“Helping Charities While Reducing Taxes- Part I” - November 8, 2009

I recently met with a client couple as part of an estate planning review. As is true with so many people, this couple expressed a strong desire to give to charities both during their life and at their death. This week, I’ll focus on a strategy for giving to charities at death.

Often people will make charitable gifts by designating a Specific Bequest in their will. The typical logic is that they want to make sure that all of their assets are available for their support during their lifetime. Then, at the last of them to die, they want to make a gift, typically of a certain dollar amount, to their church, college or other charity. While this is pretty straight-forward planning, there may be an even better way to accomplish the same goal while significantly reducing taxes that will have to be paid by heirs.

Think of your own situation or maybe a family member. Do you (or they) plan to make charitable gifts at death? Instead of making a specific bequest in your will, consider making the same gift by using your retirement account. You see, contributing to a retirement account is one of the best ways to accumulate wealth during your working years because you receive a tax deduction for your contributions and tax-deferred growth until the funds are taken out during retirement. During retirement, people often leave as much money as possible in their retirement account in order to avoid income taxation on their withdrawals. As a result, they often die with money still left in their retirement account. However, a retirement account is one of the worst assets for an heir to receive. This is because not only are retirement accounts potentially subject to estate taxes, the heirs must also pay income taxes as they make withdrawals. For the wealthy, this combination of estate taxes of possibly as high as 55% and income taxes of possibly as high as 39.5% could eat up nearly 70% of your retirement account!

Here’s a strategy for making smarter testamentary gifts. Let’s assume that you and your wife have decided to leave your alma mater $100,000 at the last of you to die. Instead of making a specific bequest under your will, you change the beneficiary designation under your IRA account to reflect your wife as the primary beneficiary and your alma mater as the second beneficiary for $100,000 with the balance going to your children. If your wife predeceases you, your alma mater receives $100,000 and the balance goes to your children. If you die before your wife, she receives your entire IRA account and can ‘roll-over’ the account into her own name. She’ll then need to name your alma mater the primary beneficiary for the first $100,000 of the retirement account while naming the children the primary beneficiary for the balance. As a result, at her death, the charity receives the same amount of money, $100,000, from the retirement account instead of from the personal estate. You have effectively ‘given away’ the tax problem. Another advantage is that if you decide to make changes regarding your charitable contributions, changing beneficiary designations is easy and free while changing specific bequests under your will would require you to engage an attorney.