Strategies for IRA Distributions to Family and Charity – Part III

Benefiting Children and Charity—IRA Testamentary Unitrust
IRA owners who want to use their IRAs to benefit both their children and their favorite charities at death might consider a testamentary unitrust funded with an IRA as a potential solution. With this option, the IRA owner transfers his or her IRA to a unitrust at death. Since the unitrust is tax exempt, no income tax is paid when the IRA is distributed to the trust. The full IRA value is invested and produces new income to family for one life, two lives or a term of up to 20 years. After all payments are made, the remainder is transferred to designated charities.

To ensure that the transfer of an IRA is effective at death, the IRA owner will need to complete an IRA beneficiary designation form naming the trustee of the unitrust as beneficiary of the IRA. The IRA owner should work with an advisor to create the necessary documents in accordance with state law. In most cases, IRAs represent 100% untaxed ordinary income and the entire IRA distribution will be allocated to the tier-one ordinary income layer of the unitrust for four-tier accounting purposes. Thus, distributions to the IRA owner’s children will be ordinary income. However, since the unitrust is tax exempt, the full value of the IRA will be available to earn new income for the children.

Example 3:

Barbara Jones is working with her advisor to put together her estate plan. She wants to use her IRA to leave a legacy gift to her favorite charity after she passes away but also wants to ensure that she provides something for her daughter, Danielle.

Barbara’s attorney assists her in creating an unfunded unitrust for her life plus a term of 20 years. Under state law, the unfunded trust is valid but will not be active until Barbara passes away. Barbara fills out a beneficiary designation form for her IRA naming the trustee of the unitrust as beneficiary (e.g., “To Jane Doe as trustee of the Barbara Jones Charitable Remainder Unitrust dated July 4, 2018”). The trust will receive the IRA after Barbara passes away, enabling the trust to make payments to Danielle for a period of 20 years. At the end of that time, the balance of the trust assets will be distributed to the charity.

Bequest of IRA to Charity
Since charities are exempt from income tax, they are able to receive IRA assets without having to pay income tax on the value received. In contrast, as discussed above, if a child inherits an IRA, the child will pay ordinary income tax on the entire distribution amount received. If donors with large IRAs desire to transfer an inheritance to children and leave a bequest to charity, a tax-effective method is to transfer part (or all) of an IRA to charity and leave non-IRD assets, such as cash, securities and real estate, to children.

If an IRA owner has a taxable estate, the IRA could be subjected to both estate tax and income tax. For example, the individual could pay estate tax on the IRA and the beneficiaries could be subject to income tax on the IRA proceeds. By designating a charitable organization as beneficiary of an IRA, the owner’s estate will receive a charitable estate tax deduction to help offset estate tax and the children will avoid paying income tax on the IRA.

Example 4:

Tina, a surviving spouse, has an IRA currently valued at $2 million. Because her estate is valued at $18 million, which is over the $11.2 million exemption amount, she anticipates that her estate will owe taxes when she passes away. She wants to provide for her children and her favorite charity in her estate plan. She sets up a meeting with her advisor, Dave, to talk about her options.

Dave suggests that Tina designate her favorite charity as beneficiary of her IRA and provide for the children by transferring them assets that will not be subject to income tax, such as her real estate holdings, stock portfolio and liquid assets. He explains that, by doing so, her estate will receive an estate tax deduction and the charity will be able to use the entire value of the IRA because it will not have to pay tax on the amount received. The children will receive the balance of her estate and can avoid the income tax that would have otherwise been due if they inherited the IRA. Tina moves forward with this cost-effective plan and is pleased that she is able to provide for her children and leave a legacy gift to her favorite charity.

If you would like to support a favorite Catholic church, school, or ministry through an IRA contact Scott Hartman (614-443-8893 or shartman@catholic-foundation.org) for additional details.