Putting the stretch back in your inherited IRA

Given all the turmoil in the world around us, you may have been distracted from some major developments in the world of personal finance. One of the biggest of these developments occurred on Jan. 1 as the SECURE Act officially became law. I’ve written about the SECURE Act before, but a recent conversation with Michael Jones, a local CPA and national IRA expert, highlighted an interesting idea that I think you should know about.

According to most experts, the SECURE Act will help millions of people gain access to retirement plans. This is a worthy goal, but it comes at a cost. Perhaps the biggest cost — and the one that has caused the greatest amount of grousing, including by yours truly — was the elimination of the so-called stretch IRA.

The stretch IRA allowed a person who inherited an IRA to stretch distributions from the inherited IRA over his or her lifetime. With the SECURE Act, all assets in IRAs that are inherited after Jan. 1, 2020 must be distributed within 10 years of the year in which the decedent passes.

There are no required minimum distributions during those 10 years, but the inherited IRA must be empty by the end of the 10th year.

Fortunately, there are some things you can do to put the stretch back in an inherited IRA. One strategy is to leave the IRA to a charitable remainder trust, or CRT, with your intended heir named as the CRT’s income beneficiary. Like an IRA, a CRT will provide your heir with an annual stream of taxable income for a given number of years or her lifetime. Then, when the trust expires, any remaining assets will pass to the trust’s designated charity.

There are two types of charitable remainder trusts. Unitrusts (referred to as CRUTs) pay a fixed percentage of the trust assets to the income beneficiary each year. Annuity trusts (known as CRATs) pay a fixed dollar amount to the income beneficiary each year. A CRUT works best for this strategy since it most directly mirrors the way a stretch IRA would work.

To qualify as a CRUT, a trust must follow very specific rules. For example, the payout rate for a CRUT must be between 5 and 50 percent. In addition, the payout must be set so that, at the time the assets are put into the CRUT, the expected value of the remainder interest is at least 10 percent of the contribution. Calculating the expected value of the remainder interest is beyond the scope of this column, but an experienced financial advisor and an attorney can help you set everything up properly.

This isn’t a free lunch. A CRUT is not going to pay your income beneficiary as much as a true stretch IRA would. However, if it is structured correctly, your heirs will probably do better with the CRUT than they will inheriting an

IRA with the 10-year rule.

You can also use the CRUT strategy if are on the receiving end of an inherited IRA. In this case, your best approach would be to leave the inherited IRA in place until the end of the 10-year window. Before the end of the 10th year, create a CRUT and contribute the IRA to it.

Remember that CRUTs are irrevocable trusts. Once they are created, they are very difficult to change and once assets are contributed to them, those assets are no longer yours. Before you try to implement this strategy, work with a qualified advisor to help make sure you understand exactly what you are trying to accomplish. You can then communicate your desires to an experienced attorney who can draft the appropriate documents.