1. The SECURE Act – Elimination of the “Stretch” IRA

Inherited retirement account distributions must now be taken within 10 years and the holder can no longer stretch out the withdrawals and required tax payments on each distribution over the beneficiary’s life expectancy. Thus, the annual amounts payable to heirs who inherit the IRA will be larger and the tax costs greater.

For those who wish to leave retirement plan assets to children, there are exceptions to the elimination of the stretch IRA inherited beneficiary rules:

• surviving spouse of original owner
• minor child (not grandchild) of original owner (10-year term applies once the child reaches majority)
• less than 10 years younger than original owner
• disabled/chronically ill (as defined)

Given the elimination of the “Stretch” IRA, a charitable remainder trust (CRT) ought to be considered. The IRA/401(k) assets would be transferred to the trust after the owner’s lifetime. Annual lifetime annuity amounts will be made payable to beneficiaries at a qualified fixed lifetime/s rate. Payments will be taxed to the beneficiaries annually. Some of the annual payments may be tax preferred.

If exceptions do not apply, a charitable remainder trust can expand the payment term beyond the 10-year term and provide estate and tax planning benefits.

A CRT is an irrevocable, tax-exempt entity that provides fixed rate payments for the life or lives of named individuals. Alternatively, some CRTs may run for a term of years not to exceed twenty. One of the advantages in funding a CRT with highly appreciated property is the avoidance of taxable gains at the time of contribution.  The withdrawal and distribution of qualified plan assets to a CRT would not be susceptible to capital gains tax.

There are two types of CRTs. One, a charitable remainder annuity trust (CRAT), determines lifetime annual payments to individual beneficiaries based upon the fixed rate set out in the trust multiplied by the value of the assets transferred to the trust. Thus, if the value of the transfer from the IRA after the owner’s lifetime is $1 million and the rate is fixed at 6%, the CRAT will make annual payments in the amount of $60,000 throughout its term. These payments are not adjusted. They are fixed for the life/lives of the individual beneficiaries.

The other, a charitable remainder unitrust (CRUT) has a feature that allows for the annual adjustment of payments to the individual beneficiaries. By law, the trust assets are revalued at the close of the calendar year (or early into the next year); and the revaluation amount is multiplied by the trust’s fixed rate to determine the succeeding year’s payments. If the trust investment returns for the year are greater than the required payout, the excess is added to trust principal and is included in the revaluation. Thus, if the trust is initially funded from the IRA at $1 million, and the unitrust rate is fixed at 7%, the payments for the first year (or a proration for the first year) would be $70,000.  Assuming at the end of the year that the trust, after making its payments for that year, is revalued at $1.2 million, the payments to the individual beneficiaries for the immediately succeeding year would be $84,000 (7% of $1.2 million). It is important to recognize that there may be an annual revaluation that is lower than the entry value of the trust for the prior year, making payments for the next succeeding year lower than the preceding year. It is anticipated that the trust will keep pace with inflation.

How is this accomplished?

The CRT may be established by directions in the owner’s will or trust or as an unfunded trust established during the owner’s lifetime, which will become effective once the retirement distributions are received by the trustee. Either by direct beneficiary designation in the plan documents or by way of a distribution from the will or trust of the owner, a CRT will receive the assets in the plan after the owner’s lifetime.

The challenge is fixing a rate for the CRAT or CRUT. Language would be needed to set out a formula to determine the rate at the time the trust will be funded (i.e., as of the end of the owner’s lifetime). At present, there are IRS tests that have to be met in order to fix a rate.

• The rate cannot be lower than 5%
• A CRAT must pass two tests:

1. The 10% test – the present value of the charitable portion of the CRAT must be equal to or greater than 10% of the amount of the contribution to the trust
2. The 5% probability test – there cannot be a probability greater than 5% that the trust will run out of funds before its term ends

• A CRUT must only pass the 10% test. A CRUT can never mathematically run out of funds because it adjusts each year based on the revalued asset value.

What we cannot know until the end of the owner’s lifetime—and what substantially impacts the rate that can be fixed—is the IRS 7520 rate (known as the monthly Applicable Federal Rate) that influences the calculation and can change from month to month. We cannot know what month the trust will receive funding from the IRA until the end of the lifetime of the owner.

There will undoubtedly be a variety of planning possibilities to solve for the elimination of the stretch IRA. The use of a CRT has been applicable in estate planning even before the stretch elimination. Given the elimination of the stretch IRA, it is even more applicable for certain families now.

With a CRT, the remainder interest (i.e., the amount in the trust when it ends) is paid over to named charitable organizations either without restrictions as to use or designated for a particular program or purpose.   A remainder provision may require that the distribution be endowed.  AFHU may be named as the remainder beneficiary of a CRT.

A triumvirate of federal acts starting in 2020 have impacted tax laws relating to income tax and estate tax planning. This series of legislative acts, the SECURE Act (SA) (described above), the CARES Act (CA), and the Consolidated Appropriations Act of 2021 (CAA), have put in place a number of provisions that will affect charitable giving and tax planning well into 2021.

1. The CARES Act (CA) & Consolidated Appropriations Act (CAA)

Charitable deductions for non-itemizers –

• The CA provided for a deduction of up to $300 for individual or joint filers for certain cash gifts to charities in 2020.

• The CAA expands the deduction to $300 for individual taxpayers and $600 for joint filers in 2021.

Charitable deductions for itemizers –

• The CA expanded the deduction of certain cash gifts to public charities in an amount up to 100% of adjusted gross income (AGI). This was a considerable increase over previous rules that allowed for deductions for cash gifts in an amount up to 60% of AGI.

• The CAA continues the 100% of AGI deduction for 2021.

• The carryover provisions still apply for unused contribution deductions in 2021.

• Expect clarifications and technical corrections in 2021.

• Wealth Transfers: Estate Tax Overhaul

President Biden has proposed overhauling taxes around wealth transfers, including:

• Eliminating the step-up in basis, which allows heirs to receive assets valued as of the date of death. Instead, any unrealized capital gains would be subject to tax.

• Reducing the amount that an individual can transfer free of estate and gift taxes from $11.7 million (in 2021) to $3.5 million in transfers at death and $1 million in lifetime gifts; and an increased maximum estate/gift tax rate of at least 40%.

PLANNING CONSIDERATIONS:

• High net worth families may want to apply the current unified gift and estate tax credit ($11.7 M) during 2021. No “claw back” is anticipated if the credit is subsequently reduced.

The provisions discussed which are contained in legislation enacted for 2020 and 2021 are part of an initiative for tax revision and a support for charitable giving.  Partnering with charity may prove to be of significant benefit for taxpayers going forward, particularly if they are interested not only in tax savings but also in the importance of philanthropy.  AFHU would be pleased to partner with you and to provide you with planning ideas to review with your legal, tax and investment advisors.

For more information, please contact [email protected].