Inherited IRAs: A Charitable Solution?

Many advisors remember the old “stretch IRA,” which allowed heirs to withdraw inherited IRA funds over their lifetimes, deferring income tax for decades. The SECURE Act of 2019 largely eliminated this option, requiring most non-spouse beneficiaries to withdraw the entire IRA within 10 years.

For a specific subset of clients, there may still be an alternative. Here’s the ideal scenario:

• Your client owns an IRA.
• Your client is highly philanthropic, prioritizing charities in their estate plan even if they have children or other heirs.
• Your client has identified a young, healthy heir to whom they want to leave a legacy gift.
• This heir is likely to be in a high-income tax bracket in future years and wants to defer income tax as much as possible.

In simplified terms, instead of naming the heir directly as the IRA beneficiary, your client names a charitable remainder unitrust (CRT), or even a NIMCRUT (net-income make-up CRT), with the heir as the income beneficiary.

• The CRT receives the IRA proceeds upon the client’s death.
• As a charitable entity, the CRT itself does not pay income tax on IRA distributions, allowing the heir to receive annual income over time.
• According to the CRT terms, distributions can occur annually over the heir’s lifetime (or a fixed period of up to 20 years), with the heir paying income tax only as the distributions are received, similar to the old stretch IRA.

Why doesn’t everyone use this strategy?

• The heir may be too young. IRS rules require that a CRT’s payout produce a present value of at least 10% for charity, which can make the payout rate too low to justify the complexity and cost when the heir is very young.
• Premature death of the heir is a risk. If the heir dies early, the remainder interest could go entirely to charity, leaving nothing for the heir’s own beneficiaries.
• Tax benefits may take time to materialize. Even compared with the 10-year rule, it can take many years for the CRT’s tax advantages (i.e., more wealth for the heir) to outweigh the eventual transfer of assets to charity.

Bottom line: For truly charitable clients, naming a charity (such as a fund at the Community Foundation) as the beneficiary of their IRA may better fulfill their philanthropic goals while leaving other assets eligible for a step-up in basis to fund estate gifts for heirs.

As always, the team at the Community Foundation is here to help! Please reach out anytime.