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Case Study: Increasing An IRA’s Value With A CRUT

$30 trillion will pass from Baby Boomers to Millennials over the next decade. Of that staggering amount of money, about one-third — $10.3 trillion — is held in Individual Retirement Accounts (IRAs). As these two generations work together to transfer this wealth, they will be up against an unfortunate reality: one of the best tools for efficiently passing on IRA assets, the Stretch IRA, was eliminated by Congress in 2020.

So what to do? The Stretch IRA may be a thing of the past, but another structure with similar benefits has taken its place, the Charitable Remainder Trust (CRT). CRTs have become the go-to replacement for the Stretch IRA.  Indeed, using a Lifetime NIMCRUT can help you earn 90% or more from a gifted or inherited IRA than if you had otherwise done no planning. In this post, we’ll walk through a case study, drawn from our real-world experience, to help illustrate the benefits (and, of course, the tradeoffs) of using a CRT as a a beneficiary for an inherited IRA.

Before we walk through an example, here some quick context of how Stretch IRA’s were used before they were banned in 2020.

Stretch IRA

While Stretch IRAs were allowed, inheriting an IRA would often involve a parent’s IRA rolling over into the children’s, and the kids could therefore continue allowing the assets to grow tax deferred until they were 59.5, when they would be required to start taking distributions. The assets would grow faster inside of the IRA because of its tax exempt structure.

As a result of the 2020 SECURE Act, however, those rules changed, with two major implications.

  • Beneficiaries other than your spouse — kids and grandkids, for example — now have to withdraw all inherited IRA assets within 10 years of the IRA owner’s death (or pay a 50% penalty).
  • Those forced distributions are taxed at ordinary income tax rates instead of the lower capital gains rates.

Now let’s walk through how a real-life example of how a family in California is dealing with their IRA.

An Example

Rocky and Ellie are 74 and 71 and live in Marin. They’ve saved diligently over the years, and they have accumulated $3.4 million in an IRA. They no longer need that money — they have more than enough to cover their expenses in retirement — so they’re planning to pass that money on to their only child, Adam, who is 41.

Adam also lives in California, and he’s fortunate to have a steady job and sufficient savings, so he doesn’t need the IRA money right away.

Rocky, Ellie and Adam’s key question is how can they pass the funds in their IRA to Adam, enabling him to maximize the value of the gift over his (and his own family’s) lifetime?

Replacing the Stretch IRA with a Charitable Remainder Trust

Since the passage of the Secure Act, recipients of gifted IRAs like Adam have been tightly constrained: they have to withdraw all IRA assets within 10 years of their parents’ passing, and they pay ordinary income taxes (that is, the highest rates) on those distributions.

Based on his California tax rate, Adam would withdraw the entire IRA amount upfront and he’ll owe the government about $1.7m (out of the $3.4m IRA value) on account of the combination of federal and California’s (extraordinarily high) ordinary income taxes.

That number is so big it drastically alters Adam’s financial plans.

Fortunately, there’s a better way: By setting up a Charitable Remainder Trust — specifically, a lifetime NIMCRUT that runs for the length of his and his partner’s lives — Adam can mimic the benefits of the Stretch IRA, including the extended withdrawal schedule and deferred tax treatment.

Lifetime Decision

A quick refresher on Net Income with Make-up Charitable Remainder Unitrust (NIMCRUTs) before we jump into the numbers:

A NIMCRUT is a Charitable Remainder Trust that allows the grantor to defer the taxes on a big income event for as long as his or her entire lifetime (or even longer), take annual income distributions when needed, and leave a large sum to a chosen charity.

NIMCRUTs are a species of CRUT. Unlike Standard CRUTs, which includes a required annual distribution, NIMCRUTs allow the beneficiary to elect (with some constraints) to receive some or all of that distribution in a given year. And any amount not withdrawn rolls over to future years.

So how can Adam and his parents use a NIMCRUT to maximize the value of the family’s IRA?

Recapping the numbers

  • Adam’s parents’ IRA is worth $3,400,000 when they pass away.
  • If Adam withdraws the IRA funds immediately, he’ll pay $1.7 million of taxes up front and have $1.7 million left over to invest. That $1.7 million invested over his life would earn him $5.2 million after estimated taxes.

