Charitable remainder trusts as IRA beneficiaries.

• Author: Baptise, Philip J.

Individual retirement accounts (IRAs) in large estates are subject to very onerous tax rates. It is not uncommon for taxes to deplete 85% or more of an IRA on the death of its owner if the assets are required to be distributed quickly (e.g., if the assets are needed to pay estate taxes or beneficiary designations or other IRA distribution planning has gone awry). The IRA may be subject to Federal and state income taxes, Federal and state estate taxes and the excise tax on excess accumulations.

As a result of this high effective tax rate, individuals receiving IRA distributions who have elected to recalculated life expectancy with their spouses as beneficiaries face a difficult problem if the nonparticipant spouse predeceases the participant. The new IRA recipient, who may be a newly designated beneficiary, will be forced to pay tax on the entire IRA balance within one year of the surviving spouse's death. A similar problem exists for nonspouse IRA beneficiaries when the IRA is not in pay status at death. These beneficiaries are required to liquidate their ERAs within five years of the participant's dead.

The impact of these taxes in situations in which the beneficiary cannot continue to defer income taxes is illustrated in the following example.

Example 1: J, a single individual residing in California, died during December 1995 with a $2,000,000 IRA. The IRA is part of her $5,000,000 taxable estate. J left her entire estate to her only child, B. B is required to withdraw all of the IRA funds immediately. B receives only $295,251 of the $2,000,000 IRA:

IRA balance $2,000,000 Less: Federal and state income taxes (571,677) Estate taxes (at 55% rate) (1,015,578) Excise tax on excess accumulation (153,494) Net to B $ 259,251

One alternative available to individuals who wish to continue the tax deferral is to name a remainder trust (CRT) as the IRA beneficiary. A CRT is a trust that provides income to a beneficiary or beneficiaries for life or a term of years not exceeding 20 years, with the remainder going to a qualified charity. The CRT is exempt from income tax and the donor receives a charitable deduction for the value of the remainder interest. The use of a CRT as an IRA beneficiary can be illustrated in the following example:

Example 2: J, from Example 1, named a charitable remainder unitrust (CRUT) as the beneficiary of her IRA. The CRUT provided that it would pay 9% of its value to B (age 45) for life. On J's death, the CRUT will receive...