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Welcome to the Top 2%


By Bill Moritz, JD

Let’s say that you have been fortunate and been able to accumulate a significant retirement plan during the course of your working career. Being a responsible person, you decide that you are not going to draw down that retirement plan, but live on the income from it for your retirement and then pass it on to your children. Maybe, you have structured your income so that you don’t make over $450,000 a year in retirement and your children don’t make $450,000 a year, so you are all under the threshold for being "RICH" in America, in the top 2% as it is now defined, so you are not really feeling the sting of the new tax rates. Congratulations, when you pass away, if you leave your retirement plan to your children, your children have probably just become part of the top 2%!

What does being part of the top 2% and paying their fair share mean for your children? First, since money received from a retirement plan has not been taxed, it is taxed as ordinary income. If your children’s income with the retirement assets is above $450,000 they will be in the top tax bracket of 39.5%. In addition, there is also a loss of exemptions for anyone making over $300,000, so that will also boost their taxes.   If they had any capital gain income in that year, it could add another 3.8% tax.   Finally, when you add the state tax onto the federal tax rate, in a state like Minnesota or Iowa, your retirement plan could be taxed as high as 49% and in California or Oregon as high as 53%! Paying your fair share can mean losing half of your retirement plan when you die to the tax man, a retirement account that it took you a lifetime of work to accumulate and that is assuming that there is not estate tax due as well at your death!

You can solve this problem by using the Spousal Charitable IRA Trust or its successor the Family Advantage Charitable IRA Trust.


There are probably no more highly regulated entities under the IRS code than the qualified retirement plans. Retirement plans can be structured as corporate plans, IRAs, KEOGHs, 403(b) plans or 401(k) arrangements. Plan assets are potentially subject to at least three types of taxes:

  1. The 10% penalty tax for distributions before age 59 ½ under IRC 72(t).

  1. The income taxes during life (IRC 61(a)) or at death (IRC 691(a)), which are due when assets are taken out of the plan

  1. Estate tax under IRC 691(a) which could be up to 40%, depending on the size of the estate after 2013.

Even Generation Skipping tax can occur when retirement assets go directly to grandchildren or great-grandchildren. (IRC 2601).

The 10% penalty tax is easily avoided by waiting until age 59 ½ to withdraw money. Estate tax and generation skipping tax are often handled with normal estate planning or now with the high exemption amount, but the income tax consequences will affect almost everyone.

Income In Respect Of A Decedent

The proceeds of IRAs and qualified retirement plan accounts after death are taxable for income tax purposes to the direct recipient of the plan assets in the year received. This additional income is called Income in Respect of a Decedent (IRD). This income is normally taxed at the top tax rates because the total is added to your heirs’ income in the year received -- usually driving them into the top tax bracket for some or all of the proceeds. This income is subject to both federal and state income taxes, leaving the recipient often now with less than 60% of the value of the assets. For example, if an individual had a retirement plan of $800,000 at death, over $350,000 could be due in income taxes and it could be higher depending on the tax situation of the recipient.   Given such erosion in value, it’s no wonder that increased attention is being paid to combining charitable gift planning with retirement plan distributions.

Because of the tax-free accumulation and growth that occurs in retirement plans, the government has gone to great lengths to build a complicated tax structure to reclaim any lost tax revenue. Fortunately, the tax code has continued to protect charitable planning, at least for now, which is one of the few ways left to ease the tax burden from retirement plans at death.

Contribution To A Charitable Remainder Trust

Perhaps the most useful technique to minimize the adverse tax effects of IRD and maximize the benefits available to children and other heirs is to distribute the plan assets to a charitable remainder trust. The primary goals of this type of planning are to eliminate IRD tax, enable the children to enjoy the economic benefits of the retirement plan proceeds over time, and provide a substantial gift to charity after the term of the trust. The Charitable Remainder Trust (CRT) can pay an income to individuals for a term of years or their lifetimes, and then the principal that is left in trust goes to charity. The CRT is a tax-exempt entity and is not subject to the IRD tax. It also provides a charitable estate tax deduction for a portion of the amount placed in trust.

