annually, not to exceed 50%, and once the payout rate is set, it cannot be changed.

 

There are several factors that determine how much can be distributed annually to the income beneficiaries and whether the payout can last for the lifetime of the beneficiaries or for a term of years.  The primary factors are: 1) the age(s) of the beneficiaries and 2) an interest rate established monthly by the Treasury Department called the Applicable Federal Rate, or AFR.

 

The goal of most IRA owners choosing this strategy will be to pay the maximum amount of income to their beneficiaries over the longest period of time before the remainder goes to charity.  However, a charitably-inclined IRA owner could choose to reduce the amount or the duration of distributions to individual beneficiaries, or include one or more charities as income beneficiaries during the term of the CRT.

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The following diagram shows each step in the IRA to CRT Tax Deferral Strategy designed to pay a lifetime income stream to beneficiaries with the remainder distributed to one or more charities:​

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