Retirement funds and charitable planning may not be two areas that most people would naturally think of combining. But in many cases, donating retirement benefits to charities can be an ideal solution for both the donor and the recipient.
The first and best reason to leave retirement benefits to a charity is, as with any philanthropic gift, to benefit the organization. If you do not want to help a particular charity achieve its goals, there is no advantage to it being a gift. While you can certainly make charitable gifts in more or less profitable ways, the purpose of the donation is to transfer assets to a cause you want to support. Leaving retirement benefits to charity can help achieve other estate planning goals, as I will discuss later in this article, but only if philanthropy is already a priority.
That said, once you have one or more charities in mind, few people want to cut the government a bigger slice of the cake than necessary. Giving money to retirement plans for charitable purposes can be a highly efficient tax use of your savings.
Keep in mind that, throughout this article, the retirement VA benefits I am discussing are those in which the distributions normally trigger the income tax, such as traditional IRAs or qualified retirement plans. Roth’s plans, where the distributions are tax free, offer no particular benefit for charitable donations.
Since charities are exempt from income tax, they can receive tax-free gifts of retirement VA benefits. Provided that the gift is structured correctly. Therefore, the assets of the retirement plan are worth more to a charity than they would be to a person who would have to pay taxes on any distribution.
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On the contrary, an inheritance is not considered income, so the inherited cash would not be subject to income tax. The heirs must pay the capital gains tax on other inherited assets, such as stocks or bonds, but generally only on the profits that occur after the death of the deceased; Income taxes that accrued during the decedent’s life are forgiven through a so-called increase in the asset cost basis to its death date value. A retirement plan, on the other hand, does not receive this base increase.
There are situations in which leaving retirement benefits to charity might not be an ideal estate planning solution. A young individual beneficiary can, in fact, do better to inherit a retirement plan than to inherit an equivalent amount of dollars after taxes. This is because, if you use the mechanism that extends the payments over the life expectancy of the beneficiary, the power to defer the income tax can leave the beneficiary better.
The rules of minimum distribution for retirement accounts also mean that you could end up leaving charity relatively little if you live long enough to exhaust most of the value of the plan. Participants in the long-term plan may consider giving their required minimum distribution directly to the charity each year, or review a succession plan to provide the charity in a different way as the retirement plan decreases in value.
How to make a charitable gift with retirement benefits
If you plan to leave your retirement plan to a charity, there are several ways to do it, each with its own advantages and disadvantages. Perhaps the most direct way is simply to name the charity directly as the beneficiary of 100 percent of the value of the VA benefits plan at the time of death. Income tax can be easily avoided, and the charitable deduction of inheritance tax is available for the total value of the gift.
This method also works if you leave a retirement account to multiple beneficiaries, as long as they are all charities. With this method, it is important to make sure all the paperwork is in order. Some plan managers may require documentation before allowing the charitable organization to collect the VA benefits. So it is important to make sure that no one involved is taken by surprise.
If you want to divide a retirement account among several beneficiaries, and not all are charities, the planning becomes a bit more complicated. The general rule is that either all beneficiaries must be individuals, or none of them can use the life expectancy payment method.
If you name your child and a charity as equal beneficiaries of your IRA, unless you take additional steps, your child will be forced to waive the income tax deferment that he or she might otherwise enjoy. Keep in mind that if your spouse is the only non-charitable beneficiary, this problem is not a concern, since he or she can simply transfer the portion of the VA benefits to your own retirement plan.
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There are two ways to avoid this rule. If the interests of the beneficiaries in the retirement plan constitute “separate accounts”, each account is treated as a separate retirement plan, so that individuals can take advantage of the incredible payment options.
This method is useful, but risky, because beneficiaries must establish separate accounts before December 31 of the year after the year of the death of the VA benefits plan participant; if they do not, the less beneficial rules apply automatically. The other option is for the charity to receive full payment from you before September 30 of the year after the year of the participant’s death. In this case, the charity is “discarded” as a beneficiary and individuals or individuals can take distributions as they would if no charity had been named.
