Charitable Planning for Retirement Benefits

 There are numerous tax advantages of giving qualified retirement plan and individual retirement account (IRA) benefits to a charity.

When funds are drawn out of retirement plans and IRAs by noncharitable beneficiaries, federal income tax of up to 37% (in 2019) will have to be paid. State income taxes also may be owed. Furthermore, retirement funds possessed at death may be subject to substantial federal estate tax and state death tax.

Retirement benefits are to be contrasted with other assets that can be passed to noncharitable beneficiaries free of income tax. For example, an individual inheriting stock worth $300,000 from his parent (that was purchased by the parent for $100,000) won't have to pay income tax on the $200,000 appreciation. That's not the case for retirement benefits. They are subject to both income tax and estate tax. A special income tax deduction for the estate tax helps noncharitable beneficiaries but the combined income and estate tax can still be quite substantial. Because of this double tax bite, someone who plans to make charitable gifts should consider naming a charity as beneficiary of his IRA or retirement plan to gain these advantages:

•       The retirement benefits going to the charity won't be subject to federal estate tax and generally won't be subject to state death taxes.

•       The estate won't be considered to receive taxable income when the benefits are paid to the charity.

•       The retirement account owner's surviving spouse, children and others who may be beneficiaries of the estate won't be considered to receive taxable income when the retirement benefits are paid to the charity.

•       The charity won't have to pay federal income tax on distributions from the qualified plan or IRA and generally won't have to pay state income taxes.

For one who is not in a position to leave his/her entire retirement benefits to a charity, there are these options:

•       An individual with two or more retirement plans (e.g., an IRA and a profit-sharing plan, or two IRAs) can leave one to a charity and the other(s) to family members.

•       An individual with a single IRA can split it into two IRAs and leave one to a charity. This can be achieved tax-free through a rollover or a trustee-to-trustee transfer.

•       A married individual can have his/her benefits paid to a QTIP trust for his/her spouse with a charity to receive the benefits that remain at the death of the surviving spouse. The marital deduction will shield the benefits from estate tax when the individual dies. When the surviving spouse dies, the remaining benefits will go to the charity free of estate and income tax.

•       An individual can have his/her will establish a charitable remainder trust at his/her death to provide a noncharitable beneficiary with a fixed annuity for a set number of years (not to exceed 20) or for life, with the remainder going to charity.

Another popular way to transfer IRA assets to charity is via a tax provision which allows IRA owners who are 70 ¹/₂ or older to direct up to $100,000 per year of their IRA distributions to charity. These distributions are known as qualified charitable distributions, or QCDs. The money given to charity counts toward the donor's required minimum distribution (RMD), but doesn't increase the donor's adjusted gross income or generate a tax bill.

Keeping the donation out of the donor's AGI is important because doing so can (1) help the donor qualify for other tax breaks (for example, having a lower AGI can reduce the threshold for deducting medical expenses, which are only deductible to the extent they exceed 10% of AGI (for 2018 and thereafter)); (2) reduce taxes on the donor's Social Security benefits; and/or (3) help the donor avoid a high-income surcharge for Medicare Part B and Part D premiums (which kick in if AGI is over certain levels).

Further, because charitable contributions will not yield a tax benefit for those taxpayers who no longer itemize their deductions (thanks to the larger standard deduction for 2018 and thereafter), those who are age 70 ¹/₂ or older and are receiving RMDs from IRAs may gain a tax advantage by making annual charitable contributions by way of a QCD from an IRA. This charitable contribution will reduce RMDs by a commensurate amount, and the amount of the reduction will be tax-free.

If you would like to discuss any of these techniques, please contact us.