Planning

If, instead, Adam’s parents rolled their IRA into a Charitable Remainder Trust when they pass away and Adam defers his distributions for a few years, he’ll pay zero taxes up front and earn about $10 million after taxes over his lifetime, that’s an additional return of 90% over the $5.2 million he could have expected if he had simply inherited his parents’ IRA.

Understanding the benefits of an IRA-to-CRUT-rollover

Adam could earn an additional $4.8 million in absolute dollars if his parents simply move their IRA into a CRUT before they give it to him. But why does this strategy work so well?

Deferring taxes beyond 10 years

If Adam received the IRA proceeds directly without a trust, he would be required to pay 50% taxes on the IRA money within the first ten years. With a lifetime NIMCRUT, by contrast, Adam can effectively control when he receives most of his distributions and, as a result, he can defer the taxes on those distributions well beyond 10 years. So instead of paying $1.7 million in taxes up front when he inherits the IRA and only having $1.7 million of the IRA money left to invest, he is able to keep the entire $3.4 million invested and growing, for more than 10 years — and as long as his entire life, or even his life plus some time afterward for his children.

From there, the power of compounding kicks in. By preserving the additional $1.7 million upfront and reinvesting it, Adam is able to create an additional $4.8 million over the length of the trust (even after his own periodic withdrawals).

Lower Tax Rate on Investment Gains

A less-discussed but significant consequence of the elimination of the Stretch IRA has to do with another set of taxes — not the taxes Adam has to pay on the money his parents left him via their IRA, but the taxes he’ll owe on any gains he earns from reinvesting that money.

If Adam’s parents pass their IRA on to him without additional planning, Adam will owe ordinary income taxes on the initial $3.4 million, but he’ll also owe ordinary income taxes on any gains he earns while those assets are kept in the IRA.

If his parents put their IRA into a CRUT, instead, Adam would still pay ordinary income tax on the initial $3.4m gift — though those taxes can be deferred out further — but, critically, he would pay long-term capital gains taxes on any investment earnings he captures from deploying those funds after he inherits them.

That’s a significant benefit; instead of paying around 50% in taxes on his investment gains for the first ten years — until he cashes out the IRA — Adam would pay around 35%. That could be a difference of hundreds of thousands or even millions of dollars, just due to the reduced tax rate.

Available Withdrawals

We’re starting to see the numbers take shape, but there’s one more significant data point we haven’t gotten to yet: How does Adam plan to use his money?

One of the first questions our customers ask us is the following: “These massive absolute gains are great, but will my money be locked up for the entire term of the trust?” The answer, emphatically, is “No.” There are many ways to get liquidity out of a CRT, and we discuss them in some depth here But the simplest answer is that, due to the structure of NIMCRUTs, Adam (and you) will have access to a growing share of the money every year.

If he uses a trust, Adam will be owed around 5% of the trust’s value every year. That amount will accumulate until it is distributed. In 5 years, for instance, Adam could accumulate as much as $1 million in deferred distributions — 5% of the $3.4 million ($170,000) in the first year, and 5% of the trust’s total value, after appreciation, every year after that.

Total Returns

What would all of these tax savings, investment gains, and withdrawals mean for Adam’s bottom line? Adam’s trust is expected to last around 50 years. With a lifetime NIMCRUT, Adam could earn an additional $4.8 million in payouts, for a total of about $10m. If, instead, Adam had withdrawn the money from the IRA, assuming the same withdrawal schedule, he would have ended up with about $5.2 million over the course of his life. That additional 92% return is the essence of the power of using a Charitable Remainder Trusts to rollover an IRA between generations.

ira case study
IRA Case Study

Next Steps

We’ve prepared a comprehensive guide on gifting your IRA to help you out in the process of growing your capital gains! You can also try our CRT calculator to evaluate the potential return on investment given your situation, or you can contact us for a meeting.

About Valur

We have built a platform to give everyone access to the tax planning tools of the ultra-rich like Mark Zuckerberg (Facebook founder), Phil Knight (Nike founder) and others. Valur makes it simple and seamless for our customers to utilize the tax advantaged structures that are otherwise expensive and inaccessible to build their wealth more efficiently. From picking the best strategy to taking care of all the setup and ongoing overhead, we make take care of it and make it easy.