In spite of charitable intent, many generous folks fail to include charities in their estate planning. When inspired to make a “planned gift,” they procrastinate rather than go through the trouble of redrawing their will. Does this sound like you?
Here is one possible solution: Call your banker, investment advisor, or human resources person at work and request a “Change of Beneficiary” form for your IRA or company retirement plan. Fill out the form including your charity for some percentage of the account.
These particular “pre-tax” assets are ideal for giving at death relative to other “after tax” assets like real estate and securities you own. This is because they have imbedded tax liability to a person who withdraws from them. That is, you will pay tax at ordinary income tax rates when you draw from your IRA or retirement plan and so will your heirs after your death. The good news, and the point of this article: a qualified charity-beneficiary will pay zero percent tax on these dollars.
By comparison, a life insurance death benefit is tax-free to individuals. Also, investments made with after-tax dollars in real estate or stocks, for example, can be inherited with a cost basis equal to the value of that asset at the date of your death. This is referred to as a “step-up in basis” and it is a true tax benefit to your heirs. The gain or loss your heirs report upon sale will be the difference between the value at your death and the value when they sell. If they sell almost immediately, that could mean zero gains, zero tax.
Therefore, it would be best to will appreciated non-IRA assets (stock, for example) to your children and leave an IRA to charity. For example:
You have $500,000 in stocks you have been accumulating for decades. The basis in the stocks is $100,000 so the gain, were you to sell them today, would be $400,000. At today’s rates (in 2014), you would incur taxes between $60,000 and $90,000 in federal taxes alone, depending on your income. The good news is that you have no intention of selling the stock so you are not worried about the gain.
You also have a $500,000 IRA. Every dollar of this is subject to tax if you draw it out and, worse, it is subject to ordinary tax rates which get as high as 39.6%.
You wish to leave $500,000 to charity and $500,000 to your children who pay taxes at an average rate of 30%.
In the “poorly advised” scenario, you leave the $500,000 IRA to the children and the stocks to the charity. The charity grosses and nets $500,000, of course, as the charity does not pay tax anyway. The children inherit an IRA with a net value after taxes of about $350,000.
In the “better advised” scenario, you leave the $500,000 IRA to the charity and the stocks to the children. The charity grosses and nets $500,000, of course, as the charity does not pay tax. The children inherit $500,000 of stocks with a cost basis equal to the current value–stepped-up at your death. Therefore they could sell the stocks today and pay zero capital gains taxes. They gross and net $500,000.
Only the IRS can complain; they “inherit” $150,000 less in this scenario.
The best part about this technique is its ease; a beneficiary form is quite simple to complete. However, it is important to coordinate beneficiary designation planning with the rest of your estate plan. You could, for example, duplicate a planned gift by providing for it in your will and also in the beneficiary designation without coordinating language. Or, if you rely solely on a beneficiary designation and do not back up the planned gift in your will, there is a possibility that your charities will receive nothing if that source account is depleted late in life.
Your competent estate planning attorney and capable financial advisor should be consulted prior to your making substantive changes to your beneficiary. For a thorough exploration of the best way to create a perfect outcome at your death, read the article entitled Planned Giving Problems and Solutions.
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.