WHEN A CHARITABLE TRUST BEATS A "STRETCH IRA"
Professor Christopher R. Hoyt
University of Missouri (Kansas City) School of Law
(c) 2002 Christopher R. Hoyt All Rights Reserved
A fundamental estate planning principle is that
after a person's death, distributions from his or her retirement
plan account should be deferred to the beneficiaries for as long as
possible. The longer that amounts can remain in a tax-sheltered
environment, the greater the investment income for the
beneficiaries. For example, if a retirement plan distributes $100 to
a beneficiary, the beneficiary must pay federal and state income tax
(e.g., perhaps $40), leaving only the after-tax amount for the
beneficiary to invest ($60). By comparison, if the plan can retain
the amount, the entire $100 can be invested by the plan and the
beneficiary can have nearly double the investment income.
In order to defer distributions over the longest
possible time period, estate planners generally focus all of their
attention on the minimum distribution regulations for retirement
plans that were issued in April, 2002. Their usual objective is to
establish a "stretch IRA" upon the account owner's death. If certain
conditions are met, payments from a decedent's IRA may be stretched
over the life expectancy of the beneficiary -- potentially a very
long time!
Although the final regulations make it much easier
to have a stretch IRA compared to the old rules, there still are
some situations where estate planners are frustrated. A significant
challenge exists when there is a sequence of beneficiaries (e.g.,
"to A for life, then to B for life"). This situation appears most
often with a surviving spouse (e.g., "payments to spouse for life,
remainder to children"). If there are multiple beneficiaries, the
stretch IRA regulations require distributions to be made over the
life expectancy of the oldest beneficiary (e.g., the surviving
spouse). The IRA will likely be depleted when the oldest
beneficiary dies. How can an IRA make distributions over the lives
of the younger beneficiaries?
A solution to this challenge comes from a completely
different field of law than the stretch IRA regulations: a
charitable remainder unitrust ("CRUT"). A CRUT can benefit a
series of individuals for life and then distribute the assets to a
charity when the last beneficiary dies. Like an IRA, a CRUT pays no
income tax. Unlike an IRA, the term of a CRUT can last until the
last of the multiple beneficiaries dies, which will usually be the
youngest beneficiary. Consequently, a CRUT will usually defer
distributions from a decedent's IRA longer than a stretch IRA can
anytime that there is a sequence of beneficiaries. The benefits will
usually be greatest if there is a significant age difference among
the beneficiaries or if one of the beneficiaries is elderly. Under
the right set of facts, the family will be better off. In addition,
a charity will benefit.
EXAMPLE: Mr. Husband has a terminal
illness. He would like his IRA to provide income to his second
wife (age 70) for the rest of her life and then provide income to
his children from his first marriage (currently ages 42 and 45)
for the rest of their lives. If his IRA is payable to a QTIP trust
that benefits both his spouse and children, the IRA must be
completely distributed by the year his wife attains age 87 (the
life expectancy of a 70 year old is 17 years). Reg. Sec.
1.401(a)(9)-5, Q&A 7(a) and 7(c)(3), Ex. (1) and Reg. Sec.
1.401(a)(9)-9, Table A-1. The result? The IRA will likely be empty
when the surviving spouse dies, leaving nothing in the IRA for the
children. What's worse, the IRA must be empty when the surviving
spouse attains age 87, even if the spouse in fact lives to be 100!
By comparison, if the IRA is distributed to a CRUT upon his death,
the CRUT will provide income to his wife for the rest of her life
(which could be well beyond age 87) and then provide income to his
children for the rest of their lives. In other words, the CRUT can
extend payouts from the life expectancy of a 70 year old to
the actual years lived by a 42 year old or a 45 year old.
The CRUT also provides estate tax advantages: none of the assets
in the CRUT will be included on the estate tax return of the
surviving spouse. Furthermore, Mr. Husband has the personal
satisfaction of benefiting his favorite charity.
For more information on how a charitable remainder
unitrust might provide greater benefits than a stretch IRA, please
see the May, 2002 issue of Trusts and Estates magazine and
the March, 2002 issue of Planned Giving Today,
http://pgtoday.com/PGT/Articles/selected_articles.htm
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