How to Create a “Stretch” IRA Lifetime Income For Your Family While Also Benefiting Charity

As of January 1, 2020, a number of changes to existing laws governing retirement plans were enacted under the Setting Every Community Up for Retirement Enhancement (SECURE) Act. One of the changes eliminated the ability of a non-spouse beneficiary inheriting an individual investment account (IRA) to stretch the payments over her lifetime.

Prior to the passage of the SECURE Act, non-spouse beneficiaries who inherited a Roth or traditional IRA were subject to required minimum distributions (RMDs) based on her life expectancy. This provided a significant benefit to the beneficiary by allowing those inherited assets to grow tax-free during the distribution period.  However, the new law now requires the non-spouse beneficiary to withdraw the inherited IRA within 10 years, thereby doing away with this “stretch” benefit.

As a result of this change, IRA owners are seeking alternative ways to incorporate tax-effective giving strategies into their estate plans. One way to maximize a gift to a beneficiary, while also benefiting a charity of choice, is by using a Charitable Remainder Trust (CRT).

A CRT can mimic some of the effects of the stretch IRA strategy by paying out the IRA income over the lifetime of the beneficiary, with the remainder going to a charity of choice.  Rather than your beneficiary receiving a lump sum payment from your IRA upon your death and having to pay taxes on that amount, he will receive a lifetime income stream that is determined annually by the IRS, called the Section 7520 rate. The remaining balance at death will then go to a designated charity. What results is often a greater after-tax advantage to the beneficiary and a tremendous benefit to charity as well.

Estate Planners

By way of example, suppose that Jane left a $1,000,000 IRA to her daughter, Sarah. After taxes, Sarah would receive about $600,000. Using this new strategy, Jane would create a Charitable Remainder Trust and name Sarah as her income beneficiary and Charity A as her remainder beneficiary. Upon Jane’s death, Sarah would receive an annual income based on the Section 7520 rate and Charity A would receive the remaining amount in the trust after Sarah’s death.  How much more Sarah would receive using a CRT is dependent upon how long she lives and the Section 7520 rate, but using reasonable assumptions, Sarah would have to live to 63 years old to receive more than if she simply inherited the $1,000,000 IRA outright. Moreover, Charity A would receive a large lump sum payment upon Sarah’s death as well.  Additionally, Sarah would receive many of the other benefits of inheriting assets through a trust like creditor protection and protecting her assets in the case of a divorce.

Whether this strategy is a good fit depends on various factors, including the life expectancy of the beneficiary. If the named beneficiary dies prematurely, the remaining assets in the CRT would go directly to the charity and not the beneficiary’s estate. However, this could be addressed by buying a term life insurance policy on the beneficiary naming his or her children as the beneficiary of the policy. 

Investors looking to provide security for their heirs, stretch the tax-benefits of an IRA and benefit a charity, should consider creating a CRT.  As always, please consult with your estate planning attorney and tax advisor about strategy.

Olson Wealth Group is a full service investment, family office and wealth management firm. With wise counsel and clear strategies, our experienced specialists provide tailored approaches that strive to maximize wealth.

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Disclosures: This information is not intended to be a substitute for specific individualized tax advice.  We suggest that you discuss your specific tax issues with a qualified tax advisor.

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