Guidance

RESOURCES TO HELP SHAPE YOUR FINANCIAL FUTURE

Profile Photo
Ethel R. Kaplan, J.D., CTFA
Senior Vice President and Trust Officer
The Chicago Trust Company

IRAs increasingly make up a significant part of many individuals’ estates. While IRAs provide advantages that allow investors to save substantial amounts for retirement, they can be a problematic asset to leave to surviving spouses and heirs. Fortunately, the potential tax and distribution problems of IRAs can be mitigated or eliminated through the use of charitable planning strategies. By leaving “good” assets to family and “bad” IRA assets to charity, investors can spare their family potentially sizeable income and estate tax expenses.

Provided an investor plans to benefit both charity and family in his or her estate plan, one tax-efficient strategy is to designate the IRA to charity and leave other assets to family. Along with savings bonds and commercial annuities, IRAs are considered income in respect of a decedent (IRD). Consequently, it is a “bad” asset to leave to family. Instead, family should receive “good” assets—those that receive a step-up in basis, such as appreciated stocks or real estate. Under this strategy, the charitable organization receives the full IRA value, free of both income and estate tax, while heirs receive the “good” assets with a step-up in basis. Those “good” assets may be sold with little-to-no income tax.

For many investors, however, IRA assets are the largest component of their estate. If they were to leave all IRA assets to charity, the remaining “good” assets may be an insubstantial inheritance to children or other family members. These individuals may feel their only choice is to leave the IRA to family and may be seeking other tax-efficient ways to benefit charity and family using the IRA. In these cases, one such solution is to use the IRA to fund an irrevocable life insurance trust (ILIT). This solution provides heirs an income and estate-tax-free inheritance while naming charity as the IRA beneficiary. In this scenario, the trustee of the ILIT is both the owner and beneficiary of a life insurance policy based on the life of the IRA owner. Each year, the IRA owner receives an RMD and transfers some or all of it to pay the premium on the life insurance policy. The ILIT trustee then uses the contributed amount to pay the premium on the life insurance policy held inside the trust. Upon the IRA owner’s passing, the insurance proceeds are transferred to the ILIT, which may then be distributed to family members as an inheritance according to the trust’s terms. In addition, when the IRA owner passes away, the charity receives the IRA estate- and income-tax-free.

An ILIT provides a number of advantages. The internal rate of return on the policy could be in the range of 3-4% and the proceeds are free of both income and estate taxes. Furthermore, if the ILIT is properly drafted, then the annual contributions to the ILIT by the IRA owner qualify for the gift tax annual exclusion.

To learn more about tax-efficient means of bequeathing IRA assets, speak with a Wintrust Wealth Management professional.