The current question is, which of the trust types discussed in recent threads; conduit trust, accumulation trust, and charitable remainder unitrust (CRUT), works the best in a typical scenario. I modeled that scenario based on the following assumptions:
- • A 40 year-old single, able child is the beneficiary of her parent’s $1m Inherited IRA trust.
• The child has a salary of $99k, meaning any tIRA proceeds she receives will be taxed at the 24% rate and upwards.
• tIRA distributions coming into and remaining in the trust are taxed at the 37% rate.
• The trusts/tIRA invests in a tax-managed market index fund with unrealized annual growth of 5%, net of trustee fees.
• The accumulation trust has to sell 2/5 of the 5% growth (net of capital gains tax) to distribute to the beneficiary at December 31 each year.
• The CRT values itself on January 1 each year.
• The CRT has to sell all 5% of its January 1 value (no capital gains tax) to distribute to the beneficiary at December 31 each year.
• The accumulation trust and CRUT are terminated at either 20 years or 40 years.
Model A
Results:
1. The conduit trust has to take out the tIRA distributions over 10 years, so current balance/remaining years is withdrawn annually, except in the final year, when the entire remaining balanced must be withdrawn. After 20 (and 40) years, the average funds protected were $0.33m ($0.17m), the ending funds protected were $0 as the tIRA was fully distributed to the beneficiary, the beneficiary received after-tax $0.97m after 10 years, and charities received $0.
2. The accumulation trust has to receive tIRA distributions by either 5 or 10 years but as the tax rate is always the same, the funds are removed in year 1. The amount of funds coming into the trust is an after-tax $630k (37% tax rate). This trust allows 2/5 of the 5% growth to be sold and distributed to the beneficiary as a capital gain. After 20 (and 40) years, the average funds protected were $0.90m ($1.24m), the beneficiary has received after-tax $0.29m ($0.81m), and charities have received $0. The trust had accumulated funds of $1.14m ($2.06m).
3. The CRUT takes out the tIRA distributions immediately and pays no tax on the distribution. The funds in the CRT are paid at 5% of the trust’s beginning of year value and the beneficiary receives that net of tax. After 20 (and 40) years, the average funds protected were $1.0m ($1.0m), the beneficiary has received an after-tax $0.76m ($1.52m), and charities will receive $1.0m, the trust’s ending balance.
Findings:
- A. Over 20 years, the conduit trust provides more money into the hands of beneficiary before trust defunding, the accumulation trust ends up with the most funds still under trust, and the CRT has the highest average funds under trust and of course the only charitable donation.
B. Over 40 years, the accumulation trust has the highest average and ending funds still under trust (despite distributing 40% of its growth) and the CRUT provides the most money into the hands of the beneficiary before trust defunding and the only charitable donation.
C. The trust defunding at termination is key for getting money to the beneficiary but it happens only at termination. The conduit trust terminated after year 10 with no funds remaining. The CRT terminates in either year 20 or 40, distributing its remainder to charity. The accumulation trust pays its remainder to the beneficiaries at either year 20 or 40. After 10 years, the conduit trust has paid the beneficiary after-tax $0.97m. The CRT paid the beneficiary after-tax $0.76m (20 years) and $1.52m (40 years) and will pay the charity $1m. The accumulation trust, using an blended 18% defunding capital gains tax rate, paid the beneficiary after-tax $1.33m (20 years) and $2.61m (40 years).
To make up for the fact that the CRT gets an estate tax deduction for the actuarial value of the remainder interest, I had the tIRA donate 10% of their funds to charity before distributions to the conduit or accumulation trusts. While the actuarial amounts are similar, the total dollar amounts are significantly different, due to the timing of the donation. This pre-tax donation did not affect the relative results described above, so there should be more room available for the accumulation trust to increase its charitable donations.
Model C
Because the funds reach the beneficiary at different times in varying amounts, it would be useful to look at invested monies both inside and outside the trust. Using the assumption that 50% of the monies distributed to beneficiaries is spent on necessaries and the other 50% is reinvested with a growth rate not burdened by the trustee fee, the results show the same pattern, that total funds to the beneficiary, both in trust and in their own re-invested funds, is highest with the accumulation trust.
Conclusions:
The CRT ends up with more total funds available, but a significant portion of those are ear-marked for charity. That is the crux of the analysis, that the CRT has more total funds because of its tax exempt status but the accumulation trust pays more funds to the beneficiary over its lifetime and protects a larger amount of funds for longer periods of time.
There are also variations worth modelling. One would look for timing impacts on the beneficiary distributions, e.g. the conduit trust’s distributions all come within the first 10 years, instead of over 20 or 40 years and trust defunding. Another is leaving funds in the tIRA for 10 years before distribution to the accumulation trust, avoiding beneficiary distributions for 10 years. Conversely, the accumulation trust could both increase its payouts to the beneficiary and still leave a charitable donation with some part of the final trust balance.