Personal Planner

Harold and Helen were concerned about planning for the future. They had built a substantial estate of $1,200,000. When Harold was 70, he rolled over his $400,000 qualified retirement plan into an IRA. Because he is now over age 70½, Harold is taking distributions.

Helen also has an IRA. They jointly own their home, which is debt free, and have savings accounts, stocks and bonds.

If Harold were to pass away first, Helen would like to be able to reduce her income tax. She is concerned because she and Harold both have pensions in addition to the IRA and also receive income from their investments.

Helen said, "We seem to be paying a lot of income tax. When Harold takes distributions from his IRA, that just pushes our income up higher and we pay more and more tax. Is there a way that I could reduce my income tax if Harold passed away?"

A Solution for Helen

Harold could name Helen as the designated beneficiary of his IRA. After Harold passes away, Helen may roll his IRA over into her IRA. But because she now is also age 70, she would soon be required to start distributions from the IRA. The added income would continue to cause her to pay higher taxes than she desires.

A solution that gives Helen protection and good flexibility is for Harold to transfer his IRA to a special trust for when he passes away. Under the design of this trust, Helen could receive a 5% income payout or she could encourage the trustee to invest for growth.

If Helen decides to let the income grow inside the trust, it will grow tax free until she wants to receive more income. At a future date Helen may decide that the balance of the estate is not producing as much income as desired, and she could encourage the trustee to start making the payments. By that time, it is quite possible that the $400,000 would have grown and the trust payouts could be significantly greater.

How to Create the Trust

The trust has a special name. It is called a net income plus makeup charitable remainder unitrust. Harold and Helen talked to their attorney, George. He prepared a trust document that Harold and Helen signed.

Under their state law, this trust document is valid even though it is not yet funded. Harold then selected the trust as the designated beneficiary for his IRA and Helen consented in writing to that designation.

When Harold Passes Away

If Harold passes away first, Helen will own the family home outright and will inherit their other assets except the IRA. Harold's IRA will be transferred directly to the unitrust. Because it is a net plus makeup unitrust, the trustee may discuss her goals with Helen and then invest the $400,000.

Helen's Options

If Helen has sufficient income from her own IRA, Social Security and pension, she may choose to allow the trust to grow for a period of time. However, if Helen believes that she would like to receive income from the $400,000 unitrust, then the trustee can invest to produce at least the 5% income and pay that amount to Helen.

Because Helen has modest expenses, no debt and sufficient income to enjoy the traveling that she usually does each year, Helen may decide to allow the trust to grow. At a future date she could request the trustee change the investments from growth to income. For now, Helen is comfortable with the trust investments in growth securities.

Saving Income Taxes

Because the growth of the trust is tax free and Helen is not receiving substantial income from the trust, her income will be lower and there will be substantial tax savings. Helen shared with her attorney George, "I have more than enough and I could always spend a portion of my CDs if needed. It is a relief not to have the extra income and have to pay those high income taxes. Plus, I know that the trust is growing and I could receive a larger income in the future if needed."

Benefits for Family and Charity

Helen will receive the income from the unitrust in the future, if necessary. However, she may choose to allow the trust to grow and live on her other income. When Helen passes away, the trust principal plus growth will go to three favorite charities of Helen and Harold.

In addition, the children of Harold and Helen will also receive a substantial inheritance. The balance of the estate, including their home, CDs, stocks and bonds, will be divided between their two children.

Helen is very pleased that she will be able to reduce her income taxes and enjoy a larger total estate. Over time, the trust could grow quite substantially. The combination of security for Helen, trust growth for charity and the benefits to family from the inheritance of the balance of the estate create a very good plan for Harold and Helen.