The Spousal Charitable IRA Trust

The Spousal Charitable IRA Trust (SCIT) is a specially designed charitable remainder unitrust that has been developed to benefit a surviving spouse who is due to receive a large retirement plan inheritance at the death of their mate. Since retirement income has not been taxed, withdrawals are taxed at the highest possible tax rate, compounded by required Mandatory Minimum Distribution rules.   A surviving spouse may be paying a large amount of income tax, as high as 45% in some states, on money that he or she really doesn’t need for living expenses. With the SCIT, this money could accumulate in a tax-free environment during the spouse’s lifetime and be used for income if he or she needs and then for children and charity. Here’s how it works:

  1. The Spousal Charitable IRA Trust is a part of the revocable living trust with the surviving spouse as the primary beneficiary and can have children as the secondary beneficiaries.       At the death of the first spouse, if he or she is the owner of the retirement plan, the funds in the plan are distributed directly to the SCIT.   There will be no tax on this distribution since the trust is tax-exempt. One planning option might be to name the spouse as the primary beneficiary and the SCIT as the successor. That way the surviving spouse will have a choice as to whether to roll over the retirement plan personally or have it paid into the SCIT by disclaiming all or part of her interest. He or she could also keep the IRA personally and then have it got to a Family Advantage Charitable IRA Trust after death. This decision can be made after the first spouse’s death depending on the situation at that time.
  1. The SCIT is a net income with make-up charitable trust which invests its assets, usually in a single member LLC, so that income is only paid out when the surviving spouse wants to receive it. There are no Mandatory Minimum Distribution requirements with a charitable trust. Income the spouse does not want to receive can either accumulate for their future use, be saved for the children or be given away to charity.       One advantage that comes with giving money to charity from the SCIT is that the surviving spouse gets a current income tax deduction in the year of the gift without having to declare any income. The IRA Rollover that has been used the last couple of years was a benefit because money went to the charity without having to be received personally, making it a wash. This is even better, because the spouse gets a tax deduction by releasing principal from the trust without having to declare the income so he or she can use the deduction against their other ordinary income and unlike the IRA Rollover the money going to charity can go to a Donor Advised Fund.
  1. The SCIT can be written so that it pays a large income to the spouse, for example 10% a year, and then pay that income to the children for a period of years, up to 20, after the surviving spouse’s death. Because one of the advantages of the trust is the ability to receive a current charitable tax deduction for gifts to charity, the SCIT is often written so that it has the least charitable value allowed by law, which is 10% of the value of the trust, and the greatest amount attributable to the income interest for the spouse and the children, which is 90%.       This will produce the highest amount of current tax deduction when gifts are given to charity during the term of the trust. The SCIT can also be written so that income can be distributed during the life of the surviving spouse to the children and taxed to them in their tax bracket without any income tax consequences to the surviving spouse.  Using an independent Trustee, the family can make the decision each year as to who will get the income - the surviving spouse, the children or charity.
  1. The SCIT can be written so that it is outside of the estate of the surviving spouse and the children so it cannot be reached by creditors. It would also not be marital property and would not disqualify beneficiaries from receiving government benefits like Social Security Disability or Medicaid.
  1. The SCIT does not have to be funded with all of the retirement plan. The spouse can roll over half of the IRA to their own IRA and disclaim half so it will go into the SCIT. In so doing, charitable deductions from the SCIT can be used against Mandatory Minimum Distributions from the personal IRA making distributions from the IRA tax-free.
The Spousal Charitable IRA Trust is a great way to enable charitably minded couples to plan to make significant charitable gifts, while saving taxes, after a spouse passes away. Because the trust is not funded until after the retirement plan owner’s death, it can be changed up to that time or the surviving spouse can choose not to fund it or only partially fund it. But if the SCIT is not in the revocable living trust and named as a successor to the plan, you will not be able to take advantage of the benefits.   If the spouse that does not own the plan dies first, then the SCIT operates as a Family Advantage Charitable IRA Trust (FACIT) for the benefit of the children at the owner’s death.   Its name is appropriate since it can act like a “faucet” to flow income to children with reduced taxes. The payout to children could be 10% of the value for 10 years or a term up to twenty years and then the assets in the FACIT will go to the charities of your choice or to your Donor Advised Fund. This enables you to give the assets in your retirement plan away twice, once to your children for a term of years and then to charity.   Unfortunately, unless congress changes the law, the SCIT or FACIT cannot be funded during the retirement plan owner’s lifetime, which would make the benefits even greater.

Moritz and Associates, PC has been in business for over twenty-five years. We have helped clients with this type of estate planning technique and would be happy to help you implement this plan or customize a plan specifically for your situation.


New Horizons Foundation

The New Horizons Foundation, founded in 1989, is a nonprofit, tax-exempt, public charity, organized and operating under the laws of Colorado for the purpose of helping individuals accomplish their charitable objectives in religious, educational, scientific, benevolent and health related activities.  Read More