Establishing Charitable Trusts in Estate Plans: Part 2 — Strategic Solutions

In Part 1, Charles and Maddie’s story illustrated how life and politics can make a father’s desire to provide for his daughter much harder than it should be. While not ultra-wealthy by any standard, Charles has enough retirement savings that he should be able to structure supplemental income for Maddie for many years should he succumb to heart disease complications or any other premature death.

Instead, he worries about unfettered access to massive distributions from his $12 million IRA after taxes cut its value nearly in half. Maddie’s erratic lifestyle warns that she may not handle an income increase responsibly. Worse, she may not have the discipline to pay the annual income tax bill.

Depression and other mental health issues tend to be lifelong struggles. Yet, Maddie’s case probably will not qualify for a chronic-illness exemption from the SECURE Act’s 10-year retirement distribution rule.

Finally, Charles cannot imagine what would happen to her quality of life when, after 10 years of money distributions, the money stops coming in: Will she be living in housing that she can no longer afford? Will she accumulate massive debt while trying to maintain her new high living standard? Will Maddie’s mom feel that the money should be hers and try to take advantage?

Does he know that there is an estate planning solution that could address each issue?

Understanding Charitable Remainder Trusts

Charles does not have to name Maddie as the recipient of his retirement account. He could establish a charitable remainder trust and make it the beneficiary upon his death. This will provide him with several financial benefits:

  • The CRT protects the IRA from estate taxes.
  • Charles can structure the distributions (within reason) to keep the income tax percentage low.
  • The trust is irrevocable; no one can interfere with its course.
  • The trust cannot be seized by third-parties such as creditors or lawsuits.
  • Charles can place restrictions on Maddie’s use of trust distributions.

At least 10% of the original principal should remain after Maddie dies, at which time it must go to a qualifying charity. That still leaves the vast majority payable for either a fixed term or the rest of Maddie’s life.

Improving the Financial Outlook

Already, Charles’ situation looks better.

Using a CRT as part of his estate planning strategy, he avoids hefty income taxes when the IRA pays out to the CRT. Therefore the funds may last longer to provide for his daughters needs. A CRT addresses both of the issues stemming from the 10-year distribution rule: the large distributions and tax burden. He can structure the payouts both to keep her trust income at a supplemental level and help her avoid soaring income taxes. A study shows that Maddie’s depression and risky behavior may account for a shortened life expectancy. If Charles chooses a life income beneficiary term, it is reasonable to assume that she will have annual trust distributions for about 40 years. As long as she keeps her gross employment salary under $18,000, she can stay in the 12% tax bracket.  This would provide for a decent standard of living while allowing her the time and freedom to pursue her art career.

Charles can continue easing his anxiety by removing the potential for Maddie (or her mother, for that matter) to misuse the money. As with most trusts, he can place stipulations that only allow her to spend the money on certain things, such as education or art supplies. Furthermore, he could instruct the trustee to distribute the funds directly to the party responsible for her housing, living expenses and even to the IRS as he sees fit.

Finally, it is a charitable trust, after all. Charles can designate the remainder of the trust to a charity close to his and Maddie’s heart. This could be a museum foundation or a mental health awareness campaign.

How a CRT Can Work for You

Charles and Maddie’s situation is a grossly oversimplified example. Still, it shows that the tax benefits of charitable remainder trust can make it a preferable alternative to simply naming recipients in a will.

Plus, how you set up your CRT depends significantly upon your goals. If you are an active philanthropist, there is nothing to stop you from leaving a higher percentage of the principal to your favorite charities.

If your primary goal is to sidestep capital gains taxes rather than donate to charity, investigate your other options with our side-by-side feature comparison of a charitable remainder trust and a deferred sales trust.