General
Charitable gifts of retirement plan assets are popular because income in respect of descendent (IRD) left to charity can escape both estate and income taxation. Generally, if the client’s estate is large enough to provide for both individual heirs and charitable gifts, the best strategy is to leave individual beneficiaries the non-IRD property, which receives a stepped-up basis (under IRC 1014) at death so is not double taxed, and leave the retirement plan proceeds to charity.
Example
Assume that Lorraine Smith is a widow with one child, Jack, who is in the 35% federal and 4.6% state income tax bracket. Her estate of $1.5 million consists of a $650,000 rollover IRA, her house valued at $400,000, and $250,000 of stocks. She has her full unified credit available. Lorraine wishes to benefit both Jack and the local University.
Table 1: Lorraine leaves 50% of each asset to Jack and 50% to her favorite charity so at her passing the following occurs:
Table 2: Lorraine leaves the entire IRA to charity and the house and securities to Jack and dies. The income tax from the IRA is avoided, and Jack receives $128,700 more.
These examples and tax concepts are for illustration purposes only. In the real scenario, a further detailed analysis may be necessary to compute the actual tax savings.
Outright Testamentary Charitable Gifts of Plan Proceeds
Charity as Sole Plan Beneficiary
Donors are often advised that an outright testamentary gift of retirement plan proceeds to charity is simple planning since the charity needs only to be named the plan beneficiary on a beneficiary designation form. This approach is typically an inexpensive strategy since no unique documents are required, so no legal fees are involved.
Various Plan Beneficiaries with Charity as a Beneficiary
Most important to understand is that a charity is not a “designated beneficiary” for minimum distribution rules that permit distribution options to natural persons, such as the ability to take a payout over the life expectancy.[1] A charity’s deemed life is zero, which can create challenges when a portion of a retirement account is given to a charity beneficiary. The remaining portion is given to natural persons.
Example
Larry Fowler, a widower with one adult daughter, has a $1 million IRA. Before his RBD, he completes a beneficiary designation specifying that $10,000 of the IRA proceeds is to pass to his Community Foundation and the balance to his child. If Larry passes away before his RBD, all of the proceeds must be paid out within five years.[2]
This concern can be avoided by splitting the IRA into two separate IRAs, with one payable to Larry’s charitable beneficiary and one payable to Larry’s child. The distribution to charity will be in a lump sum, but since the charitable organization is tax-exempt, there is no accelerated income tax. In 2020 however, Larry’s daughter will be required to take all distributions from the inherited IRA within ten years of establishing her inherited IRA.
Payment to Estate or Living Trust
If the right to receive retirement plan benefits is bequeathed explicitly to charity under a will or living trust for income tax purposes, it should be the same as if the charity were designated as the plan beneficiary. When the recipient is a charitable organization, it will receive the proceeds tax-free.
When the right to receive the plan proceeds is bequeathed to charity, but the proceeds are paid to the estate before the estate may transfer to the charity the right to receive the IRD, the estate will be subject to the IRD. It may not be able to claim an offsetting charitable income tax deduction. Similarly, if a will or living trust includes a pecuniary charitable gift, and the executor or trustee decides to (but is not required to) fulfill a gift with plan proceeds payable to the estate or trust, the estate or trust must pay income tax on the proceeds with zero offsetting charitable deduction.
According to the governing instrument, a deduction is also allowed to an estate for amounts “permanently set aside” for charity.[3] This method eliminates income tax on retirement plan proceeds paid to an estate that passes to a residuary charitable beneficiary. The benefits are not distributed to the charity in the year the estate receives them.
Conclusion
Charitable gifts of retirement plan assets are popular because IRD left to charity can escape both estate and income taxation. Further, these gifts are relatively simple to make, and often the donor can make the necessary adjustments on their beneficiary’s documents themselves.
- Code §401(a)(9)
- Proposed Treasury Regulation 1.401(a)(9)-1 Q & A E-5
- IRC Section 642(c)(2)
You must be logged in to post a comment.