The SECURE Act dramatically reduced the deferral period of retirement plan benefits for a non-spousal beneficiary from their lifetime to 10 years. All benefits must be paid at the end of 10 years from the date of death of the account owner. However, no distributions are required until the 10th year; therefore, the beneficiary, if so inclined, could continue deferral for 10 years less a day.
For a donor with meaningful charitable intent, a testamentary charitable remainder trust (CRT) might make sense as a deferral mechanism. There will be a federal estate tax charitable deduction for the value of the remainder interest. Payments from the CRT to the non-charitable recipient most likely will be taxed as ordinary income under the tier accounting rules because the IRA is considered income in respect of a decedent (IRD).
Another option could be a testamentary charitable gift annuity. The estate tax charitable deduction is allowed for the charitable gift annuity if the decedent’s will defines the amount of the annuity to be paid*.
Most testamentary charitable gift annuities will be funded with cash or assets that have received a stepped-up basis to fair market value at date of death. What would be the income tax consequences to the charity, estate and annuitant if funded with an IRD item, like an IRA or qualified plan benefit? Interestingly, a private letter ruling left the question unanswered as to whether a portion of the annuity payments would be considered a tax-free principal.
In Private Letter Ruling 200230018 (April 22, 2002), the IRS approved an arrangement where the taxpayer would fund a charitable gift annuity by naming the charity as the beneficiary of her IRA. The charity would pay a third party an annuity over his life, beginning at the death of the taxpayer. The IRS made the following determinations:
- The charity’s exempt status would not be adversely affected by the arrangement, and the charity would not recognize unrelated business taxable income.
- The value of the IRA at the taxpayer’s death would be includable in the taxpayer’s gross estate.
- An estate tax charitable deduction would be allowed, equal to the value of the IRA on the taxpayer’s date of death less the present value of the annuity as of the taxpayer’s date of death.
- The proceeds of the IRA would be considered income in respect of a decedent to the charity and not to the taxpayer’s estate.
The taxpayer also sought a determination that the annuity payments should have a tax-free basis. Specifically, it requested the IRS to determine that annuitant’s “investment in the contract” equals to the IRA proceeds transferred to the charity in exchange for the annuity less the estate tax charitable contribution deduction. The IRS refused to answer since the taxpayer and annuitant were both alive.
What is the result? Read my upcoming blog to find out! I will also discuss the comparative merits and disadvantages of the testamentary charitable remainder trust and gift annuity as a way of creating a charitable-stretch IRA.
By Professor Chris Woehrle, Chair & Professor of Tax & Estate Planning Department, College for Financial Planning, Centennial, Colorado
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* See IRC 2055(e)(2)(A); Reg. 2055-2(e)(1). ↵
