Stretch IRAs Are Dead. Long Live CRTs!

The "stretch IRA" was virtually eliminated with the signing of the SECURE Act in December 2019. However, there are other tools that can help you pass wealth to heirs and minimize taxes. If you have a substantial balance in a traditional IRA, a charitable remainder trust (CRT) may enable you to replicate many stretch IRA benefits.

No Longer an Option for Most

For years, stretch IRAs allowed the children or other beneficiaries of accountholders to stretch inherited IRA savings over their life expectancies. This was a big advantage, because it allowed funds to continue growing and compounding on a tax-deferred basis — potentially for decades. The SECURE Act essentially killed the stretch IRA by requiring most beneficiaries of inherited IRAs (other than spouses) to withdraw all of the funds within 10 years.

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Requiring non-spouse heirs to withdraw IRA funds more quickly means they'll have to pay income taxes on those funds whether they need the money or not. It may even push them into a higher tax bracket. As before, they may roll the funds into their own IRAs and defer distributions until they reach age 72. The SECURE Act designates several other potential beneficiaries for which a stretch IRA is still an option. These include people who aren't more than 10 years younger than you; people who are disabled or chronically ill (as defined by the SECURE Act); or minor children, provided they're sole beneficiaries of a separate share of the IRA, either outright or in trust.

For minor children, annual distributions may be based on the child's life expectancy until they reach the age of majority (usually 18 or 21), after which the remaining IRA funds must be distributed within the next 10 years. The SECURE Act also provides that the beginning of the 10-year distribution period may be delayed until age 26 if children are students.

Come Close to Duplicating Benefits

Leaving your IRA to a CRT can come close to duplicating the benefits of a stretch IRA. It allows your beneficiaries to receive distributions over a term of up to 20 years, or in some cases over their lifetimes or joint lifetimes. And even though the trust must preserve some of its assets for charity, the tax savings enjoyed by your heirs often make up for the loss of principal.

Here's how it works: In your estate plan you specify that on your death, your IRA will be transferred to a CRT. A CRT is an irrevocable trust that pays out a percentage of its assets to your children or other beneficiaries for life (or for a term of up to 20 years) and then distributes its remaining assets to one or more charities. A CRT is a tax-exempt entity, so any assets you contribute to the trust — including IRAs — aren't subject to tax unless they're distributed to noncharitable beneficiaries.

There are two types of CRTs: a charitable remainder annuity trust (CRAT) and a charitable remainder unitrust (CRUT). Both pay out a fixed percentage of the trust's assets, ranging from 5% to 50%, to your beneficiaries. The difference is that CRATs pay out a percentage of the trust's initial value while CRUTs pay out a percentage of its value, recalculated annually.

Longer is Better

The longer distributions can be stretched out, the closer a CRT comes to replicating a stretch IRA. It's important to note, however, that the trust's ability to do so depends on the age of your beneficiaries when you die.

There are limits to how long a CRT can spread out distributions to your heirs. IRA rules require that the actuarial value of the remainder interest left to charity — determined at the time the trust is funded — must be at least 10% of the trust's initial value. This requirement creates a floor for how young the noncharitable beneficiaries can be and still receive distributions over their lifetimes.

The floor depends on several factors, including the applicable federal interest rate. But in general, a lifetime CRUT requires the beneficiaries to be at least in their 40s, and substantially older for a CRAT. Any younger and the trust will not be able to pass the 10% test. However, even if a lifetime CRT isn't possible, the noncharitable beneficiaries will still enjoy significant benefits by spreading distributions over a 15 or 20-year term, rather than 10 years.

Meeting Your Goals

If you have a significant portion of your wealth in a traditional IRA, you likely have several options for easing the tax impact of passing it to your heirs. Based on your estate planning and tax goals, your advisor can review these choices with you.

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