This story appears in the June 28, 2015 issue of Forbes. Subscribe
You're widowed and have a $1 million individual retirement account. Do you leave it to charity or your kids?
Maybe both. The once obscure technique of leaving an IRA to a charitable remainder unitrust (CRUT) is getting new buzz, what with some politicians (most notably, President Obama) wanting to limit IRAs left directly to nonspousal heirs to a five-year life. "If you don't trust Congress, this is a great answer to get you nearly all the benefits of the stretch locked in at a nominal cost for a good cause," says Michael Jones, an estate planner in Monterey, Calif. and author of Inheriting an IRA.
Currently, if you're the named beneficiary on an IRA left by a parent, grandparent, sibling or anyone other than a spouse, you rename it "John Doe (the decedent's name), inherited IRA" and can then stretch out required minimum distributions over your own life expectancy. Assuming it's a traditional pretax IRA (not a Roth), all distributions are taxed at high ordinary income tax rates, which top out at 39.6%. But by taking advantage of the stretch you get possibly decades of additional tax-deferred growth. (You can stretch a Roth IRA, too, and the distributions aren't taxable.)
Stretch IRAs are a good tax deal. But they're too often foiled by human nature. If beneficiaries don't retitle the IRA properly, it may have to be liquidated. Even more common, Jones says, heirs don't appreciate the tax value of the stretch (or simply want the cash) and empty the IRA immediately.
The CRUT solves that problem. You put a provision for a "testamentary" CRUT in your will (you'll need a lawyer, not a do-it-yourself document, for this) and then name that CRUT the beneficiary on your IRA form. (The form is crucial, since it governs where your IRA goes, no matter what your will says.)
The CRUT can make annual payments to an heir (or heirs) for a fixed number of years (say, 20) or for their lifetimes. Either way, the charity gets what's left at the end, and by law its share must be projected to be at least 10% of the starting value.
Here's a simple-as-we-could-make-it example. A widowed 90-year-old California dad dies this year, leaving his $1 million IRA to a CRUT that pays his now 64-year-old daughter a set percentage of the balance for life, with the remainder going to Stanford. She lives 21 years, collecting $100,000 the first year and 10% of the remaining CRUT balance each year thereafter. Jones calculates the net present aftertax value of the payments to the daughter as $696,000. If Dad left her the IRA directly and she cashed out immediately, she'd get only $550,000 (assuming she pays a combined federal and California rate of 45%). If she had to liquidate it over five years, the net present value would be $613,000.
True, if she inherited the IRA directly and stretched out payments over the next 21 years herself, the net present value to her would be a bit higher at $718,000 (assuming an annual return of 7% for funds held in the IRA and 4.7% outside the IRA).
But the idea here is to help both charity and an heir, while protecting that heir from changes in the law governing stretch IRAs and the temptation to cash out.
One selling point for a CRUT is that most big charities, if named as the beneficiary, will manage it for free. Harvard, for example, will take a CRUT with as little as $100,000 and manage both its investments and administration. Alasdair Halliday, director of principal gifts, reports that Harvard has seen more CRUTs set up recently to benefit deceased donors' less wealthy siblings and even their aged parents, as well as their kids.
