This letter is part of a series on cash balance retirement plans, one of the best strategies to help high-earning Americans reduce taxes and accelerate their retirement savings. Since the loosening of IRS restrictions in recent years, cash balance plans have become extremely popular and only continue to grow, commanding over $1 trillion in assets. Adding a cash balance plan on top of a 401(k) profit-sharing plan can generate hundreds of thousands of dollars in annual tax savings. Cash balance plans are without a doubt one of the best above-the-line tax deductions available today. By increasing deductions by thousands—or hundreds of thousands—of dollars, they have the potential to massively reduce tax burdens for wealthy Americans. But how do you know if a cash balance plan might be right for you or your business? Individuals or businesses with the highest likelihood of benefiting from a cash balance plan include: Professionals with high incomes A large majority of cash balance plans are held in professional practices, with doctors’ and dentists’ offices alone accounting for 37 percent of all existing cash balance plans. The high contribution limits, ability to accelerate retirement savings (particularly helpful for those who began their careers with substantial education debt), and flexibility for multi-partner firms all make cash balance plans an appealing option for professional practices. Business owners over 45 or who want to aggressively expand their retirement savings Over fifty percent of Americans are not on track to meet their retirement needs, a staggering figure. For many people, saving for retirement is simply not a top priority. Business owners in particular, often spend their lives funneling money back into their businesses and neglect their retirement accounts. By the time they reach their forties, they’re stuck trying to catch up to their savings goals. With the high contribution limits of cash balance plans, catching up on retirement savings becomes much simpler (and brings some excellent tax savings to boot). Highly-profitable companies For any successful business, attracting and hiring the top talent is crucial. Having a cash balance plan in your business’s retirement options sets you apart from the competitors and is an excellent draw for potential employees. The significant tax deductions that a cash balance plan brings also help businesses to maintain a healthy bottom line. Many people, of course, don’t fit into any of these categories and still reap excellent benefits from a cash balance plan. The best way to find out whether a cash balance plan might be right for you is to discuss your options with your financial advisor. The potential benefits might blow you away.
This letter is part of a series on cash balance retirement plans, one of the best strategies to help high-earning Americans reduce taxes and accelerate their retirement savings. Since the loosening of IRS restrictions in recent years, cash balance plans have become extremely popular and only continue to grow, commanding over $1 trillion in assets. Adding a cash balance plan on top of a 401(k) profit-sharing plan can generate hundreds of thousands of dollars in annual tax savings. The Pension Protection Act of 2006 established the cash balance plan as a viable and legally recognized retirement savings option. Before 2006, cash balance plans faced frequent legal challenges. Those bringing the lawsuits argued that cash balance plans violated the rules for benefit accrual and discriminated against older workers. The rulings on these cases were inconsistent, and many business owners didn’t want to risk establishing a plan that simply didn’t have firm legal footing. The Pension Protection Act ended this legal uncertainty and set a few specific requirements for cash balance plans, including: • Clarification on age discrimination claims: A cash balance plan does not violate age discrimination legislation if the account balance of an older employee is equal to or greater than that of a similarly situated younger employee (i.e. with the same length of employment, pay, job title, date of hire, and work history). • A vesting requirement: Any employee who has worked for their company for at least three years must be 100% vested in their accrued benefits from employer contributions. • A change in the calculation of lump sum payments: Participants can usually choose to receive a lump sum upon retirement or termination of employment instead of receiving monthly payments. Before 2006, some plans used one interest rate to calculate the anticipated account balance upon retirement but, if a participant opted to receive a lump sum, used a different interest rate to discount the anticipated retirement balance back to the date of the lump sum payment. This led to discrepancies between the hypothetical balance of the account and the actual lump sum payout, an effect known as “whipsaw”. The Pension Protection Act eliminated the whipsaw effect. There are, of course, many other points included in this lengthy piece of legislation, but the takeaway is this: The Pension Protection Act of 2006 removed the legal uncertainty surrounding cash balance plans and made them a much more appealing option for small business owners. According to Kravitz Inc., the number of cash balance plans in America more than tripled after the implementation of the Pension Protection Act. Additional regulations in 2010 and 2014 made these hybrid plans an even better option, and their popularity only continues to grow. There are thousands of highearning business owners who can reap huge, tax-crushing benefits from implementing cash balance plans . . . you just have to know about them first. The most valuable tax deductions are above-the-line deductions that reduce earned income dollar for dollar. These deductions have the exceptional effect of being able to move the taxpayer into a lower tax bracket, thereby significantly increasing his or her tax savings. With combined federal and state income tax rates at around 45% for top earners, finding and taking advantage of the right deductions becomes more important than ever. Cash balance plans provide this kind of dollar for dollar deduction, making them invaluable for many Cash Balance Advisors clients. Cash balance plans belong to the group of “qualified plans” described in Section 401(a) of the Tax Code that hold a tax favored status with the IRS. Most tax advisors strongly recommend that qualified plan options be fully funded before pursuing other tax strategies, as they provide some of the most comprehensive and powerful tax benefits in existence. With a cash balance plan, you have the added benefit of saving not only on the contribution amount, but also on the subsequent earnings generated by the contributions. As an example: a contribution of $130,000 that earns 5% for 30 years would be worth $561,852 at the end of that time. However, if that contribution were taxed at the highest tax rate and the 5% earnings each year were also taxed, the value after 30 years would be only $162,937—clearly a less desirable amount than the first number. Ultimately, these numbers show what I say all the time: cash balance plans are one of the best options for high earners looking to protect their income and grow their retirement savings and should certainly be investigated.
