How to Make Charitable Gifts from Your IRA
Thanks to the success of tax-deferred investments within qualified retirement plans, many people have found that they have sufficient funds for retirement and that they will probably have funds left for distribution to heirs and charitable causes they wish to support.
IRAs as Charitable Bequests
An IRA can be one of the best assets to use for a charitable bequest. Distributions from an inherited IRA to the beneficiary are usually fully taxable to the beneficiary, an exception to the rule that most inheritances are exempt from the income tax.
Example: Assume Frank would like to treat his two grandchildren, Patty and Michael, equally. Upon his death, he leaves Patty $100,000 in stock that he had purchased for $60,000. He leaves his $100,000 IRA to Michael. When Patty receives her $100,000 in stock, she will not have to pay any capital gains tax. In fact, she obtains a "stepped-up" cost basis in the stock so that if she sells the stock for $100,000, she will pay no capital gains tax. By comparison, when Michael receives the $100,000 from the IRA, the entire amount will be subject to income tax because IRA distributions are taxable, even after death. Consequently, Frank did not treat his two grandchildren equally. Michael will receive less money than Patty after he pays the income tax liability. If you are planning to make a charitable bequest, you should consider leaving the taxable IRA assets to your favorite charitable organization so your family and friends will receive more of the other income tax-free assets (e.g., cash, stock and real estate). The organization will not be worse off. It is tax-exempt and will be able to keep the full amount of every IRA distribution.
Estate Taxes and Your IRA
Whereas the highest current estate tax rate is 45 percent, inherited IRAs are subject to an even higher tax rate because each distribution will trigger an income tax liability and a potential estate tax liability. For most taxable estates of more than $2 million, the combination of federal income and estate tax rates on IRA assets can reach 65 percent. If your state has an income tax, those assets could be facing a total tax rate of nearly 70 percent! While your IRA assets are subject to double taxation (i.e., both federal estate and income taxes), the IRS allows the IRA beneficiary to take an income tax deduction for the estate taxes paid on the IRA. Without this deduction, your IRA could be reduced further, leaving your heirs a fraction of the original amount. To show the benefit of the tax deduction, consider the following:
Example: Assume that Kathryn's total taxable estate is $3.2 million and that all of it will be transferred to her sole heir, her daughter. If $100,000 in an IRA is distributed to the daughter and the daughter is in a 35 percent marginal income tax bracket, then the combined estate and income taxes after the deduction is factored in would be roughly 64 percent ($64,250) on the $100,000 IRA.
Without the deduction, the daughter may have paid more than 70 percent of the IRA in federal and
state taxes.
A Charitable Solution
A bequest of your IRA assets to a charitable organization avoids all estate and income taxes. The organization will keep 100 percent of the IRA assets and will apply them to a charitable purpose you choose. How does this work? First, your estate may claim a charitable estate tax deduction
because the IRA will be transferred to a charitable organization. Second, if you name the charitable organization as the beneficiary on the IRA forms and if the IRA is distributed directly to the organization after your death, then neither your estate nor your heirs will have to report any
taxable income from the distribution! Because a tax-exempt organization is the beneficiary, it will not have to pay any income tax when it receives the distribution. Thus, instead of having the government decide how to spend nearly 70 percent of your IRA assets, you can apply 100 percent of those assets to a charitable purpose that is important to you.
How to Make a Charitable Bequest of an IRA
The best way to make a charitable bequest of your IRA assets is to name your favorite charitable
organization as the beneficiary on your IRA beneficiary designation forms. Please note: Your will
does not govern your IRA. An IRA is a separate trust or custodial account that usually passes outside of probate. The most important document, therefore, is the beneficiary designation form you receive from the IRA administrator.
For More Information
See a competent tax advisor before you take any action with your IRA accounts. With good planning, you can make a major charitable gift of your IRA at a very small cost to your family and friends.
Copyright: The Stelter Company. The information in this publication is not intended as legal advice. For legal advice, please consult an attorney. Figures cited in examples are based on current rates at the time of printing and are subject to change. References to estate and income tax include federal taxes only; individual state taxes may further impact results.
