Take-Away: One response to the SECURE Act’s 10-year distribution rule is to make an IRA payable to a charitable remainder unitrust (CRUT) which pays the non-charitable beneficiary over his/her lifetime, much like the old stretch IRA distribution rules, a/k/a a synthetic stretch. Designating a testamentary CRUT as the beneficiary of a decedent’s IRA can also mitigate the high income taxation that the IRA beneficiary would otherwise face if the IRA were inherited outright by the decedent’s mid-life child.

Background: I will skip what has been repeatedly written (by me and others) on the perceived benefits of naming a CRUT as the beneficiary of a decedent’s IRA, in order to replicate, to some extent, the stretch IRA concept that was eliminated by the SECURE Act. The problem is that the distributions from the inherited IRA, income in respect of a decedent, or IRD, will be added to earned income of the beneficiary, who will probably be in his/her peak earning years when their parent dies. Consider a decedent IRA owner who dies at age 83. His or her designated beneficiary, probably their child, will be in his or her 50’s, i.e. their peak earning years. The taxable distributions will be added to the beneficiary’s own earnings and probably subjected to marginally higher federal income tax rates.

Slow-Drip CRUT Overview: The ‘slow-drip’ CRUT [a planning opportunity identified by law professor Christopher Hoyt] is intended to reduce the beneficiary’s working-years taxable distributions, and to have their deceased parent’s IRA become the source of their own retirement income. A short summary of the basic rules and thinking behind the ‘slow-drip’ CRUT follow.

  • The IRA could be immediately liquidated on the IRA owner’s death and paid to the CRUT. There would be no tax on the distribution of the IRA assets to the CRUT, since the CRUT is tax exempt, but distributions from the CRUT to its non-charitable beneficiary would be taxed as ordinary income.
  • CRUTs require a minimum 5% distribution of the CRUT’s assets each year to the non-charitable current beneficiary. If the CRUT received a lump sum distribution of the decedent’s IRA balance, then 5% of that lump sum amount would have to be distributed to the beneficiary as taxable income.
  • Rather than liquidate the IRA immediately upon its owner’s death, the CRUT trustee defers distributions from the inherited IRA to the CRUT.
  • The law will not permit a deferral of 10 years for the IRA to fund the CRUT, a non-individual non-designated beneficiary of the IRA. Instead, a different distribution time limit will apply. Depending on the IRA owner’s age at death, payments from the IRA to the CRUT can be deferred to either (i) up to 5 years (owner dies prior to his/her required beginning date, or age 72); or (ii) in annual distributions of up to 15 years (owner dies after age 72 for which the distributions can be taken over the IRA owner’s ghost life expectancy), hence the name slow-drip.
  • The slow-drip funding of the CRUT can significantly reduce the child’s taxable distributions in the early years.
  • Example: A lump sum distribution from a $1.0 million IRA to the CRUT will require a first year distribution of $50,000 taxable income to the current non-charitable beneficiary. Assume the required distribution from an inherited $1.0 million IRA to a CRUT using a ghost life expectancy is $70,000. That same year’s taxable distribution from the CRUT to the child-beneficiary will be lower (e.g. 5% times $70,000= $3,500.)
  • By distributing smaller amounts from the inherited IRA to a CRUT in its early years after the IRA owner’s death, more resources can accumulate in the tax-exempt CRUT in the later years to provide greater retirement income to the child-beneficiary, plus a larger distribution to the CRUT’s remainder charitable beneficiary.

Basics: If a CRUT is named as the beneficiary of the decedent’s IRA it is not a see-through trust, since the trust has a charitable beneficiary, i.e. the CRUT is not a designated beneficiary nor an individual beneficiary. That results in different IRA liquidation rules, not the SECURE Act’s 10-year distribution rule. Instead of 10 years, the liquidation periods are either (i) 5 years if the owner dies prior to April 1 of the year he/she attained age 73; or (ii) the remaining life expectancy of someone who was the decedent’s age in the year of death, known as the ghost life expectancy, if the individual died after April 1 of the calendar year that follows the year that he/she attained age 72.

  • With the 5-year rule, there are no minimum required distributions until the end of the 5th Hence, the CRUT trustee could wait and pull all of the funds from the inherited IRA until the 5th anniversary of the IRA owner’s death, permitting the funds to grow in a tax-deferred IRA for that 5  year period.
  • With the ghost life expectancy rule, rather than a 5-year or 10-year liquidation period, the statute provides the distributions must be made ‘at least as rapidly as the lifetime distributions.’ [IRC 401(a)(9)(B)(i) and (H)(i).] The Regulations interpret this to mean that minimum distributions can be made over the remaining life expectancy of someone who was the decedent’s age in the year of death.
  • With the ghost life expectancy method, required minimum distributions are required each year over that time period, or else there is the 50% excise tax on the undistributed amount.
  • Example: The life expectancy of a 76-year old is 14 years (until age 90.) In the year of death, the required minimum distribution (RMD) is determined as if the person was still alive. In the year after death, that ghost life expectancy If in that year the applicable distribution period is 14 years, then the first year’s RMD from the inherited IRA is 1/14. The next year the denominator is reduced by ‘1’ to 1/13, then to 1/12, and so on over the 14 years.

