Ideas for Transferring IRAs and 401k’s

Beneficiary Designations And How to Gift to Charities Most Tax-Efficiently

When doing estate planning, the issue of gifting to favorite charities often arises.   Is there a best way to contribute to a non-taxable charitable entity, such as a church, a school, or some other organization that has been granted non-profit, tax-exempt status?   In fact, there are two ways to contribute to a charity that may be more advantageous from a tax standpoint.

First, it must be clear that the very nature of the question involves analyzing your accounts subject to tax and those that are deemed “after-tax”.  A taxable account, a.k.a. a qualified plan might include retirement plans through your employer or an IRA.

IDEA #1:

An individual who designates assets that are after-tax, such as brokerage account investments, to a charity will certainly accomplish the goal of gifting funds to the person’s favorite non-profit entity.  However, it should be considered whether it is better to name a non-profit entity or another individual  of a qualified plan, such as an IRA[1], is drafted to be the charitable organization, it would be a more efficient use of dollars.  Here’s why: Let’s say the IRA holds $100,000.   If this amount is transferred at the individual’s death under the beneficiary designation to the charity, then the charity receives $100,000 with no taxes owed.  The full gift is $100,000.  If $100,000 had been given to an heir or another individual, taxes would be owed, perhaps as much as 40%, leaving the gift to the individual at $60,000.  A loss of $40,000 to taxes would be incurred.  Clearly, a tax qualified plan naming a non-profit entity as beneficiary would be a more efficient use of dollars.

IDEA #2:

A living individual who is at least 70-1/2 years of age must take a portion of the qualified plan account each year under current tax law.  This amount is called a Required Minimum Distribution (RMD).   Tax law also permits such an individual to take his RMD but transfer it directly to the charity and have it qualify as the actual RMD.  No tax will be owed by the individual, nor, of course, will tax be owed by the charity. So for example, an IRA holding $100,000 might require an RMD of $8,000 in a particular year.  Donating this amount directly to the charity passes the amount tax-free, rather than subjecting the amount to the individual’s tax bracket. It becomes a much more tax-efficient use of contributing the $8,000 by donating it directly to the charity.

DOWNSIDES:

Taxes are an important consideration when moving money.  But taxes can be weighed against other factors.  Either of these ideas require an administrative process that allows for the easy transfer of funds.   If naming beneficiaries in a qualified plan and expecting the plan administrator to timely contact the charity about its beneficiary designation.  Unless, the charity knows of its designation in advance, and then has knowledge of the death of the individual, such beneficiary designation may never be consummated by a transfer of funds to the charity.

A second factor to consider is the tax bracket of the individual who might otherwise receive the funds.  If that person is in a low tax-bracket, say 15%, the advantage may not be significant.

Another factor to consider would be charitable intent.  If the individual participant in the qualified plan wants all funds to go to family and friends without any funds going to charity would not be interested in ideas such as those outlined above.

Finally, it should be remembered that with nearly all financial ideas, the benefits can be parsed to the degree desired.  For example, if the individual only wants to name a charity to receive $25,000 of the $100,000 IRA, then the charity would be designated to receive 25%, or that specific dollar amount.  The remainder could then be left to the individual’s heirs.

If you are interested in discussing these ideas further, please contact our office to set an appointment.

 

This article does not intend to provide any tax or legal advice but suggests that you contact an appropriate professional to consult with on your specific situation and whether these ideas meet with your goals and objectives.

[1] A qualified plan means the plan holds funds that are “tax-qualified” such that taxes are still to be owed those funds.  Qualified plans generally include IRA’s, or employer-sponsored retirement plans such as 401(k)’s, profit sharing plans, or other types of defined contribution plans under the Internal Revenue Code.

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