SECURE Act: Optimize Outcomes with Charitable Trusts

Avery Tucker Fontaine, Andrew B. Seiken, Keith Kellum

The SECURE Act limits the opportunities for using an IRA in both direct and generation-skipping planning. Charitable trusts offer a compelling alternative to increase the inherited amount and the overall estate value while also creating an opportunity to make a charitable impact.

Stretch IRAs may no longer be the optimal way for individuals to defer inherited income due to new rules under the SECURE Act that limit intergenerational planning. A compelling alternative for multigenerational planning is the use of properly structured charitable trusts in conjunction with IRAs, even for those who are not charitably inclined. This approach provides significant after-tax benefits for the family's estate and intended beneficiaries while also creating an opportunity to make a charitable impact.

What Changed?

The SECURE Act increases the age requirement for Required Minimum Distributions (RMDs) from 70.5 to 72, and gives traditional IRA owners the ability to make contributions indefinitely. As a result, IRAs can grow for a longer time period, taking advantage of compounding. In addition, the SECURE Act mandates that most non-spouse inheritors of IRAs take distributions that empty the account within 10 years of inheritance. Non-spouse inheritors of IRAs must also consider that these required disbursements will be taxed as ordinary income.

Benefits of Charitable Trusts

Whether an individual is interested in making charitable contributions or not, the use of a charitable trust provides an opportunity to optimize beneficiary income.

Charitable trusts can be structured as either a lead trust or remainder trust, as well as either an annuity trust or unitrust. These differences determine which beneficiary (charitable and non-charitable) receives distributions during the term of the trust versus the remainder, as well as how the annual distributions are calculated.

  • A Charitable Lead Annuity Trust (CLAT) pays the charitable beneficiary an annual annuitized sum first over the given trust term, and the remainder goes to the individual beneficiary.
  • A Charitable Remainder Unitrust (CRUT) pays the individual beneficiary an annual sum first over the given term, and the remainder goes to the charitable beneficiary.

Trusts can be structured to accomplish a wide variety of goals, as illustrated in the following scenarios. In Scenario A, the grantor's goal is to maximize the value of steady payments to an heir over 10 years, while the goal in Scenario B is to maximize the amount bequeathed to an heir.

Scenario A: Maximize Steady Payments to Beneficiary Over 10 Years

Sam inherits a $4 million IRA from his grandfather from an IRA with level payments to the beneficiary. Assuming a 5.41% portfolio total return rate and 37% federal and 5% state income tax rates, he takes after-tax payments of $286,246 each year for 10 years. His total after-tax distributions over 10 years would be approximately $2.8 million.

If Sam's grandfather wants to maximize the amount of payments to Sam over a 10-year period, a Charitable Remainder Unitrust (CRUT) with a 20% payout rate provides more after-tax income than the pure IRA inheritance. As illustrated in the table below, Sam would receive $2.94 million in income, which is approximately $78,000 more than the straight IRA payment option.

Payments for the 20% CRUT are heavily weighted at the beginning of the period (approximately $451,000 in the first year) and decline over the term (approximately $165,000 in year 10). Additionally, the nonprofit of the grantor's choosing would receive nearly $750,000 at the end of the 10-year period — a benefit not included in the level IRA. Regardless of charitable intent, the CRUT option allows the estate of Sam's grandfather to receive a charitable deduction of $400,000 (a $160,000 benefit to the estate), Sam to receive more income over 10 years and the charity to receive a significant gift.

The chart below reflects the increased value created when an IRA is gifted to a CRUT compared to bequeathing the IRA only.

Scenario B: Maximize Payout to Beneficiary

In many cases, stretch IRAs are used to transfer assets to younger family members to help pay for college, entrepreneurship, family needs or retirement. Given the SECURE Act change requiring the beneficiary to take all distributions from the inherited IRA within 10 years, Sam's grandfather sets up a balloon payment IRA that allows Sam to take advantage of tax-free growth in the account for 10 years. At the end of the period, assuming the same portfolio allocation as above with a 5.41% portfolio total return rate and 37% federal and 5% state income tax rates, Sam's after-tax payout in year 10 would be maximized at approximately $3.7 million.

Alternatively, Sam's grandfather can fund a child's or grandchild's needs later in life using a Charitable Lead Annuity Trust (CLAT). Assuming 5.41% portfolio growth and even annuity payments to the charity of $200,000 each year for 10 years, the portfolio would distribute about $4.2 million in kind (securities, not cash, to avoid federal, state and capital gains tax) to Sam in year 10, an increase of more than $500,000 over the IRA.

The CLAT allows Sam to have an infusion of income, perhaps when he needs it most, that is of greater value than inheriting the IRA outright. Between the two charitable trust scenarios, the CLAT pays out 43% more than the CRUT. In addition, the charity increases its operating or programming cash flow for 10 years. If Sam's grandfather wants to give Sam greater autonomy in either charitable trust scenario, he could give Sam power to change the charitable beneficiary in the document during the 10-year period. This would provide Sam with community standing and a significant inheritance.

The chart below reflects the increased value created when an IRA is gifted to a charitable lead trust compared to maximizing a bequeathed IRA with a balloon payment in year 10.

Ultimately, the SECURE Act does limit the opportunities for using an IRA in both direct and generation-skipping planning. Charitable trusts, however, are expedient vehicles both to increase the inherited amount and the overall estate value. Regardless of charitable intent or belief system, the CRUT and the CLAT, in this instance, serve all parties well and have the added benefit of supporting the community.

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