INDIVIDUAL RETIREMENT ACCOUNTS
The typical donor:
- Has substantial sources of retirement income.
- Has other assets to pass to heirs.
- Wants to make a substantial gift at death.
Gift features and benefits:
- Estate tax deduction (gift at death).
- Available if needed during life (gift at death).
- Avoidance of taxable withdrawals (gift at death).
- A significant gift to charity (gift during life or at death).
Like many Americans, you are probably aware that the accumulation
of assets in your retirement plan is the basis for a financially
secure future. To preserve your retirement assets after your lifetime,
consider the benefits of using them in a totally different way.
Retirement accounts are often exposed to income taxes and estate
taxes, at a combined marginal rate that could rise to 75 percent
or even higher on large, taxable estates. Yet many of these taxes
can be avoided or reduced through a carefully planned charitable
gift.
Other considerations come into play when deciding on using retirement
plan assets for charitable giving. Your account can pass directly
to a charitable organization as your primary beneficiary, or it
can be transferred to a deferred giving arrangement that will
pay an income for life to a family member, after which the remaining
assets pass to the organization. You might even consider a deferred
gift that is designed to pay a life income to yourself.
How Retirement Accounts Are Taxed
Qualified retirement plans are those that receive favorable income
tax treatment during an employee's lifetime. No income tax is
due on the funds as contributed, and no income tax is due on the
earnings and appreciation while in the plan. You pay taxes on
the funds only when you receive them. Such plans come in many
forms: a defined benefit or contribution pension plan, money purchase
pension, profit-sharing plan, annuity plan, 401(k) or 403(b) plan,
stock bonus plan, Employee Stock Ownership Plan (ESOP) or simplified
employee pension (usually a SEP-IRA) from your workplace, and
Keogh accounts and Individual Retirement Accounts (IRAs) you set
up for yourself.
Generally, the undistributed balance of qualified retirement
plans is fully includable in your gross estate for estate tax
purposes. Since the funds in retirement accounts usually represent
deferred compensation that has not been subject to income tax,
giving the accounts to individual heirs exposes the funds to income
taxes. Your retirement dollars can be seriously depleted by this
double taxation.
A qualified retirement plan often makes a large, taxable distribution
shortly after an employee's death. As a general rule, qualified
plans other than IRAs will specify how quickly distributions must
be made from the plan. In the case of an IRA, if the owner dies
before reaching the required beginning date, the plan benefits
must generally be distributed within five years or, in some cases,
within one year. If the owner dies after the required beginning
date, then the entire balance can be distributed over the owner's
life expectancy or over the designated beneficiary's remaining
life expectancy. The new regulations are a major improvement over
prior law and allow designation of a beneficiary as late as the
last day of the calendar year following the calendar year of the
owner's death. Only a surviving spouse can roll over an inherited
distribution to his or her own IRA and benefit from further income
tax deferral; all other beneficiaries are taxed according to the
above rules.
Income in Respect of a Decedent
The IRS labels estate assets that were not previously included
in a decedent's taxable income as items that generate "income
in respect of a decedent" (IRD). In plain language, these
are assets that would have been taxed as income had the recipient
lived long enough to receive them. In addition to qualified retirement
plans, IRD items include accrued interest on Certificates of Deposit
and savings bonds, unused vacation pay, non-qualified stock options,
deferred payments of capital gains and other undistributed but
earned income. Among all your assets, the largest IRD source will
probably be your retirement accounts.
By donating retirement assets, those funds avoid both estate
and IRD taxes, and you can be certain that 100 percent of the
balance of your retirement funds will support your philanthropic
objectives. Generally, the cost to individual heirs will be modest.
Example: Bill is considering adding a charitable
bequest to his will, with the residue of his estate passing
to his children. Instead, he should name Baltimore Community
Foundation as beneficiary of his profit-sharing account. The
death benefit passing to the organization will not only qualify
for the estate tax charitable deduction but will also pass free
of any income tax obligation. His children will benefit from
this change because, rather than getting the profit-sharing
account proceeds that are subject to income tax, they will receive
other assets of his estate that are free of income taxes.
For example, Bill owns stocks that have a low cost basis. He
can secure a further tax advantage by leaving these to his children.
They will receive a step-up in the income tax basis to the date-of-death
value of the stocks. Since the basis is the amount from which
any gain or loss will be figured when the new owner ultimately
sells the property, this means there will never be a tax on the
appreciation that occurred during his lifetime. The person who
inherits the property will owe tax only on appreciation after
the time of Bill's death.
How to Donate Your Retirement Account
The simplest way to leave the balance of a retirement account
to us after your lifetime is to list us as the beneficiary on
the beneficiary form provided by your plan administrator. Never
make a beneficiary change, however, before discussing your desires
with your professional advisor. For an IRA or Keogh plan you administer
personally, notify the custodian in writing and keep a copy with
your valuable papers.
If you are married, your surviving spouse is entitled by law
to receive the entire amount in these qualified plans: money purchase
pension, profit-sharing plan, 401(k) plan, stock bonus plan, ESOP
or any defined benefit or annuity plan (though not an IRA). In
order for the assets to be transferable to BCF, your spouse must
execute a written waiver (even though you may designate a charitable
organization as beneficiary on your employer's forms). Your spouse
can execute one after your death, if necessary. In that case,
the document must also include a qualified disclaimer.
If you prefer to make your spouse the primary beneficiary of
the retirement account, you can name BCF as the secondary beneficiary.
Perhaps you want your children to benefit from your retirement
account, too. In that case, you might designate a specific amount
to be paid to us, before the division of the rest among your children.
