There’s an alternative to the IRA conversion. It works well for people who are using the IRA mostly for estate planning, don’t plan to take contributions during their lifetimes, and want to give substantial amounts to both charity and their families. When those are your goals, consider a charitable remainder trust instead of an IRA conversion.
Suppose Max Profits has an IRA of $250,000. Instead of converting, Max withdraws the entire balance of the IRA. He also creates a charitable remainder trust and contributes the IRA distribution to the trust. The trust will pay income to Max and his wife, Rosie, for 10 years. After 10 years the trust balance goes to the charities they named when creating the trust.
The Profits take a charitable contribution deduction the year they donate to the trust. The deduction is not for the full amount of the donation but for the present value of the estimated amount the charity will receive in 10 years. IRS tables are used to determine the deduction. The longer the Profits are expected to receive income, the lower the deduction will be.
The Profits use the income from the trust to pay premiums on a permanent life insurance policy payable to their children. The benefits are increased when the Profits purchase a second-to-die policy and put it in an irrevocable trust, to ensure it avoids any estate taxes.
The deduction for contributing to the trust won’t eliminate taxes on the IRA distribution, but it should make the taxes substantially less than those on a conversion. In addition, income from the trust should enable the Profits to purchase an insurance policy with benefits that are substantially higher than the estimated future value of a converted IRA. On top of that, they make a significant donation to charity through the trust.
This strategy isn’t for everyone. You should be charitably-inclined, and you need to have enough assets outside the IRA to pay the taxes on the distribution and to maintain your standard of living indefinitely. You’ll also need to work with an estate planning attorney or accountant who will maximize the benefits by determining the term of the trust and the type of insurance to buy.
RW September 2010