Charitable Remainder Trust: The Stretch IRA Alternative

The SECURE Act killed the stretch IRA, but a properly constructed charitable remainder trust can deliver similar benefits, with some caveats.

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An older couple stretch while sitting on exercise mats in a park.

(Image credit: Getty Images) published 17 April 2024

You may have heard about it before. The "stretch IRA" was a popular estate planning tool embraced by people who sought to leave a financial legacy to their heirs in a tax-efficient manner. This strategy allowed beneficiaries of an IRA to prolong the inherited funds by withdrawing only the required minimum distributions (RMDs) annually. This had the potential to leave a large sum within the IRA, enabling beneficiaries to enjoy the tax-deferred growth of inherited retirement funds over their lifetimes.

Death and taxes: The end of the stretch IRA

Unfortunately, the stretch IRA is no more. The passage of the SECURE Act in 2019 marked the end of the stretch IRA for account holders who passed away after December 31, 2019. The new regulation necessitates the full taxation of inherited IRA funds by the end of the 10th year following the death of the original account holder. When compared to the long-term benefits of the stretch IRA, this new rule felt like a significant reduction of flexibility.

For every rule, though, there is an exception. According to the SECURE Act, certain beneficiaries can bypass this forced depletion. Instead of withdrawing all the funds by the end of a decade, these "eligible designated beneficiaries" can use their life expectancy to calculate the amount to be withdrawn annually.

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Eligible designated beneficiaries include:

Beneficiaries who are disabled or chronically ill
Non-spouse beneficiaries who are no more than 10 years younger than the account owner who died
A biological or legally adopted child of the deceased, until they reach the age of 21. After that, the 10-year depletion rule applies

If you're not in one of those three categories, you may very well be forced to deplete an inherited IRA by the end of 10 years following the account holder's death.

Needless to say, the passage of this rule has significantly changed the financial planning landscape for IRA inheritors, especially for younger inheritors who could have benefited from an extended tax-deferral period.

How charitable remainder trusts work

However, not all is lost. Fortunately, there are strategies you can implement, with the help of an experienced financial adviser, that can emulate the power of the stretch IRA and the benefit it carried for your heirs.

One of those strategies is employing a charitable remainder trust (CRT) as the beneficiary of your IRA. This alternative setup offers a blend of charitable giving and tax benefits. Here's how it works:

First, you name a CRT as your IRA beneficiary
Upon your death, as the holder of the IRA, the assets pass to the CRT
The CRT, being a tax-exempt entity, allows the assets to continue to grow tax-deferred
Beneficiaries of the CRT receive income distributions over a specified term
After the term ends, the remaining funds go to a charitable beneficiary

Beneficiaries of a CRT receive income distributions from the trust over a specified term, reducing the immediate tax impact compared to what they'd see with a direct inheritance (or a mandated 10-year inheritance). This setup can be particularly advantageous for larger IRAs, where direct distributions might push beneficiaries into higher tax brackets.

Additionally, CRT terms can be arranged to be relatively flexible. Beneficiaries may have the ability to adjust the timing and size of distributions received from the trust. This flexibility allows beneficiaries to adapt their income stream as their needs change over time.

Considerations and caveats for CRTs

Leveraging CRTs in your estate planning strategy can certainly seem appealing. However, we need to look at both sides of the coin. There are three primary drawbacks to look out for when considering a CRT:

Complexity. It's not easy (or cheap) to establish and manage a CRT. Individuals considering this strategy need to consult with experienced financial advisers and estate planning professionals, pay legal fees and pay to maintain the trust over time. The total cost of a CRT can vary significantly, so it's important to consider every aspect.
Charitable commitment. Inherent in a CRT is the eventual transfer of the remainder of the assets to a charitable beneficiary. The CRT pays income to non-charitable beneficiaries for its term, but after that, the rest goes to charity. It's critical for individuals to carefully consider their philanthropic goals and select a charity that reflects their values and priorities.
Legal and tax implications. As we alluded to above, CRTs are subject to complex legal and tax regulations. Specifics can vary based on your jurisdiction, but no matter where you live, you must thoroughly understand the ramifications of establishing and administering a CRT.

Build your legacy with a charitable remainder trust

The death of the stretch IRA has birthed a new estate planning landscape. Using a charitable remainder trust as the beneficiary of your IRA presents a strategic opportunity that can offer tax benefits to your heirs while supporting a cause that's important to you.

Of course, it's essential to approach this strategy with careful consideration of the legal, financial and philanthropic implications. With proper guidance from experienced professionals, you can effectively leverage a CRT to augment your estate plan, ensuring a lasting impact for future generations.