Preparing for the inevitable should happen now, before the unthinkable happens. Taking care of your estate for your beneficiaries and loved ones who outlive you can be complex.
From stretch IRAs to charitable remainder trusts, you have options depending on your goals for your financial legacy. Which one is the right fit for you?
Before you decide on any one method of passing assets to your loved ones, here is what you need to know about the limitations of a stretch IRA and why a charitable remainder trust may be the right move.
What is a Stretch IRA?
With all of the available options to pass a financial legacy to the next generation, stretch IRAs were just one method to help plan your estate. These specific individual retirement accounts were used to pass some of your assets to beneficiaries in the next generation without sacrificing the tax-deferred status of the IRA method. This allowed them to continue earning without having to pay those pesky taxes on growth.
Unfortunately, stretch IRAs were disallowed by the IRS back in 2019 as part of the SECURE Act, unless you were already a current beneficiary. At the moment, all funds in a stretch IRA must be removed within ten years of the death of the account owner. Now, you can only use a stretch IRA to provide for a minor or a disabled person.
These stretch IRAs were extremely beneficial for estate planning if you had significant wealth to pass to the next generation. They had very few requirements for taking distributions and drawing money from the account, allowing assets to sit and grow for years or decades sans taxes.
Now, your beneficiaries are forced to take distributions from a stretch IRA even if they do not need them at the moment. This can trigger them to fall into a higher tax bracket than they would be otherwise, and can eat into some of the financial help you intended to give them. Suddenly, the stretch IRA wasn’t so stretchy.
What is a Charitable Remainder Trust?
Because the stretch IRA is so limited in how you can use it these days, you may need to look into other estate planning options. A charitable remainder trust (CRT) is a great substitute for these IRAs. In fact, it’s fairly simple to convert your IRA to a CRT. All you need to do is die.
In this method, the named IRA beneficiary is your Charitable Trust, which is removed from your taxable estate. The assets continue to grow in the trust, tax-deferred. Upon your death, the charitable remainder trust provides income distributions to your designated beneficiaries either for life or until the term ends.
When the term ends, the remainder of the funds in the trust are donated to a charity that you get to select upon formation of the trust, but you can retain the right to change the charities at any time. You must donate at least 10 percent of the initial present value of the trust to a charity to avoid triggering tax consequences.
Like a stretch IRA, beneficiaries get the benefit of your financial legacy spread over a large window of time compared to a windfall inheritance. Even the decade-long option of the inherited IRA can trigger a massive tax bill that could erode your lifetime savings if it pushes beneficiaries to a higher tax rate. Flexibility is key with charitable remainder trusts.
How a CRT Can Replace a Stretch IRA
While it may not be a one-to-one tradeoff to switch from a stretch IRA to a charitable remainder trust, there are some benefits that your loved ones will get to enjoy. First, they will not be limited to receiving distributions only for a decade after your death. Instead, they can receive for a term of twenty years or even for life, depending on the wording of your trust and their ages at the time of your death.
Like a stretch IRA, a charitable remainder trust is a tax-exempt entity as long as you follow the legal requirements. Namely, this means contributing some portion of the assets (at least 10 percent) to a charity or charities of your choice at the end of the trust – the remainder. While your loved ones may not receive the full value of the trust, losing 10 percent is a lot better than 40 percent, and you can rest easy knowing that you made a philanthropic impact while caring for loved ones long-term.
The benefit of a CRT over the standard inherited IRA is that your beneficiaries will not have to pay income taxes on the funds of the IRA if they do not need the money. Because IRA funds must be pulled out within ten years, they may be forced to take distributions that they do not want or need. They could prefer to sit on those funds until a time when they truly require a cash infusion.
Like the rules of the stretch IRA, charitable remainder trusts’ beneficiaries only pay taxes on the funds they receive from the trust. These taxes are filed on their own personal tax return.
Establish Your Estate Plan with Magellan
Are you ready to start thinking about the alternatives to a taxable inherited IRA for your beneficiaries, your financial legacy, and your estate? Then it is time to consult with the professionals. Magellan offers comprehensive estate, tax, legal, and financial planning all under one roof. You never have to go anywhere else to get the help you need.
Reach out to us today to evaluate your options for a charitable remainder trust in lieu of an old stretch IRA!
Cetera Advisor Networks, LLC exclusively provides investment products and services through its representatives. Although Cetera does not provide tax or legal advice, or supervise tax, accounting or legal services, Cetera representatives may offer these services through their independent outside business. This information is not intended as tax or legal advice.
This material provided by Kevin Meaders was written by Axle Eight, a non-affiliate of Magellan Planning Group and Cetera Advisor Networks LLC.