Using a “Testamentary” Charitable Gift Annuity (T-CGA) To “Stretch” The IRA Payout

The stretch IRA was a popular tool for extending the benefits of a tax-deferred account to a non-spouse beneficiary. The goal was to minimize the tax impact of the required minimum distributions (RMDs). Typically, it worked by having the account owner designate a child or grandchild as the beneficiary, who was then allowed to stretch the RMDs out over their own lifetime. This meant smaller distributions, less tax paid, and more tax-deferred growth on the remaining assets in the account.

However, in late 2019, the Setting Every Community Up for Retirement Enhancement Act (the “SECURE Act”) was passed into law. A major change is that it requires non-spouse beneficiaries to withdraw the balance of the account within 10 years after the death of the original account owner. This can radically increase the size of the RMDs, and therefore effectively ends the use of the stretch IRA strategy. With the SECURE Act having effectively killed the “stretch” IRA for beneficiaries significantly younger than the decedent, there is a renewed interest in the idea of designating a charitable remainder unitrust as beneficiary of a decedent’s IRA, to replicate the “stretch.”

There are, of course, costs to creating and then administering a charitable remainder trust over the life of an individual beneficiary – legal start-up and document fees, trustee fees, investment advisory fees, tax return preparer fees, etc. Where the account value is less than $500,000, these costs may be seen as prohibitive and even at higher asset levels, simply more complex or burdensome.

A more simple, flexible, less expensive alternative would be for the participant to designate a charity as the beneficiary outright, in exchange for a commitment from the charity to issue one or more gift annuities to named individual beneficiaries. There are several advantages to the “testamentary” gift annuity (T-CGA):

• generally, there are no expenses to create the gift annuity,
• administrative costs are much lower, and are already accounted for in the ACGA recommended rates,
• minimum funding amounts may be $10,000-20,000,
• a charitable donation is made at the time of the last death to one or more charitable organiztions,
• the payout to younger beneficiaries may be lower than the five percent minimum required of a CRUT, and
• a fixed payout is guaranteed over the beneficiary’s life (1 or 2 lives).

How would an IRA account owner implement the T-CGA plan? There are a number of considerations to keep in mind when utilizing this strategy. First, the account holder will of course be deceased when the annuity goes into effect. This means it is very important to ensure that expectations regarding the designation and annuity agreement are clearly understood. If the transfer is completed properly, it is likely that there would be no income realization for either the estate or the annuitant.

While IRS has not issued formal guidance on this strategy, there is at least one letter ruling saying the direct payment of the account proceeds in exchange for the gift annuity would not cause the decedent’s estate to recognize income on what might otherwise have been treated as a “bargain sale.” And although a letter ruling is not a legal precedent, the reasoning of PLR 200230018 on this point is persuasive: the account proceeds did not pass through the estate, but were received directly by the issuing charity.

To implement this plan, the IRA account holder would enter into an agreement with the issuing charity that would be contingent on the beneficiary designation actually taking effect. In other words, this would not be an obligation enforceable against the account holder’s estate, so there would be no income realization event on funding of the annuity.

With those considerations in mind, the charity and IRA account holder will need to decide whether a charitable gift annuity is appropriate for the situation. If so, they will need to jointly determine what terms for the annuity agreement are acceptable. These terms should include:

1. Who the annuitant(s) will be
2. Legal name, date of birth, address, and social security number of the annuitant
3. Whether the annuity will be immediate or deferred
4. Rate of the annuity
5. Frequency of payments
6. What charity(ies) the remaining assets should go to following the annuitant’s death

Luckily, these are normal questions when creating a CGA contract, and are generally similar to standard gift annuity agreements.

There are some special contractual considerations, however. Note that the T-CGA should be issued to the annuitant at the prevailing rate at the time of the donor’s death, since it could be many years before that happens. To prevent the charity from incurring any tax liability due to unrelated debt financed income, the agreement should provide that the annuity rate will be reduced to the extent necessary to pass the greater than 10% actuarial remainder test required by Internal Revenue Code section 514(c)(5).

Additionally, the agreement need only be enforceable against the charity. To that end, the agreement should indicate that it is contingent on the beneficiary designation actually taking effect. Finally, the agreement should not be assignable to any party other than the charity, and the assets in the IRA should be liquidated as quickly as possible to avoid any decline in value following the death of the account holder and prior to the funding of the annuity.

Finally, one item to keep in mind is that payments on the T-CGA may be deferred until the intended annuitant is old enough to meet the charity’s risk tolerance. Many charities will not issue even “normal” CGAs to annuitants who are under 50 or 55. So an IRA account holder looking to use the T-CGA to benefit younger children should be mindful that from a planning perspective, it is possible that the annuity payments will be delayed.

A testamentary charitable gift annuity can be a great solution for the needs of a donor with an IRA account and functions like an efficient spendthrift trust alternative for beneficiaries. Since the SECURE Act effectively stopped the stretch IRA option, financial advisors have been scrambling for alternatives. A charitably-inclined IRA owner who would also like to secure some income for a younger family member should consider a T-CGA. A simple beneficiary designation on the IRA account is all that is required to transfer the funds to charity. The charity and donor will also execute an annuity agreement contingent on that designation remaining in place. The T-CGA can be a simple and elegant solution for IRA account holders and charities alike.