Frequently clients are interested in making a gift to one or more charities they supported during their lifetime, such as their college, church or synagogue, or a charitable organization where they volunteered their time. Properly funding the gift is an important parts of a well-developed estate plan.
For clients with retirement benefits, charitable planning also involves discussions about the income tax benefits to using retirement benefits to fund the charitable gift(s). Using qualified retirement plans and/or individual retirement accounts (IRAs) to fund charitable gifts provide income tax benefits to the donor, while maximizing the other assets available for non-charitable beneficiaries.
If a donor leaves a retirement account to a non-charitable beneficiary, the beneficiary will be responsible for federal income taxes on the distribution (up to the maximum income tax rate). The beneficiary may also owe state income taxes on the distribution, which could result in a beneficiary paying as much as 50% in combined federal and state income taxes on the distribution. Additionally, the donor’s estate may have paid federal and state estate taxes on the asset if the donor’s assets were above the applicable exclusion amount (currently $5,450,000, less lifetime use, in 2016) and did not pass to the donor’s spouse.
If a charity is the beneficiary of retirement benefits or IRAs, the charity will not pay federal income tax on distributions from the plan (and the donor could receive an estate tax charitable deduction for the amount left to the charity). The charity may also be exempt from state income taxes, which would allow the entire amount to pass to the charity free of tax.
Consider a donor who has $100,000 in cash and $100,000 in an IRA. She wants to leave $100,000 to her daughter and $100,000 to her church. If the donor names her daughter as beneficiary of the IRA, the daughter will pay income tax (assume a combined federal and state tax rate of 40%), leaving her with $60,000. The charity would receive the $100,000 in cash.
Instead, if the donor names the charity as beneficiary of the IRA and leaves her daughter cash, the charity receives the entire $100,000 (no income tax is assessed on the distribution from the IRA) and the daughter receives $100,000.
Even for donors wishing to make small gifts to charity (rather than the entire balance in their retirement accounts) there are ways to divide retirement accounts and set up beneficiary designations that can take advantage of the income and estate tax savings afforded by using retirement accounts to fund charitable bequests.
If you are charitably motivated, now is a good time to review your existing estate plan to make sure that your charitable gifts are properly structured to maximize your income and estate tax savings.