Two charitable gift ideas made better by the SECURE Act

By Don Laubacher, CFP®, CPA, AEP®
Senior Vice President, Family Wealth, Sequoia Financial Group

The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law on Dec. 20, 2019 (that seems like a long time ago!). One significant change in SECURE is the elimination of the stretch provision of IRAs inherited by most non-spouse beneficiaries. Under the prior rules, a non-spouse beneficiary like a child or grandchild could take distributions from the inherited IRA over their life expectancy. For example, a 25-year-old who inherits her grandfather's IRA could stretch the distributions, and the associated tax, over 58.2 years. For most non-spouse beneficiaries, SECURE mandates that IRA distributions must be completed within 10 years.

Because IRA distributions are taxable income to beneficiaries, leaving part or all of them to charity (which are tax-exempt) is a great choice for those with charitable intent. The elimination of the stretch makes this option even more attractive! In addition, and for the same reason, it makes a charitable remainder trust (CRT) a more intriguing choice as an IRA beneficiary. This article explores these ideas in a bit more detail.

Designating a charity as a beneficiary of your IRA

Making a charity the beneficiary of an IRA is done by requesting a beneficiary designation form from the plan's administrator or custodian and indicating what percentage should be designated to which charity(s). One caution, however, is if charity is not designated to receive 100%, but is one of multiple beneficiaries, the designation to charity may have a negative impact on the options available to noncharitable beneficiaries. This is because a charity is not an individual, and therefore has no life expectancy to calculate annual distributions. For example, if I die before my required beginning date (age 72*) and have designated a portion to charity along with other noncharitable beneficiaries, my noncharitable beneficiaries will be required to withdraw all the assets by Dec. 31 of the fifth year following the year of my death. There are two ways to avoid this result:

All my beneficiaries can establish separate retirement accounts by Dec. 31 of the year following the year I die, or
The charity I named can cash out its portion of the inherited assets by Sept. 30 of the year following the year I die.

Because these alternatives are not common knowledge and may not be executed, many practitioners believe it's a best practice to open a separate IRA for the portion you wish to go to charity. For example, if I'd like to designate 10% of my IRA to Akron Community Foundation, but want my wife and children to receive the other 90%, it might be better for me to open a separate IRA with 10% of the assets, and designate that ACF will be a 100% beneficiary of that smaller IRA. The larger IRA is then left for my wife and children. Also, remember that married individuals will need their spouse's consent if they are not the beneficiary of all the IRA assets.

Using a Charitable Remainder Trust as a substitute for the stretch IRA

A CRT is a trust that distributes an annual payment to one or more beneficiaries either for life or a term of no more than 20 years. At the end of the life, or term, the remaining assets are paid to charity.

In this context, I'm talking about naming a trust as the beneficiary of your IRA. Of course, if you're married, your spouse would be the primary beneficiary, and the CRT would be the contingent beneficiary. Therefore, this CRT is a testamentary (arises upon death) trust that isn't funded before you and your spouse die.

The required analysis compares naming your children/grandchildren as beneficiaries, who must withdraw the IRA within 10 years, with a CRT, which can make a stream of payments, usually ranging annually from 5% to 8% of the trust assets, for life or a term of up to 20 years.

If a life interest is selected, the remaining assets in the CRT are distributed to charity whether the beneficiary dies after one year or 30, so you may find a 20-year term more attractive to ensure that the payments will last regardless of the beneficiary's lifespan. Although, if the election is based on the lives of three children, for example, the odds of all of them dying prematurely is remote.

Below are additional factors to consider when deciding whether to leave an IRA to heirs versus a CRT:

The desire to leave a charitable legacy.
An attorney is required to draft the CRT.
A trustee of the CRT will need to be named.
While the CRT is tax-exempt, it is required to file an annual tax return.
The trustee of the CRT will issue a form K-1 to each beneficiary, reflecting their reportable income.
Unlike an IRA, the beneficiary of a CRT will get a certain dollar amount or percentage each year.
The IRS sets a maximum annual payout for the CRT to ensure that the charity will receive at least 10% of the initial balance.
Future income tax rates are likely to be higher, perhaps improving the math for the CRT option.

Using a CRT as a substitute to more closely resemble the old stretch rules, as opposed to the new 10-year requirements of SECURE, may yield a better overall result. Using a financial advisor that can evaluate the numbers and compare results is critical. In addition, CRTs can be complicated, so using legal counsel experienced in charitable and estate planning is key.

To learn more, contact Laura Lederer at 330-436-5611 or llederer@akroncf.org.

*The required minimum distribution age increased to 73 as of Jan. 1, 2023.