This letter is part of a series on cash balance retirement plans, one of the best strategies to help high-earning Americans reduce taxes and accelerate their retirement savings. Since the loosening of IRS restrictions in recent years, cash balance plans have become extremely popular and only continue to grow, commanding over $1 trillion in assets. Adding a cash balance plan on top of a 401(k) profit-sharing plan can generate hundreds of thousands of dollars in annual tax savings. Despite the explosive growth and substantial tax benefits of cash balance plans, most Americans are unfamiliar with one of the best tax-deferred savings opportunities in existence. When combined with a 401(k) profit-sharing plan, cash balance plans substantially increase the contribution limits for retirement plans, sometimes increasing available top-line deductions by over 400%. This means that participants, particularly older contributors, can accelerate their retirement savings and simultaneously take advantage of significant tax savings. Cash balance plans are classified as “hybrid” retirement plans: defined benefit plans (think traditional pension plan) that function like defined contribution plans (think 401(k)). Like a defined benefit plan, the ultimate benefit received is a fixed amount, independent of investment performance. The plan sponsor directs investments and ultimately bears investment risk. What sets a cash balance plan apart, though, is its flexibility and hybrid nature that makes its function appear similar to that of a 401(k). When businesses choose to add a cash balance plan, they generally do so on top of an existing 401(k) profit-sharing plan. This allows high-earning employees to put away more money for retirement at a much faster rate while providing significant tax savings. Those who stand to benefit the most from a cash balance plan include: • Professionals with high incomes such as doctors, engineers, lawyers, orthodontists, etc. • Business owners over 45 looking to substantially increase their retirement savings in the coming years • Highly-profitable companies • Business owners wanting to contribute more than the traditional 401(k) limits to their retirement while accruing substantial tax savings For Americans earning over $400,000 per year, cash balance plans are a game changer. With the potential for hundreds of thousands of dollars in annual tax savings, a closer look is well worth the time.
With the Qualified Small Business Stock Exemption, you could pay zero taxes on the sale of $10 million of equity — and protect more with advanced planning.
✅ Key Takeaway: Using the Qualified Small Business Stock (QSBS) Exemption, you can pay 0% federal and state taxes on most of your startup equity if you have held it for five years. And you can even multiply that protection by gifting equity to a Charitable Remainder Trust—the tax exemption is potentially unlimited.
The Qualified Small Business Stock Exemption is the single most important tax rule for many startup founders, investors, and employees. The QSBS rule allows some owners of startup equity to eliminate 100% of the taxes—state and federal—on the greater of their first $10m of gains per asset or 10x the cost basis of an asset. Generally, $10m of gains tends to be the more common scenario for early employees and a 10x cost basis may be more applicable to later-stage employees that have a higher cost basis.
It's important to note that the QSBS exemption is currently one of many items proposed by the current administration to undergo a variety of structural changes. The proposed changes mean there will still be benefits to having QSBS eligible stock, but the tax-free benefit will be limited to a smaller sum of the gains. We'll be sure to keep you updated in real-time as these potential changes become law! Until then and for 2021, the following QSBS rules apply.
We'll explain how QSBS works and how you can ensure that you get this protection when you sell. First, though, let's take a look at some context: Why does QSBS exist at all?
Why does the QSBS exemption exist?
Congress enacted the Small Business Stock Tax Exemption in 1993 to encourage investment in specific types of small businesses. It did this by providing a simple tax exclusion: Anyone who starts, invests in, or works for a small business can exclude certain gains when they sell their shares (provided that they meet certain conditions--see below).
And although Congress probably didn't have tech startups in mind when it created the exemption the year before Netscape Navigator was born, the exemption applies to shares in all kinds of "small" businesses, including young tech startups (and Congress confirmed as much when it renewed the exemption as part of the Small Business Jobs Act of 2010).
How does it work?
Today, the primary benefit for holders of QSBS—and it is a huge benefit—is the zero-percent tax rate on eligible gains up to $10 million per company, per person. We don't have to tell you that this tax break is a major boon for employees of high-growth technology or technology-enabled startups. And it applies to most startup equity earned during a company's early years.
Ways to do even better
You might imagine that it's hard to beat a 0% tax rate on $10 million in gains. And you'd be partly right: If you live in a high-tax state, that could mean an extra $3.7 million in your pocket.
But what if there were a way to multiply that exemption? As we've mentioned, the QSBS exclusion is $10 million per taxpayer, per company. One way to take advantage of this detail is to claim the exclusion for multiple investments--if you're an early employee, you get up to a $10 million exemption for each.
