The SECURE Act repeals the stretch IRA beneficiary payouts and changes the time from life expectancy to 10 years. What plan could replace the former stretch IRA distribution? Could a plan combine the tax-saving benefits of a stretch IRA with a term-of-years or life payout to children or other heirs? Could this plan also have the tax-free growth benefit of a stretch IRA? While it sounds too good to be true, the IRA to testamentary unitrust plan includes all of these benefits.
The SECURE Act reduces future taxes for IRA owners by increasing the age for required minimum distributions from 70½ to 72. However, to pay for the cost of this tax reduction, the taxes paid by future nonspouse IRA beneficiaries (typically children) will increase.
Married couples usually designate the survivor as their IRA or other qualified plan beneficiary. The survivor may roll over the plan into his or her IRA. However, when a single person or surviving spouse passes away, the IRA is transferred to one or more nonspouse designated beneficiaries. If there is a charitable beneficiary, that portion of the IRA is normally distributed in full to the nonprofit. However, distributions to children, nephews, nieces and other family members may be made over a term of years.
For individuals who passed away in 2019, an IRA beneficiary was able to “stretch” the IRA payout over his or her life expectancy. Assume mother Mary owns a traditional IRA and passed away in 2019 at age 90. She designated daughter Susan (age 60) as her IRA beneficiary and Susan could take distributions over her life expectancy. For a child age 60, the potential distribution period was between age 60 and age 87. By “stretching” the traditional IRA payout, Susan reduced her income tax and benefitted from tax-free growth for many years. Yet, even more tax deferral and growth was possible. A grandchild designated beneficiary may have stretched the tax-free growth and IRA payouts over 60 or 70 years.
However, if Mary passed away in 2020, Susan must take all distributions within ten years. She can wait and take the full payout in the tenth year, but that will greatly increase the tax rate paid on the IRA. Most children will choose to take partial payouts each year for the ten years. With a ten-year payout, the income taxes paid by Susan will be substantially higher than the prior “stretch” plan.
What plan could replace the 2019 “stretch” IRA distribution? Could a plan combine the tax-saving benefits of a stretch IRA with a term-of-years or life payout to children or other heirs? Could this plan also have the tax-free growth benefit of a stretch IRA?
While it sounds too good to be true, the IRA to testamentary unitrust plan includes all of these benefits. A single person or surviving spouse may create an unfunded lifetime unitrust or testamentary unitrust in a will or living trust. The IRA beneficiary designation is to the trustee of that unitrust. When the IRA owner passes away, the unitrust is funded with the traditional IRA. Because the unitrust is tax-exempt, there is a bypass of the income tax on the traditional IRA and any future growth.
Fund a Testamentary Term Unitrust and Benefit your Favorite Charity
Sam and Anna Jones raised four children. Sam passed away last year and Anna rolled over Sam’s IRA into her own IRA. She now has an estate of $1.6 million. $800,000 is in her IRA and the estate balance is in her home, CDs and mutual funds.
Anna signs a one-life plus term of 20 years unitrust. She and Sam have always supported a local charity, and Anna would like to benefit her four children and the charity. She changes the beneficiary designation of the IRA to the trustee of the unitrust. When Anna passes away, the $800,000 IRA is transferred to the 5% payout unitrust, saving all of the income tax on the IRA. It is invested for a term of 20 years and pays out over $800,000 to the children during that time. After the 20 years, approximately $1 million will be distributed to Anna’s favorite charity.
Each of the four children will receive $200,000 from the balance of the estate. Over a period of 20 years, each child will also receive $200,000 of income. Anna especially likes the way the plan is balanced. Each child receives principal when she passes away and then income for a term of years. Anna believes that this is a desirable plan for the children and a $1 million future gift from the trust remainder will help her favorite charity.
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