Example 1If the original IRA owner reached age 70½ prior to death, the default distribution schedule typically follows the original IRA owner's RMD schedule. The beneficiary does have the option to choose a lump sum distribution or a life expectancy distribution. In many cases, children may elect accelerated distributions instead of the smaller RMD distributions and create large income tax payments.
Angela, age 50, inherited her mother's IRA valued at $400,000. After weighing her options and consulting with her advisor, Angela chose to take the IRA distributions over her life expectancy. By choosing this option, Angela will not be subject the 10% early withdrawal penalty. She will pay income tax on each distribution at her ordinary income tax rate. If instead the charity received the IRA, Angela could inherit other "good assets," like stock or real estate, and sell them tax free. The charity would have been able to receive the IRA tax free. Under the IRA life expectancy tables Angela reached life expectancy at age 84, at which point the IRA payments from the inherited IRA ceased. Angela was an active and healthy woman, she lived to age 98. The IRA distributions ended well before she passed away.
William inherited an IRA valued at $400,000 from his uncle. His uncle's estate was rather large. William consults with his professional advisor and determines he would like a lump sum distribution. The IRA is subject to estate tax of $160,000 before being distributed to him. William's professional advisor ensures that William has adequate tax withholding on the IRA distribution. William understands that the IRA distribution will increase his tax rate. He will also need to increase his withholding on his wages and other income because his entire income will be taxed at a higher tax rate. He will pay ordinary income tax of $84,000 on the IRA. The original $400,000 IRA will be substantially reduced by estate and income taxes. William is left with $156,000, which is only 39% of the original asset. If his income tax withholding is insufficient, William could also end up with a large income tax bill from the IRS including interest and penalties.
Example 3A testamentary CRUT funded with an IRA allows the IRA owner to provide for family in an income tax favored way while also generating a substantial legacy gift for charity. Using a CRUT as the inheritance vehicle for an IRA ensures the proceeds of the IRA are distributed over time and not disbursed in a lump sum. This can aid IRA owners' peace of mind knowing their loved ones will have regular payments measured over their lives or a term of years. This may be a great solution for heirs lacking in money management skills.
If, instead of leaving the IRA to Angela (see example 1 above), her mother created a testamentary CRUT for the benefit of Angela, the results would better meet her mother's goals. Assume that instead of receiving the IRA through the beneficiary designation form, Angela was the income beneficiary of a testamentary charitable remainder unitrust that was funded with her mother's IRA. When the trust was funded, the IRA was valued at $400,000. Angela received a 5% unitrust payout from the CRUT for her lifetime. Angela lived to age 98 and over the course of her life received over $1.22 million in trust payments. The charity received the remainder value of the trust, which at the time of Angela's passing was valued at almost $645,000. The combined value of the trust payments and remainder value to charity was over $1.86 million. The charity is able to receive the remainder value tax free. Angela's mother left a lasting legacy gift and was able to provide for Angela during her remaining lifetime.
Example 4The IRA owner should obtain the testamentary CRUT document and the appropriate consent forms from his or her attorney prior to updating the beneficiary designation form to ensure a smooth transfer. The testamentary CRUT must be in existence at the time of the donor's death to qualify for an estate tax deduction. The CRUT can be formed as a funded or unfunded CRUT, but it must be created during the life of the donor to qualify for an estate tax deduction.
Over his lifetime, Edward has accumulated a substantial amount of assets. Edward wants part of his estate to benefit his young children. He wants his favorite charity to benefit from his IRA. His wife will be well cared for through other assets in his estate. Edward's attorney highlights the benefits of using a testamentary term of years CRUT. Edward is very happy that he can benefit his favorite charity and provide his children with some added security.
Edward's attorney drafts the testamentary CRUT. His attorney also creates the required consent form and Edward's wife signs the form. Edward finally updates his IRA beneficiary designation form to reflect the desired outcome. Edward's taxable estate is valued at $14 million and includes his IRA worth $3 million. The IRA plus $7 million other assets will go to the 20-year testamentary trust, creating an estate tax deduction of just over $3.68 million. Edward's estate will save almost $1.13 million in estate taxes with this inheritance plan. Edward's children will receive income for 20 years and the remainder will go to charity. The charity is projected to receive almost $11 million from the trust at the end of the trust term.