Let's look at an example. Say you are an employee of a very successful Food Delivery startup that's nearing an IPO, but before that you worked for a fast-growing Data Analytics start-up. Let's assume you paid next to nothing for your shares, because you early exercised, and today each company's stock is worth $5 million (that's a total of $10 million between the two). First off, congratulations, you're receiving a massive landfall, but what does this mean for applying for the QSBS exemption? Assuming your shares meet the QSBS criteria (it's always worth checking with your company), the proceeds from your sale would be tax-free and you would have $10 million in your pocket. If the price of the stock went up and each company's shares were worth $10 million each, you could sell it all and realize up to $20 million of gain tax-free. (That's $10 million per asset.)
What to do now
Timing is key to the QSBS multiplier strategy, and there's an important tradeoff:
Are my assets eligible?
The IRS documents on QSBS can be tough to follow--shocker, we know--and there are nuances to the requirements. We've done our best to make them digestible here, but please reach out if you have questions and we'll gladly help you understand if your shares are eligible and how to stack your QSBS exemptions.
Original issue requirement. The taxpayer must have received the stock at original issue from the company (that is, not in a secondary sale) in exchange for money, other property, or services. Most equity grants to founders, employees and investors will qualify.
Five-year holding period. The taxpayer must have held the stock for at least five years prior to the sale or exchange. (The clock starts from the time the stock was exercised, not when it was granted.)
Domestic C corporations only. The issuing company must be a domestic C corporation at the time of issue, at the time of the taxpayer’s sale or exchange, and during substantially all of the taxpayer’s holding period. This shouldn't be a major barrier for most people; virtually all U.S.-based startups are C corporations when they take their first venture funding, and that'll be enough to qualify as QSBS.
Active business and qualified trade or business requirements. At all times during the taxpayer’s holding period, the issuing company must be actively engaged in a "qualified trade or business." Most professional service firms, finance, and investment management businesses, and hospitality businesses will not qualify, but most technology companies—even tech companies serving those disqualified fields—typically are fine.
Small business requirement. At all times before and immediately after the issuance of the taxpayer’s stock, the corporation’s adjusted basis in its cash and other assets must not have exceeded $50 million. This provision is complicated, but a good, rough heuristic is that you will qualify if you were issued your stock before your company raised $50m in funding. Still, the best way to figure this out for sure is to ask your company's finance team.
State tax rules. Most states follow the federal QSBS rules and exempt qualified gains from state taxes as well. But some states--California and Pennsylvania, for example--don't, and others, such as New Jersey, impose additional requirements.
You can create significant returns -- in most cases above 50% -- by passing on your IRA to your kids via a Charitable Remainder Trust or Roth conversion. Which option is better depends on whether you are using your IRA for living expenses, how long you expect to live, and how important financial flexibility is to you.
You can create significant returns by passing on your IRA to your kids via a Charitable Remainder Trust or a Roth conversion.
Which option is better depends on whether you are using your IRA for living expenses, how long you expect to live, and how important financial flexibility is to you.
Now that the Stretch IRA is a thing of the past — those who inherit an IRA can no longer spread their withdrawals over many years — there has been a rush to anoint the next best thing. For some, that will be to do a Roth Conversion today, thereby eliminating the tax burden on their heirs. For others, rolling over there IRA into a trust will to allow their assets to grow on a pre-tax basis and defer their tax bill for as long as possible. In most cases, though, some advance planning will be necessary.
In this post, we’ll compare these approaches, identify a few tradeoffs, and help you identify the right strategy for you.
Why do tax planning in advance for an IRA gift?
The case for doing something is self-evident if you plan to pass on your IRA assets to future generations, in most cases the additional return from using either of these options is above 50%. If you don’t plan ahead for gifting your IRA on to your loved ones when you pass away, they will be hit with both mandatory distributions and significant ordinary income taxes on all distributions, each equally painful in their own right.
With respect to mandatory distributions, they’ll be required to withdraw all of the gifted funds within 10 years. This forced distribution schedule will significantly hinder the prospects for asset growth since the number one way to achieve growth is by leaving your money to grow untouched by taxes and taking advantage of pre-tax compounding.
Even worse, when your loved ones make those mandatory withdrawals, they’ll owe the highest tax rates — state and federal ordinary income tax rates, which can total 50% or more — on every dollar they withdraw. These high tax rates can mean that your heirs can end up with less than half of the assets you intended to leave behind.
Faced with those costs, it makes sense for most people to do what they can to reduce the withdrawal tax rate and/or delay those mandatory distributions. But how?
The tax-advantaged options: Roth or Charitable Remainder Trust (CRUT)?
For most people, there are two leaders in the clubhouse when it comes to tax-advantaged planning for an IRA gift: Doing an immediate Roth conversion or setting up a Charitable Remainder Trust that will hold the assets when you pass away.
Why convert a standard IRA to a Roth?