Comparative Examples: Mom, age 76, owns a $1.0 million IRA. She has one child, a daughter, Sue, age 50. Mom’s IRA produces a 7% return each year. Sue is in her peak earning years at age 50 when Mom dies.

  • Sue Waits 10 Years: A 10-year liquidation would apply on Mom’s death with no required distributions to Sue until the 10th If no distributions were made to Sue until the last day of the 10th year,  when Sue is age 60, the inherited IRA account balance, with a 7% investment return each year, would have grown to $1,967,000- all taxable income to Sue in that 10th year.
  • Sue Exploits Ghost Life Expectancy Payout: Instead of delaying until the 10th anniversary of Mom’s death, Sue exploits the ghost life expectancy rule, and that  distribution time period is 14 years. The first year distribution to Sue would be $71,429 [$1.0 million divided by 14.] That amount would be added to Sue’s own taxable income.
  • CRUT Trustee Takes Lump Sum Distribution From Inherited IRA: If Mom named a CRUT that pays Sue 5% each year as the beneficiary of her $1.0 million IRA, the entire $1.0 million balance of the IRA could be paid to the CRUT shortly after Mom’s death. There would be no taxable income on the transfer of the IRA’s assets since the CRUT is a tax-exempt trust. The first year’s distribution from the CRUT to Sue would be $50,000 [5% times $1.0 million.] Each year thereafter distributions from the CRUT to Sue would increase by 2% for the rest of Sue’s life [the difference between the 7% investment return and the 5% annual CRUT distribution.]
  • CRUT Trustee Exploits Ghost Life Expectancy Payout: If the CRUT trustee takes required minimum distributions to the CRUT over Mom’s 14 year ghost life expectancy period, the CRUT would receive $71,429 in the first year after Mom’s death. Then, the CRUT would distribute 5% of $71,429 to Sue, or $3,571. Thus, the slow-drip CRUT- a CRUT that is annually funded with the RMDs from an inherited IRA using the deceased owner’s ghost life expectancy. By having Mom’s IRA assets gradually fund a CRUT over time, a larger amount can accumulate in the CRUT that can provide Sue with greater retirement income, and the CRUT’s charity with a larger benefit when the CRUT terminates on Sue’s death.
  • Big Picture Outcome with a Slow-Drip CRUT: Sticking with the example, if the RMDs from the $1.0 million IRA are distributed annually over 14 years to a 5% CRUT at a time when investments consistently earn a 7% return (pause for the inevitable ‘eye-roll’ from all wealth management advisors) the computations suggest the following: (i) For the first 11 years, distributions from a slow-drip CRUT would be less than the distributions from a CRUT funded immediately after Mom’s death, with her IRA not pushing Sue into a marginally higher income tax bracket. Thereafter, annual distributions from the CRUT to Sue, then age 61, would be larger; (ii) After 15 years, annual distributions from the CRUT funded with the slow-drip method would be 50% greater than from a CRUT that was funded with the entire IRA immediately after Mom’s death ($100,000 v $66,000 in year #16, with a 2% annual growth thereafter); and (iii) The charity remainder beneficiary of the CRUT will receive 50% more assets upon the CRUT’s terminate with a slow-drip CRUT than a CRUT funded immediately upon Mom’s death.
  • The Numbers: If Sue lived for 30 years after Mom’s death, and the CRUT was immediately funded with Mom’s $1.0 million IRA, Sue would have received over that 30-year period $1,780,000 from the CRUT in 5% annual distributions. If the trustee of the CRUT had exploited the slow-drip approach to funding the CRUT over the 14 years of Mom’s ghost life expectancy, the amount Sue would have received over the following 30 years would be $2,680,000, or $900,000 more.

Conclusion: Obviously, not all individuals are charitably inclined, and if philanthropy is not important to them, then the CRUT is not going to be a viable option to consider. However, consider the fact that most IRA owners will die in their 80’s, and most single IRA owners leave their IRAs to their children, who are more likely to be in their late 40’s or early 50’s when their parent dies. The child may then be in their peak earning years, so that their receipt of the inherited IRA could be rapidly eroded when exposed to higher marginal federal income tax rates. Thus, the use of a CRUT as the designated beneficiary of the deceased parent’s inherited IRA permits an indirect stretch longer than 10 years. In addition, if the beneficiary is approaching their own retirement years, then a slow-drip CRUT exploits the IRA owner’s ghost life expectancy, which might come close to replicating the ‘old’ stretch IRA-retirement-income-for-the-beneficiary that the SECURE Act pretty much eliminated for most inherited IRAs. Since we never will actually know at what age the IRA owner will die, a formula beneficiary designation form would have to be used, tied to if the duration of the owner’s ghost life expectancy at the time of death.