How a CRT can work as a “stretch IRA” substitute
Estate, Gift, & Trust Planning
Until recently, if you named someone other than your spouse as the beneficiary of your IRA or qualified retirement plan, that person would have the option of taking distributions over his or her life expectancy. This strategy, commonly called a “stretch” IRA, offered significant advantages by allowing distributions to be spread over decades. But the SECURE Act of 2019 drastically reduced these benefits (with certain exceptions) by requiring distributions to be completed within 10 years. It’s worth noting here that while the recent CARES Act eliminated RMDs for 2020, it doesn’t technically impact the 10-year rule for beneficiaries. That’s because the 10-year “clock” starts the year following the IRA owner’s death and the SECURE Act’s rules apply to IRA owners who pass away starting in 2020. While RMDs are waived this year, the 10-year period for inherited IRAs doesn’t begin until 2021 anyway.
Fortunately, there are still strategies you can use to replicate some of the benefits of a stretch IRA. If you’re charitably inclined, one approach is to name a charitable remainder trust (CRT) as the beneficiary of your IRA or qualified plan.
Stretching distributions over a beneficiary’s life expectancy offer two primary benefits:
- It allows the funds to continue growing and compounding on a tax-deferred basis for as long as possible, and
- It often results in lower overall taxes on the distributions.
Stretching out distributions means that a significant portion of the funds will be distributed during retirement, when the beneficiary’s tax rate may be lower. If distributions are bunched into a 10-year period, they may be received during a beneficiary’s peak earning years.
Following the SECURE Act, beneficiaries must take distributions within 10 years, with a few exceptions. As before, spouses may take distributions over their life expectancies or roll the funds over into their own IRAs and defer distributions until the age of 72. There’s also an exception for disabled or chronically ill individuals or trusts for their benefit. Minor children may stretch distributions over their life expectancies until they reach the age of majority. But once they’re adults, the balance must be distributed within 10 years.
Using a CRT
If your intended beneficiary doesn’t fall within one of the exceptions, naming a CRT as a beneficiary of your IRA or qualified plan can provide some of the benefits of a stretch IRA — assuming it’s structured properly. A CRT is an irrevocable trust that distributes a percentage of its assets to one or more individual beneficiaries for life or a term of up to 20 years. After that, the remaining assets go to charity.
The percentage distributed can range from 5% to 50%, and annual payouts may be based on a fixed percentage of the trust’s initial value (a charitable remainder annuity trust, or CRAT). Or it may be based on a fixed percentage of the trust’s value, recalculated annually (a charitable remainder unitrust, or CRUT). CRUTs generally are preferable because making annual recalculations allows payouts to keep pace with inflation and ensures the funds will never be exhausted.
Because a CRT is a tax-exempt entity, the funds aren’t taxed until they’re distributed to your noncharitable beneficiaries. If payouts from the CRT are spread out over a 20-year term or a beneficiary’s lifetime, a CRT can, when structured properly, provide benefits similar to that of a stretch IRA.
However, under IRS guidelines, the actuarial value of a charitable beneficiary’s remainder interest must be at least 10% of the trust’s initial value. The need to preserve a minimum value for charity can restrict the length of the trust term or the size of payouts. This mandate may even make it impossible to establish a CRT for the life of certain younger beneficiaries.
Weigh your options
A CRT can be a viable substitute for a stretch IRA, particularly if your beneficiary is expected to live a long time. To determine whether a CRT is right for you, work with your tax and estate planning advisors to weigh the costs against the potential benefits of stretching distributions well beyond 10 years.