A Roth conversion has two virtues: Simplicity and front-loading taxes. With a Roth conversion, an IRA owner can transfer assets from a traditional retirement account (a traditional IRA, 401(k), SEP IRA, or SIMPLE IRA, for example) into a Roth IRA.
What is the benefit of this move? Traditional retirement accounts are tax-deferred; you put in pre-tax money and then pay taxes when you make withdrawals. With Roth IRA, by contrast, you put in post-tax dollars — that is, you pay taxes upfront — but then you get to make tax-free withdrawals.
When you convert a traditional retirement account into a Roth IRA, you must pay income tax on the money you convert, but you and your heirs will be eligible for tax-free withdrawals — the key benefit of a Roth account — in the future assuming the account has been open at least five years.
The benefits are clear for those looking to pass their IRA assets on to their children or other heirs (and not use yourself): By front-loading the taxes, you are freeing your loved ones of the significant tax burden that would accompany their inheritance when you pass away. However, your beneficiaries will in most cases have to withdraw the funds within 10 years. But 10 years of tax-free growth is better — for reasons that should be obvious — than tax-burdened growth over the same period.
Why roll an IRA into a Charitable Remainder Trust?
As we have explained elsewhere, another common strategy that can supercharge the tax-deferral benefits of the traditional IRA without imposing that significant tax burden on your family when they receive your IRA is to use a Charitable Remainder Trust (CRT). With a CRT, you can help your heirs extend the ten-year mandatory withdrawal schedule for as long as their entire lives and defer the harsh ordinary-income-tax bill that would otherwise apply after inheritance.
The benefits of the CRT strategy are many:
What are the tradeoffs between these strategies?
There are certainly a variety of benefits to each approach. Let’s take a look at a couple of key tradeoffs: timing and optionality.
Roth Conversion: The Roth conversion is simple — pay your taxes now and you may gift your IRA to your heirs free and clear of taxes and liquidity constraints. The tradeoff for that simplicity and those financial benefits is that you have to act soon. In fact, a Roth conversion will typically make sense only if you expect to live another 15 years or more; otherwise, you’re just choosing to take on a big tax bill today with no real payoff. And if you do act today, the move is irreversible — you’re paying a large tax bill today in exchange for lower taxes in the future, and that means sending a big, non-refundable check to the government — as much as 35% or more of the value of your IRA.
Charitable Remainder Trust Rollover: A Charitable Remainder Trust, by contrast, is a much more flexible option as there’s no commitment today and no negative implications tied to when you pass away or upfront taxes to pay. If you decide that a trust might make sense, set it up, and then change your mind later, that’s fine — there are no up-front tax consequences and no need to move your assets. This strategy is fully reversible until the end of your life and delivers a significant ROI as well.
Which approach is right for you?
With those benefits and tradeoffs in mind, when might each strategy make sense?
Roth conversion. Because it involves an up-front cost and is irreversible, a Roth conversion can typically make sense for people who:
Charitable Remainder Trust: Because it preserves your optionality and involves no up-front costs or tax bill, an IRA-to-CRUT rollover can be a fit for people: - Who is using their IRA for living expenses - Looking to minimize their expenses now and preserve and future financial flexibility - May have health issues or uncertain on how long they may live.
You should be doing some sort of planning for the IRA assets you plan to pass on. But should it be a Roth Conversion or a trust? This example will help.
So far in our series on gifting an IRA, we’ve explained the state of the law, identified key decision points, and pointed out some of the tradeoffs between the two most popular strategies: using a Charitable Remainder Trust and converting to a Roth IRA to mitigate the tax consequences of the gift. In this post, we’ll dive through a case study to pinpoint the differences between those two approaches.
A quick refresher
$30 trillion will pass from Baby Boomers to Millennials over the next decade — double the size of the entire U.S. economy. Unfortunately, the best approach to tax-efficient giving, the Stretch IRA, is no longer available as a result of the 2020 SECURE Act. Now, beneficiaries other than your spouse — kids and grandkids, for example — have to withdraw all inherited IRA assets within 10 years of the IRA owner's death (or pay a 50% penalty), and, critically, those forced distributions are taxed at ordinary income tax rates instead of the lower capital gains rates.
So what to do? Now that the Stretch IRA is a thing of the past, two strategies have risen to the top of the heap of potential replacements: Roth conversions and Charitable Remainder Trusts (CRTs). With a Roth conversion, you can pay the taxes on your IRA gains today, thereby eliminating the tax burden on their heirs. With a CRT, your assets can grow on a pre-tax basis and your beneficiaries can defer their tax bill for as long as possible. Both strategies can help you earn 90% more from a gifted or inherited IRA than if you had done no planning.
Now on to an example where we compare the impact of all three strategies.
Louis and Maria and their children
Louis and Maria are 70-year-old New York residents. They’ve never had a huge windfall, but they’ve saved conscientiously, and they’ve put together a retirement they’re comfortable with. As a result of that careful planning, they have a traditional IRA that is worth $1 million today, and they don’t expect to need that money. They’d like to give it to their kids when they pass away.
