For many years, one of the most powerful wealth-transfer strategies available to families was the "stretch IRA."
When a child inherited a retirement account, distributions could generally be taken over the child's life expectancy. The result was decades of continued tax-deferred growth, relatively modest annual taxable distributions, and the ability to transfer significant wealth across generations.
That changed dramatically with the passage of the SECURE Act.
Today, most adult children and other non-spouse beneficiaries must fully withdraw inherited retirement accounts within ten years of the original owner's death. For families with substantial IRA balances, this often accelerates income taxes into a beneficiary's highest earning years and may significantly reduce the long-term value of the inheritance.
In response, planners began searching for ways to preserve some of the advantages that the stretch IRA once provided.
One strategy receiving increased attention is the use of a Charitable Remainder Trust (CRT) as the beneficiary of a retirement account.
While a CRT cannot truly restore the old stretch IRA rules, it can sometimes approximate many of the same economic benefits while simultaneously supporting charitable goals. For the right family, it may be one of the most powerful post-SECURE Act planning opportunities available.
Understanding the Problem
Traditional IRAs and qualified retirement plans frequently represent one of a family's largest assets. Unfortunately, they are also among the most heavily taxed assets that beneficiaries can receive.
When a beneficiary inherits a traditional IRA:
- All distributions are generally subject to ordinary income tax.
- Most beneficiaries must empty the account within ten years.
- Large distributions may push beneficiaries into higher tax brackets.
- The opportunity for decades of continued tax deferral is substantially reduced.
Example: Suppose a 55-year-old beneficiary inherits a $2 million IRA. (First of all, CONGRATULATIONS!) Under current law, the account must generally be depleted within ten years. Depending on the beneficiary's income, the resulting distributions could generate hundreds of thousands of dollars in federal and state income taxes during that period.
For families that value both tax efficiency and charitable giving, a CRT may offer an alternative.
What Is a Charitable Remainder Trust?
A Charitable Remainder Trust is an irrevocable trust recognized under Section 664 of the Internal Revenue Code.
The trust operates as a "split-interest" arrangement:
- One or more individual beneficiaries receive income from the trust for a period of years or for life.
- Whatever remains at the end of that term passes to one or more charitable organizations.
The trust must satisfy numerous technical requirements, including actuarial tests designed to ensure that a meaningful benefit ultimately passes to charity.
Among other requirements:
- Annual distributions generally must be at least 5% of trust assets.
- The charitable remainder must have a minimum actuarial value of 10% of the property contributed to the trust.
How the Strategy Works
Rather than naming a child directly as the beneficiary of an IRA, the account owner names a properly drafted charitable remainder trust as beneficiary.
After the owner's death, the retirement account is distributed to the CRT. Because the trust is a tax-exempt entity, it can receive the retirement proceeds without immediately paying income tax on the entire balance.
The trust then invests the funds and begins making annual payments to the designated beneficiary.
Depending on the CRT design, those payments may continue:
- For the beneficiary's lifetime;
- For multiple lifetimes; or
- For a fixed term of years.
When the income period ends, the remaining trust assets pass to the charitable beneficiaries selected by the IRA owner or even by the income beneficiaries.
Why Some Planners Call It a "Stretch IRA Replacement"
Technically speaking, the old stretch IRA no longer exists. However, a CRT can replicate several of the economic benefits that made the stretch IRA attractive.
Under the old rules, beneficiaries received distributions over many decades. A CRT may similarly provide:
- Lifetime distributions to beneficiaries;
- Continued investment growth within the trust;
- Deferral of taxation until distributions are received; and
- Greater control over the timing of taxable income than a mandatory 10-year liquidation.
The result can resemble a lifetime "income stream" from inherited retirement assets even though the inherited IRA itself no longer exists. For this reason, many commentators describe CRT planning as a way to "re-stretch" an inherited IRA.
A Common Misunderstanding: The Income Tax Never Disappears
One of the most important points for families to understand is that CRT planning is not an income-tax elimination strategy.
The retirement account's deferred income does not simply vanish. Instead, the tax burden is often spread over a much longer period of time.
CRT distributions follow a specialized tax accounting system known as "four-tier" rules. Generally, trust distributions are deemed to come from:
- Ordinary income first;
- Capital gains second;
- Tax-exempt income third; and
- Trust principal last.
Because a traditional IRA consists largely of deferred ordinary income, beneficiaries frequently receive CRT distributions that remain taxable as ordinary income for many years.
The strategy's primary advantage is usually not reducing the tax rate itself. Rather, the advantage is often extending the period over which taxes are recognized and maintaining a larger pool of invested capital for a longer period of time.
Who Might Benefit Most?
This strategy is generally most compelling when several conditions exist:
- The IRA owner has a large traditional IRA.
- The intended beneficiaries are likely to be in high income-tax brackets.
- The family values predictable lifetime income.
- The IRA owner already has charitable goals.
In contrast, families whose primary goal is maximizing wealth transfer to children and grandchildren may find that other strategies — including lifetime Roth conversion planning — produce better results. Numerous commentators caution that CRT planning should not be viewed as the default solution after the SECURE Act.
The Bottom Line
A charitable remainder trust cannot truly restore the old stretch IRA. What it can do is transform a heavily taxed retirement account into a potential source of lifetime income for loved ones while preserving a meaningful charitable legacy.
For families who are charitably inclined and concerned about the tax impact of the SECURE Act, a CRT may provide a unique combination of income planning, tax management, and philanthropic impact that few other strategies can match.
How Roots Law Can Help
Charitable remainder trust planning is highly technical and requires close coordination among estate planning attorneys, tax advisors, financial planners, and charitable organizations. The effectiveness of the strategy depends on careful drafting, proper beneficiary designations, and thoughtful analysis of a family's tax and philanthropic objectives.
If you have a large retirement account and are concerned about the impact of the SECURE Act on your heirs, we would be happy to discuss whether a charitable remainder trust — or another advanced planning strategy — may be appropriate for your family's goals.
