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September 12th, 2022
Since the passing of the SECURE Act it has become commonplace, as practitioners, to deal with the 10-year rule that has been placed on retirement plans for clients wishing to support non-eligible designated beneficiaries. It was only three years ago when the term ‘stretch IRA’ was common nomenclature and topic of discussion with our stakeholders when talking about their long-term legacy plans. In working with charitably inclined clients, we find that there is an appetite to leave retirement assets to heirs while ensuring there is a charitable gift in the end. One of the limited ways of getting around the 10-year rule is by creating a charitable remainder trust (CRT) and making the CRT the beneficiary of the retirement plan. Let us talk about stretching out retirement plans again. How can it be accomplished? Who can it benefit? When is an appropriate time to use a CRT?
A donor can work with a trust department at a bank or financial firm, a charitable entity, or a community foundation to setup a CRT during their lifetime. The donor creates the parameters in the trust document, which will include the following:
Any person or qualified special needs trust can benefit from a CRT so long as the CRT qualifies, per IRS rules and regulations. At the University of Illinois Foundation (UIF) we use software from PG Calc to run our illustrations to ensure a CRT, in which we serve as trustee, qualifies per IRS standards. We would be happy to run an illustration for you and your client at any time.
Disclaimer: An entire blog post could be devoted to the most advantageous time to create, the similarities, and the differences between a Charitable Remainder Unitrust (CRUT) or Charitable Remainder Annuity Trusts (CRAT). The examples below use the CRUT version of a CRT. For a quick overview, a CRUT pays a fixed percentage of the trust assets, valued annually, which means the payment may go up or down based on the investment performance of the CRUT. Whereas a CRAT pays a fixed percentage based on the initial gift value, meaning the payout amount remains fixed during the term of the trust.
Let’s look at a couple examples to understand methods for helping our clients support loved ones with qualified CRUTs by stretching out the retirement plan payments.
Example 1: A married couple, ages 79 and 80, want to help their child, age 47, with lifetime income. The married couple has a 403(b) plan and it is subject to required minimum distributions (RMDs). The couple does not need the RMDs and desires to give the entire 403(b) to the child at death anyway. In addition, they would like to expedite the process in getting money out of their 403(b) and into the trust. The couple is okay with paying a little bit of ordinary income tax on the withdrawal from the retirement plan as they will receive a charitable deduction, which they use to itemize. Since the child is under UIF’s minimum age of 55 to receive the 5% payout rate, we agreed to set this up as a CRUT with a “flip” provision to pay net income to the beneficiary. And after the beneficiary attains the age of 55, the CRUT flips and pays 5% of the trust assets, valued annually. In the IRS final regulations for CRTs, they state that flip provisions could be added to CRUTs if they are subject to the following:
The final regulations allow the governing instrument of a CRUT to provide that the CRUT will convert once from one of the income exception methods to the fixed percentage method for calculating the unitrust amount if the date or event triggering the conversion is outside the control of the trustees or any other persons. (Wenzel & Lubick, 1998, pg. 5)
Neither UIF nor the beneficiary can control whether they reach the age of 55, therefore, the strategy has worked well for the couple in reaching their financial and charitable goals. When the term of the trust ends, which is the life of the beneficiary, the remainder will go to support our mission and a specific area of campus that matters to the couple. This achieves the donor’s objectives of supporting their child with a steady stream of lifetime payments from a retirement plan, extending well beyond the 10-year rule should they have simply left their child as beneficiary of the retirement plan. Here is what the illustration and deduction look like for the couple.
Example 2: Widow, age 85, wants to equally support her four grandkids, who range in age from 14-24. The donor does not want the grandkids to receive the money until after her lifetime. The beneficiaries are under the age that would qualify for lifetime payments, so we discussed with the donor the option for paying her net income during her lifetime, since she does not want her grandkids receiving payments until after her lifetime. After her life, the trust flips and pays the grandchildren for their lifetime or a term of 20 years, whichever is shorter. For the initial funding, the donor wanted to take advantage of gifting highly appreciated securities held for the long-term. The donor received a discounted, charitable deduction based on the fair value of the asset on the date of the gift.
Note: When gifting securities held for the long-term to a qualified 50% charitable organization, the donor is limited to deducting up to 30% of their adjusted gross income, with a five-year carryforward period.
After the donor created these CRUTs, she made the CRUTs the beneficiary of her retirement accounts with value of the retirement account transferred to the CRUT after the lifetime of the donor, thus stretching out the payout period for 10 years beyond the 10-year rule. Here is what the illustration and deduction looked like for the initial gift.
As you can see, CRTs provide a unique opportunity for people to stretch out their retirement plans well beyond the 10-year rule. CRTs may be the solution some of your clients are seeking. These giving vehicles are part gift and part income that can support any person(s) of the donor’s choosing if the CRT qualities. Keep in mind, these examples are for people who have charitable and financial objectives. If the goals of your client(s) is/are purely to transfer wealth to their heir(s), then consider other strategies. As always, continue to collaborate diligently with other advisors in the estate and financial planning space to ensure a plan is created that reaches the client’s financial goals.
If you want to learn more about stretching out retirement plans beyond the 10-year rule or other strategies as they relate to estate and charitable planning with retirement assets, then join Justin Seno and Meg Cline on Wednesday, September 21 from 10:00-11:15am for a FREE webinar, Estate and Charitable Planning with Retirement Assets.
By Justin Teal Seno, CFP®
Director of Gift Planning, University of Illinois Foundation
Choate, Natalie, (2022). Here’s How the Proposed Secure Act Regulations are Tougher on Older Beneficiaries. Morningstar.
Wenzel, Robert E. & Lubick, Donald C. (1998, December 10). Guidance Regarding Charitable Remainder Trusts and Special Valuation Rules for Transfers of Interests in Trusts. Internal Revenue Service (IRS), Treasury.
Disclaimer: The information referenced in Tax School’s blog is accurate at the date of publication. You may contact firstname.lastname@example.org if you have more up-to-date, supported information and we will create an addendum.
University of Illinois Tax School is not responsible for any errors or omissions, or for the results obtained from the use of this information. All information in this site is provided “as is”, with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information. This blog and the information contained herein does not constitute tax client advice.
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