After taxes. If Louis and Maria convert their traditional IRA to a Roth today, they’ll owe taxes on the amount in the IRA that they’ve earned over the years in capital gains. Given the size of the IRA, they can expect to pay around 37% in state and federal income taxes on their conversion. As a result, they’ll have about $630,000 to reinvest after they convert.
Pre-gift growth. Because they don’t need the money, that $630,000 will grow until Louis and Maria pass away. There will be some required minimum distributions (RMDs) to account for, but it’s sufficient for our purposes to assume that the account will grow 6% per year after those RMDs come out. If that happens, the account will be worth almost exactly $1.5 million in 15 years, when it passes to their children.
10-year growth and withdrawals. By the current rules of IRA inheritance, the kids will have 10 years to withdraw all of the IRA money. Assuming that they can get 7% returns per year — maybe they dial up the risk, or the market has a good decade — that $1.5 million would just about double, to $2.81 million. At the end of that 10-year period, Louis and Maria’s children would be required to withdraw the money, but those withdrawals would be tax-free because Louis and Maria paid the tax upfront when they did their Roth conversion.
Post-withdrawal reinvestment. To help with an apples-to-apples comparison, we’ll assume that Louis and Maria’s children reinvest their inheritance after it comes out of the IRA. If they continue to get 7% returns per year (and take occasional distributions to cover expenses), then after another 20 years — 30 years after Louis and Maria pass away — they’ll end up with $7.18 million in their pockets over the years, after they pay the capital gains taxes on all of the earnings they built up after they drained the IRA.
Instead of passing the IRA assets directly to their children, Louis and Maria could pass them to a Charitable Remainder Trust of which the kids are beneficiaries. That trust, in turn, can run for as long as the kids’ entire lives.
How would this help? A CRUT is a tax-exempt account much like an IRA, so Louis and Maria will pay no taxes today, and, critically, neither they nor their kids will pay taxes when the IRA changes hands. In short, an IRA-to-CRUT rollover can prolong the tax-exempt nature of the account for as long as the heirs’ lifetimes.
Let’s take a look at the math.
Current value and growth. Assuming, as before, that Louis and Maria’s IRA is currently worth $1 million and that they get 6% returns for the next 15 years, the account will be worth about $2.39 million when they pass away — they’re about $900,000 ahead of the Roth conversion because they didn’t have to pay those up-front taxes.
Tax deferral. The money then goes into a CRUT. Because the CRUT is tax-exempt, the couple’s children will pay no taxes on the inheritance at that point; instead, they’ll get to reinvest the full $2.39 million. Assuming 7% growth from there on out (plus occasional distributions to cover expenses), that $2.39 million would turn into $7.45 million over the same 30-year period.
Liquidity. Although CRUTs are more flexible with respect to distributions than many irrevocable trusts, you won’t have access to the entire value of the trust in any given year; withdrawals are capped by the IRS at somewhere between 5% and 50% of the value, depending on the type of trust you choose, but typical rates are between 5% and 15%. Let’s say Louis and Maria set up a trust that is set to receive 7% annual distributions. The children would be entitled to 7% of $2.39 million, or about $168,000, in the first year, and another 7% every year for the remainder of the trust’s term.
If instead, Louis and Maria do nothing — they don’t convert their IRA to a Roth and they don’t set up a trust — their children will be far behind at the end of the day. Assuming the same 6% growth in Louis and Maria’s final years, 7% growth once the kids take possession of the IRA, and occasional withdrawals to cover expenses, the initial $1 million IRA would grow to $2.39 million by the time Louis and Maria pass away and, due to the punitive taxes associated with an IRA transfer, just $2.85 million after 30 years.
Which to choose?
It’s clear, then, that the family should do some sort of planning for the IRA assets they plan to pass on. But should it be a Roth Conversion or a trust? As we explained last time, the tradeoffs between the CRUT and the Roth Conversion approaches are relatively straightforward:
Roth Conversion: The Roth conversion is simple — pay your taxes now and you may gift your IRA to your heirs free and clear of taxes and liquidity constraints. The tradeoffs for that simplicity are (1) you have to act soon since a Roth conversion will typically make sense only if you expect to live another 15 years or more; and (2) the move is irreversible — you’re paying a large tax bill today in exchange for lower taxes in the future, and that means sending a big, non-refundable check to the government.
Charitable Remainder Trust Rollover: A Charitable Remainder Trust, by contrast, is a much more flexible option. There’s no commitment today and no real cost to getting set up. If you decide that a trust might make sense, set it up, and then change your mind later, that’s fine — there are no up-front tax consequences and no need to move your assets. This strategy is fully reversible until the end of your life and delivers a significant ROI as well.
Which approach is right for you?
With those benefits and tradeoffs in mind, when might each strategy make sense?
