Retired Military Finances 401: Stretching an Inherited IRA with a CRUTTaxes Estate Planning
The SECURE Act changed several things related to retirement accounts. Some were good, like increasing the Required Beginning Date (RBD) for retirement accounts to age 72 (from 70 ½). Some weren’t so good, like eliminating the ability to stretch out distributions from an inherited IRA. Under the old law most taxpayers could take distributions from inherited retirement accounts based on their life expectancy. Under the SECURE Act that changed.
Under the new law, for many taxpayers, inherited retirement accounts have to be emptied in 10 years after the passing of the account owner (this doesn’t apply to spouses and a small group of other taxpayers). You can take some each year or you can wait until the last year and take it all. If the person who inherited the IRA is in a high tax bracket or near the top of a tax bracket, this can be less than optimum. Is there anything that can be done (within the limits of tax law)? There is. Enter the CRUT.
The Charitable Remainder Unitrust (CRUT) is a trust (as the name applies) that is treated as a charity. The CRUT makes payments to a designated beneficiary(ies), in this case, over their lifetime with the remainder going to a charity. How could this work for stretching out IRA distributions?
The process starts with setting up the trust. You’ll need a lawyer to do this. The trust will name the beneficiary(ies) and the charity (can be a Donor Advised Fund) that will receive the remainder interest. You then name the CRUT as the beneficiary of your IRA. When you pass, the CRUT will receive the proceeds of your IRA. Since the CRUT is treated as a charity, there are no taxes associated with this. Over the lifetime of the designated beneficiary(ies), the CRUT will pay a distribution to them (taxable) and when the beneficiary(ies) passes away the CRUT will pay out the remaining assets to the charity.
It’s not really that simple though. There are several hoops you have to jump through to qualify the CRUT. First, the payout to the beneficiary must be at least 5% of the assets annually and no more than 50% per year. Once the payout is set, it can’t be changed. Next, the charity must be projected to receive an actuarial equivalent of 10% of the current value of the assets. You’ll probably need a CPA to figure this out. Taxes are kind of weird too. As distributions come out all the income is taxed as ordinary income until reaching the value of the IRA on date of death. After that point, the income is taxed as it was actually earned. For example, if the CRUT had capital gains and all the ordinary income has already been paid out, the income will be taxable as capital gains for the beneficiary. The income taxed at the highest rate always comes out first.
It is important to note that due to the fact that 10% must be “set aside” for the charity (at least planned to do so), this technique might not provide the greatest amount of wealth transfer to the next generation. It works best for those who already have a charitable intent. But, in general, the CRUT will need 3 decades or more to “break-even” (probably your adult children) vs just accepting the 10-year IRA rule. Conversely, the beneficiary(ies) can’t be too young either as the 5% minimum distribution can result in the 10% to charity being unachievable.
This may or may not be a good idea for you, but it is always worth looking at and considering everything that is available out there.
Military Finances are Different
While this technique can be used by any American, there are many cases where the tax law treats military members and retirees differently. That can be the case with other financial matters as well. That's why we think you should work with an advisor that deals with those special military and veteran's issues each and every day. If you'd like to chat, give us a call or schedule a meeting by clicking the button below.
If you found this article useful, you might like the following blog posts:
Military Finances 301: Timing Inherited IRA Distributions After the SECURE Act
When an IRA Isn't an IRA
Military Finances 101: Inheritance and Estate Taxes. Do You Know the Difference?