Tax Planning Surprise. Use a CRAT or CRUT to “Put Back” Your Stretch IRA Options for Non-spouse Beneficiaries!

As of Jan. 1, 2020, the SECURE Act requires the entire balance of a non-spousal participant’s inherited IRA account to be distributed or withdrawn within 10 years of the death of the original owner. The 10-year rule applies regardless of whether the participant dies before, on, or after the RMD (required minimum distribution) age at which they had to begin withdrawals.

In other words, you must withdraw the inherited funds within 10 years and pay income taxes on the distributed amounts. Since the withdrawals are required, you won’t pay the 10% penalty if you’re under the age of 59½. But you must pay income taxes on the distributions, and you must eventually empty the account. Children of IRA holders, same sex partners in some states and many other non-spouse beneficiaries were affected and many people with “stretch IRA” provisions in their estate plans have not heard the news, or think because it says what they want in a Trust document that they are immune, not realizing the IRS trumps all and the trustees will now have to follow new tax rules, causing many unanswered questions to be resolved post death.

One tax planning tool that many people should consider is making their IRA beneficiary a charitable trust instead of their non-spouse. The “CRT” takes all the money from the IRA in a lump sum, but pays no taxes, and then the non-spouse beneficiaries (children of IRA holders, same sex partners, whomever) can be the income beneficiaries of the CRT and the new SECURE Act rules are superseded.  CRTs have two phases and the income actions of a CRT can pay well beyond the 10 year rules that come with IRAs, allowing a different but effective way to “re stretch” the IRA again. The trade-off is that a charity at the end of the term must also be paid, but the tax savings of allowing a longer payout period for beneficiaries can far exceed the charitable contribution.

Example: John is a doctor and his same sex partner Ted is a lawyer and both are going to retire in 10 years. They both make approximately $300,000 a year and have about $1,000,000 in various IRA and 403(b) accounts. John dies unexpectedly and his IRA must now be paid to Ted. Any amount Ted takes under the SECURE Act rules is added to his $300,000 salary, so even 10% adds $100,000 of income, causing taxation of 35% at the federal level, plus additional state tax in many cases. If instead the IRA beneficiary was a NIMcrut drafted by John, the CRT would receive the funds but could hold them until after Ted retires, adding no additional income during his working years. Then, when Ted retires, he could spread the IRA (now CRT) proceeds out over his lifetime, resulting in much lower rates. That could result in a tremendous amount of taxes being saved over time and the charity will only be required to receive a $100,000 gift by design. The results would of course vary from case to case, but the design has real merit. If the loss of ability to stretch your IRA is a major problem for your desired tax outcomes, talk to your tax planning professional about the possibility of using charitable planning to bypass the SECURE Act!