Roth conversion. Because it involves an up-front cost and is irreversible, a Roth conversion can typically make sense for people who:
Charitable Remainder Trust. Because it preserves your optionality and involves no up-front costs or tax bill, an IRA-to-CRUT rollover can be a fit for people:
Gifting an IRA via a tax-advantaged trust can be a powerful way to protect your family's assets. But how to decide whether, when, and how to make that move?
Passing an Individual Retirement Account (IRA) on to one’s children or grandchildren can be a great way to build wealth for future generations. The typical, simple gifting of an IRA, however, can carry an immense tax burden — the recipient will be forced to withdraw the money within ten years of the gift, and all of the proceeds will be taxed at ordinary income rates. As a result, IRA gifts can end up being diminished by 60% or more, just on account of this mandatory withdrawal and tax rules.
For this reason, gifting an IRA via a tax-advantaged account — specifically, a Charitable Remainder Trust (also known as a CRT or CRUT) — can be a powerful way to protect assets for one’s family. But how to decide whether, when, and how to make that move? In this post, we’ll explore these important questions, as well as the mechanics behind the strategy.
Is an IRA-to-CRUT rollover the right move?
The first question to ask when evaluating any advanced tax planning strategy is whether it makes sense to pursue it at all.
Who is this strategy for? With IRA gifting via a CRUT, the potential returns are incredible — 90% or more additional earnings over the next generation. Because the returns are so large, it will make sense for many, but especially for those with IRA’s over $250k whose inheritors (outside of their spouse) don’t expect to need that money right away.
Given those expected returns, then, why would this ever not be the right strategy? One simple reason: is liquidity. Like all Charitable Remainder Trusts, a CRUT holding an IRA will have limited liquidity in the first few years. Compare that reality to the scenario where the IRA holder gifts the account to their kids outright; there, the kids will be able to withdraw the money when they need it.
Those withdrawals will be taxed at a punitive rate, though, so there’s a tradeoff here: Outside of a CRUT, the beneficiary will have access to 100% of the assets but taxed at 50% or more. If the IRA owner passes the assets on via a CRUT, the beneficiary will have access to only around 5% of the assets per year but taxed at a much lower rate.
As with any CRUT, after only a few years of compound growth, those 5% payouts start to accumulate quickly, and you may be able to access as much as 80% of the proceeds, before taxes, in the first 7 years. For this reason, liquidity should be a barrier to using a CRUT for these purposes only if you need a large chunk of the money immediately, and if you are willing to give up significant growth for it.
When and how to set up an IRA-to-CRUT rollover?
So you’ve decided this is the right move for you and your family. You don’t need your IRA assets during retirement, and your kids and grandkids don’t expect to need access to the money right away, either. When and how can you get this set up?
As with most tax planning, the answer to “when?” is “now.” The benefits of this strategy come into play as soon as you pass away, but implementing it requires advance planning. To ensure that your IRA is correctly moved into your beneficiaries’ trust, you’ll need to do the work now to establish a “testamentary CRUT.” A testamentary trust is a trust that comes into effect upon an individual’s passing. In this case, you can establish such a trust and designate it as the beneficiary of your IRA. That way, when you pass away, the IRA’s funds will go straight into the trust with no special maneuvering — and, critically, no legal wrangling in probate. Pursuing this approach also has the virtue of being certain; if you wait too long, you might not have the ability to implement the strategy in time for the IRA to move to a CRUT when you pass away.
Other important decisions
Aside from whether to pursue the IRA-to-CRUT strategy and when to implement it, there are several key design questions you’ll want to answer as soon as you decide this plan is for you.
You need not gift your entire IRA — or all of your IRA assets if you have multiple accounts. CRUTs are flexible, and you are free to assign only some of your retirement account assets to your testamentary trust.
Who will benefit?
Who do you want to receive the income — and, eventually, a relatively large lump sum — from your IRA and trust? That income interest will likely be substantial — 5%+ of the IRA assets every year, an amount that will likely grow over time as the trust’s investments appreciate — so it’s important to think about who will be reaping those rewards and at what stage in their lives.
This is, of course, mostly a personal question, like all estate planning, but there are two technical limitations that you should consider. First, you are allowed to pass an IRA to your surviving spouse free of taxes and mandatory-withdrawal limitations. Accordingly, that should usually be the first move. Then, the surviving spouse will typically be the one to pass the IRA assets to a trust for the younger generation. (To get ahead of the planning, both spouses can establish a testamentary trust that executes only if they are the last to die.)
Otherwise, this part is up to you.
What kind of CRUT, and for how long?
Once you’ve decided to pursue this strategy, there are a few more decisions to be made. Most notably, you’ll have to decide what kind of CRUT you want to leave your beneficiaries, and how long you want it to run for. Although there are numerous permutations, this decision really varies along two axes: (1) Standard CRUT or NIMCRUT; and (2) term trust or a trust that runs for as long as possible.
We’ve written extensively on these decisions in the context of the general analysis of CRUT strategies. The calculus isn’t very different in the context of an IRA-to-CRUT transition — the main difference is that you need to be thinking about the needs of the ultimate beneficiary, whomever you choose.
