Establishing Charitable Trusts in Estate Plans: Part 1 — Case Study

If your estate is worth millions, minimizing the cut you will have to give to the IRS upon your death is likely a big component of your planning. In this two-part post, we will discuss the effect that incorporating a charitable trust has on your overall estate plan. This strategy could provide a stable, protected and higher source of income for your survivors than passing your assets to them in your will.

To see exactly how this works, let us take a look at a hypothetical scenario.

Charles and Maddie

Charles is a data architect in his 50s, earns a salary a good salary and has an IRA that is currently worth $12 million. About 20 years ago, he underwent a contentious divorce that was especially traumatic for his daughter, Maddie. Eight years old at the time, she began having behavioral and mental health problems that continue to this day.

Now in her late 20s, Maddie is mostly independent but often struggles to cope with her life. She has an art degree and a long history of short-term, entry-level jobs to make ends meet while she labors to get her artwork featured in a gallery. She lives paycheck to paycheck on an average of $21,000 a year. Charles regularly deposits cash into her bank account when he thinks she is past due on her rent and utilities.

Anticipating Future Pitfalls

After Charles received a diagnosis of heart disease, he began worrying about Maddie’s financial future should he die young. He knows there will be means to supplement her income for a time, at least. Yet, even if she does manage to break into the art world and become successful, he is not sure that would solve her financial problems.

For starters, Maddie has trouble holding down jobs and manages her money poorly. Furthermore, she still suffers from damaging depressive episodes. As a result, she often loses her current job and engages in unhealthy behavior, like uncontrolled spending and drug use. The relationship that she has with her mother also concerns him. He knows his ex-wife to be selfish and spiteful and able to manipulate Maggie easily, especially when she is going through a period of emotional instability.

In essence, Charles is afraid that any money he leaves for Maddie will be gone quickly. He also believes that she will not have the resources or the ability to maintain a decent standard of living afterward.

Discovering Estate Planning Obstacles

Charles’ outlook continued to worsen as he started researching living wills and estate plans. He had always believed that any money left to his immediate family would pass without incurring estate taxes. Unfortunately, he discovered that this is only the case when the heir is a spouse. If Charles were to bequeath his IRA to her as it stands, the IRS would take a high amount in taxes.

On top of all that, the Setting Every Community Up for Retirement Enhancement Act went into effect on Jan. 1, 2020. Included among the retirement reforms in the SECURE Act is a significant change to the IRA distribution rules for beneficiaries other than spouses. Before, the law allowed recipients to stretch out the IRA distributions according to their life expectancy. Under the new statutes, Maddie would have to take the entire $600,000 distribution within 10 years. This could lead to significant short-term income tax obligations. Moreover, it could be detrimental to her well-being. A flood of cash could intensify Maddie’s turbulent lifestyle and enable risky habits.

Learn More

Are you interested in learning more about how to manage your money now and far into the future? Contact us today or browse our online resources for tax strategies and estate planning.

Read “Establishing Charitable Trusts in Estate Plans: Part 2 — Case Study”