Tax Precautions and Options for Charitable
Transfers
Being cautious in the way you designate your charitable bequest
will assure that you are not setting your estate up for some disadvantageous
tax consequences.
Suppose your will provides that your retirement plan assets are
to be used to fulfill a specific bequest to the Foundation. A
problem could arise if your estate were required to recognize
the plan distribution as taxable income while not being able to
claim an offsetting charitable income tax deduction. To sidestep
this problem, your will should provide that payments to the Foundation
are to be made from IRD items. A different way to avoid this problem
is to omit any reference to the charitable contribution in your
will and instead simply designate the charitable organization
as the successor beneficiary on the retirement plan forms provided
by your employer.
Once you reach age 70 1/2, you are required to begin taking payments
from your qualified retirement plans if you have not yet done
so. The amount of your required minimum distribution changes if
you choose to include a second life in the calculation that determines
the minimum amount--for example, if you include a child as a beneficiary.
You could then take less of a distribution, leaving a greater
balance to be inherited.
The new IRS rules make it much easier to substitute a charitable
organization as the second beneficiary. This no longer creates
a problem if you want to minimize the distribution amount. Under
the new regulations, designation of a charitable organization
as the beneficiary of a portion of the plan benefits will not
increase the employee's minimum required distribution, despite
the fact that the organization would not qualify as a designated
beneficiary. This will be true whether the beneficiary designation
is made before or after death. It may be preferable to make certain
that the amounts are paid to the charitable organization before
the end of the year following the employee's death.
It is also possible to name your son or daughter as beneficiary,
in order to achieve a lower distribution, and us as contingent
beneficiary, with the understanding between you and your child
that upon your death your child will execute a qualified disclaimer
so that the assets pass to the contingent beneficiary. This results
in an estate tax deduction and your philanthropic wishes being
fulfilled, but you must rely on your child's word to carry out
your plan.
Life Income for Survivor
Another tax-benefiting possibility is to transfer retirement assets
at death to a tax-exempt deferred giving plan, such as a charitable
remainder unitrust or a charitable remainder annuity trust. The
trust beneficiary you designate will receive an income for life,
either a fixed percentage of the value of the trust assets as
revalued annually or a fixed dollar amount. Thereafter, the remaining
principal will support our work.
By naming a deferred giving plan as the ultimate beneficiary
of your retirement account, income taxes can be deferred over
the life of the income beneficiary you designate. This may offer
the only income tax deferral opportunity for your heirs if your
retirement plan requires an immediate distribution.
Example: Under the rules governing her company's
profit-sharing plan, Anne's account must be distributed within
five years after her death. She estimates that when she dies,
the account balance could be at least $200,000. If she were
to name her daughter, Sandy, as the beneficiary, the entire
amount would go to Sandy as ordinary, taxable income, incurring
probable federal and state income taxes as high as $55,000.
In addition, a federal estate tax of $75,000 would be due if
Anne's other assets equaled more than the amount exempt from
estate tax. Less than $70,000 of the $200,000 could be left
for her daughter after payment of all the taxes!
Instead, Anne creates a charitable remainder unitrust and names
it as the beneficiary of her profit-sharing plan. She arranges
for the unitrust to pay 7 percent of the value of the assets to
Sandy each year for life. The net result is significant income
tax deferral. The entire $200,000 can be invested to produce investment
income. The estate tax on the value of Sandy's interest would
typically be paid from other assets. The partial estate tax charitable
deduction for the present value of the charitable remainder interest
will reduce Anne's estate tax.
Calculate
how a charitable remainder annuity trust can benefit you.
or
Calculate
how a charitable remainder unitrust can benefit you.
Precautions on Transfers to Deferred
Giving Plans
As with charitable bequests, similar problems may arise with deferred
giving plans. If the retirement plan distributes to the estate
and then the will distributes to a deferred giving plan, this
may result in taxable income from the transfer of retirement assets
to the deferred giving plan. The estate, of course, is entitled
to claim only a partial charitable deduction for the value of
the remainder interest that will pass to the charitable organization.
There are currently no clear-cut precedents or tax rulings that
address whether or not a testamentary (by your will) transfer
of deferred compensation to a deferred giving plan causes the
income beneficiary of the deferred giving plan to incur taxable
income in the year of transfer rather than at the time of distributions.
In fact, there are arguments both ways on this issue. If you are
considering using your will to set up a deferred gift of your
retirement assets, rather than directly naming a trust on your
employer's forms, you may find it advisable to have your attorney
obtain a ruling from the IRS before you proceed further.
Again, the simple solution is to make the deferred giving plan
the beneficiary of all or a portion of the retirement plan assets,
so that they will bypass the estate's reportable income.
Draw Life Income From Charitable Rollover
So far, our discussion has related to arrangements after your
lifetime, but you may use retirement plan assets to benefit yourself
during your lifetime and us thereafter using a charitable remainder
trust.
You arrange a lump-sum distribution from your qualified plan.
Then, you contribute the after-tax amount to a charitable remainder
trust that assures you an income for life while committing the
remaining assets to us after your lifetime. This results in an
income tax charitable contribution deduction that may partially
offset the tax on the lump-sum distribution. (Each situation must
be analyzed individually to determine the exact financial benefits.
We recommend the counsel of a financial professional.)
Valuable Estate Planning Strategy
While donating the balance in a retirement plan account may be
the most tax-effective means of supporting our mission, it is
also a relatively new area of estate planning. Please seek guidance
from an attorney and other professionals who are thoroughly versed
in this field of tax law.