As you think through this choice, the following rules of thumb might be helpful:
A NIMCRUT will likely yield the largest overall returns, because it allows your beneficiaries to choose to further defer the CRUT distributions for many years, to take advantage of additional tax-free compounding. As a beneficiary of an IRA, the returns from a NIMCRUT are even higher because of the high ordinary income tax rates paid on inherited IRAs. A Standard CRUT, by contrast, will have lower returns but will provide more predictable payouts.
The length decision is more complex, but it really comes down to two choices: A term trust (running for 20 years) or a long-term trust. If your chosen beneficiary is younger than 27 1/2, a term trust will be the only option, and that’s totally fine: the returns are still significantly positive even over just a 20-year term. But if your beneficiary is older — and especially if they themselves have children or other younger dependents — the returns can get truly massive. This is because you can elect to set up a trust that runs for your beneficiary’s lifetime plus a term of years after they pass away. Gifting an IRA to a 50-year-old child with children of her own in their 20s, you can choose a maximum-length trust that will be expected (in actuarial terms) to last for as much as 50+ years. Those beneficiaries can draw income distributions from the trust for that entire time, as well as larger lump sums toward the end of the term, and still leave a significant gift for charity at the end.
Fundamentally, as you are deciding whether and how to design your IRA-CRUT strategy, you’ll have to answer three questions: When to do the work to get this in place (as early as possible), when the money should move over (when you pass away, via a testamentary trust), and what you should do in the meantime (let your money grow).
Planning for the end of life is not easy for anyone involved, but you can make that transition smoother by planning ahead for the tax-advantaged transfer of assets via an IRA-to-Charitable Remainder Trust rollover.
Using a Charitable Remainder Trust in place of a Stretch IRA can help you pass assets to loved ones and defer the taxes they would pay on distributions.
The largest wealth transfer in history is expected over the next two decades: About $30 trillion will pass from Baby Boomers to Millennials. As this happens, both generations will be looking at how to effectively pass on those assets. Today, we’ll be examining how parents can pass on their IRA assets to the next generation in a tax-efficient way.
Historically, one of the most powerful ways for tax planning between generations was for parents to pass on their IRA to their children — without liquidating the assets inside or paying any transfer taxes — via a “Stretch IRA.” With that arrangement, the parent’s IRA would roll over into the children’s IRA, and the kids could therefore continue to allow the assets to grow tax-deferred, just as they had been doing when the parent held them. That way, the assets could continue to grow tax-free until the children were 59.5 when they would be required to start taking distributions.
As a result of the 2020 SECURE Act, however, those rules changed, with two major implications.
As an example, imagine that Sophia’s parents died in 2020, and Sophia, a San Francisco resident, inherited a $1 million IRA that will grow 9% annually for the next 10 years before she is forced to withdraw it all. In 10 years, the IRA will be worth $2.4 million. That’s great! But when Sophia withdraws that money, she will owe ~$1.2 million in taxes (a 50% tax rate!), and she’ll keep only $1.2 million. Keeping only half of the assets is a significant step back.
But what if Sophia could keep those assets growing — and keep deferring the taxes — for longer than 10 years, or even for the rest of her life? That kind of tax magic is possible with a Charitable Remainder Trust.
Before we go into the strategy, though, here’s a quick refresher on why tax deferral is so powerful.
Why does tax deferral matter?
Deferring taxes is one of the best ways Americans have to improve on the already significant impact of an investment’s compound growth. And people have noticed: The first advice most people get when they join the workforce is to max out their contributions to their IRAs and, if available, their 401(k)s.
Why are tax-deferred accounts such a big deal? Because they protect your income from up-front taxes, and you get to reinvest and grow the tax savings. For example, if you are a California resident and you have long-term capital gains of $1 million when your company goes public, you would typically pay about $360,000, or 36%, in taxes, and you would be left with about $640,000 to invest (or spend!) going forward. With the use of a tax-deferred trust, by contrast, you could keep the whole $1 million to reinvest.
And think about what happens when you put those savings in the stock market, crypto, or angel investments: your tax savings continue to grow. While it seems obvious that you would rather have $1 million in the market working for you than $640,000, most people don’t appreciate how big of a difference that will make over time. Assuming just a 9% annual return—the average historical return from relatively conservative index investing—that extra $340,000 could turn into more than $1.9 million over 20 years. That’s the magic of the one-two punch of tax deferral and compounding.
How you can grow your IRA inheritance tax-free for more than 10 years
That’s all well and good, but we just told you that long-term tax deferral through IRA inheritance is no longer available as a result of legal changes. So what can you do?
Let’s check back in with Sophia and her family. Instead of passing the IRA assets directly to Sophia, her parents could pass them to a Charitable Remainder Trust (also known as a CRT or CRUT — read our guide here) of which Sophie is a beneficiary. That trust, in turn, can run for as long as Sophia’s entire life.
How would this help? A CRT is a tax-exempt account much like an IRA, so Sophie’s parents’ assets can continue to grow on a tax-free basis as long as they are in the trust, potentially creating 47% more growth for Sophie over her lifetime.
Comparing the numbers
Let’s assume Sophia and her parents are looking at a version of a Charitable Remainder Trust called a NIMCRUT — the most common choice among our customers — and break down how much she could save with and without a trust using the same assumptions of a 9% annual growth rate and tax code.
10-Year IRA Rollover
After the forced sale in year 10, Sophie would keep roughly half of the $2.4 million in value that has accumulated in the IRA — $1.2 million after taxes. (Recall that the tax bill is so steep because these inherited IRA distributions are taxed as ordinary income.)
Sophia reinvests that $1.2 million. Assuming she lives until 2062 — her expected lifetime according to the Social Security Administration — then at the end of her life Sophia would have accumulated $13.8 million after taxes.
What about those taxes? The rules of IRAs dictate that Sophia would pay ordinary income tax rates on the entire amount distributed from the IRA at the 10-year mark — the $2.4 million — but then would pay long-term capital gains rates on further earnings.
CRT for Life
If Sophia’s parents’ IRA fund instead went into a CRUT upon their passing (and assuming Sophia didn’t touch the money for the rest of her life), she would have $20 million after taxes.
Looking at the taxes again, Sophie would pay ordinary income taxes on the first $1 million that is distributed from the CRUT and then shift to paying long term capital gains
What is the benefit of the CRUT, then? Critically, by deferring those income taxes for an additional 30 years, Sophie can create significantly more wealth. She’ll pay only $1 million in ordinary income taxes (instead of $1.3 million) and, importantly, she’ll get to defer those taxes until the end of her life. As a result, Sophie will get to reinvest an additional $1.8 million compared to the plain vanilla IRA, and she’ll end up with a total of $20 million in the end.
How CRUTs Can Supercharge An IRA Inheritance
We’ve given you the big picture. Getting tactical for a moment, let’s take a look at the specific mechanics of Sophie’s savings. By using a version of a Charitable Remainder Trust called a NIMCRUT that runs for her life, Sophia would get a number of benefits:
$30 trillion will pass from Boomers to Millennials over the next decade. Of that amount, about one-third is held in IRAs. Here's how to plan ahead.
$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 beneficiary for an inherited IRA.
Before we walk through an example, here is some quick context of how Stretch IRAs were used before they were banned in 2020.
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.
Now let’s walk through how a real-life example of how a family in California is dealing with their IRA.
Rocky, Ellie, and their son, Adam
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.
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
Planning with a NIMCRUT
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 upfront 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 upfront 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.
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. 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.
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 90% return is the essence of the power of using Charitable Remainder Trusts to roll over an IRA between generations.
A Charitable Lead Annuity Trust can help if you've had a big income event this year. We'll take you through the details of this powerful strategy.
When and why might a grantor Charitable Lead Annuity Trusts (CLAT) work? A CLAT can be a great tool for people who have had a big income event this year, like a crypto sale, a big exercise of appreciated options, or just a big bonus. In this post, we'll take a deeper dive into this common tool.
What are the common scenarios that make sense for a CLAT?
Grantor CLATs often make sense when (1) you have enough income that you're in an inherently high tax bracket (as in the scenarios we discuss below), (2) we are in a low-interest-rate environment (as we ware today), and (3) you have a long time to let your money grow untouched (because the returns really start to skyrocket around the 20-year mark).
The tax benefits of a CLAT
There are two key tax benefits of a CLAT: 1) Shifting current income to long-term capital gains and 2) the ability to generate a "return arbitrage." We spent some time describing these benefits in the context of a case study, but we'll explain in more detail how this all works.
Case study refresher
Jeff lives in New York and started trading crypto a few years ago. Like many folks in crypto, he has had a really good year. Jeff decided to take some of his gains from Solana, Avalanche, and Shiba Inu off the table — about $300,000 — but he didn't realize that they all qualify as short-term capital gains. (Crypto moves fast!) As a result, he's now looking at a surprise 49.25% tax bill — about 37% from the federal government and another 12% from New York (city and state).
Expected Post-Tax Returns after 30 years (assuming an 8% annual growth rate over the term of the trust):
Where do these benefits come from?
What is the downside of a grantor CLAT?
The primary downside of a grantor CLAT is that you typically don't have access to the capital for a while (20+ years), and you're responsible for the income in the trust in the meantime. This means that you'll have to pay taxes on that income each year, which creates negative cash flow until the end of the term.
With that said, this shouldn't be a huge concern. The amounts we're talking about are small: In most cases, the trust's income will be a few thousand dollars a year, and your tax bill will be a fraction of that. This works because we work with you to reduce your tax liability during those years by (1) limiting income realization in the trust (dividends, sales of appreciated assets) and (2) designing the CLAT to make small charitable payments until the last year of the trust when you receive all of the remaining assets in the trust and are cash flow positive again.
My name is Dan Hopwood and I first started my career in the insurance business back in 1988. 2018 will be the start of my 30th year in the business. My agency is a member of the Better Business Bureau and holds an A+ rating.