You do not have to divide the account by percentages. You can also designate a fixed amount in dollars to go to charities, and leave the rest to other heirs. However, anecdotal evidence suggests that some IRA plan administrators will not accept such designations on a beneficiary form.
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In addition, this type of designation can trigger the same problem discussed above; Depending on how the fixed gift is structured in dollars, the option of separate accounts may not be available (although the payment method of September 30 will be). If this kind of gift is small, it may make more sense to forego the slight fiscal benefit and simply make the charitable legacy of other assets and leave the retirement funds solely for the individual beneficiaries. Alternatively, you can make the gift to a charity conditional on payment before September 30, although this will require careful planning to ensure that the estate receives the appropriate charitable estate tax deduction.
There are other ways to protect the interests of individual beneficiaries by leaving a fixed amount of dollars in charities. You can separate your retirement account into two separate accounts, leaving one completely for the individual beneficiary, and dividing the other between a fixed gift in charity and the rest for the individual. While it is possible that some of the individual VA benefits may not be eligible for additional payments, most are protected. If the account is not separate, you can also count the fixed amount of a gift to the charity as the minimum required distribution of the account in the first year after the participant’s death.
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Some donors may wish to leave an amount that is neither a fixed amount nor a percentage, finding it more convenient to determine the amount using a formula based on the size of the general estate or with adjustments that depend on other amounts that go to the charity . However, IRA providers may refuse to accept such designations, since the provider has no way of knowing the total size of the participant’s assets and may not be inclined to engage in complicated accounting issues.
Naming a charity as a beneficiary directly, either alone or together with others, may be the most direct solution, but it is not the only way to make this kind of gift. If it is not possible to name a charity as a beneficiary for any reason, there are several alternatives. You can leave the VA benefits to a trust, with instructions that the trustee distribute the assets to the charity. This option, however, creates substantial complexity with respect to the required minimum distributions and taxes on fiduciary income. As an alternative, leaving retirement VA benefits to a donor-advised fund, which is exempt from taxes, will circumvent many of these problems, although funds advised by donors have their own drawbacks and benefits.
You can also leave retirement VA benefits to your estate, with instructions in your will or other estate planning documents, which the executor must deliver to the charity. The estate is entitled to a deduction of income tax for the amounts paid or reserved for charitable works, but like leaving benefits to a trust, this option is complicated and requires expert knowledge, both in the writing and in the execution.
If you want to encourage philanthropy in an individual heir, such as an adult child, you can make a gift activated by disclaimer rather than making a gift entirely. For example, you could name your daughter the main beneficiary of the plan, with the charity as a contingent VA benefits beneficiary. Specifying that the organization would receive the benefits that your daughter rejects. You may or may not express the wish that your daughter leave all or part of the benefits to the charity. In any case, this disclaimer allows your primary beneficiary to redirect all or part of the benefits to the charity without paying first income taxes.
Types of charities
Up to this point, I have simply said “charity” when I speak of the object of a philanthropic gift. In order to ensure the beneficial tax treatment that I mentioned, it is important to understand which organizations are the right options to make a gift of retirement benefits. Most of the techniques in the previous section are based on the assumption that the charity is exempt from taxes.
A public charity, which can sometimes be heard as a 501 (c) (3) organization, is what most people mean when they simply say “a charity.” These VA benefits organizations meet a variety of requirements imposed by the Internal Revenue Service to secure and maintain the tax-exempt status. Gifts to such organizations present the least amount of complications, although it is best to verify that the organization is truly exempt. For most charities, this will not be a problem.
Private foundations are usually also suitable recipients. They are also 501 (c) (3) organizations, but are mainly supported by contributions from a donor or family. While it is a little more complex from the administrative point of view than public charities, private foundations will also offer similar tax benefits (although there are stricter limits for income tax on gifts to many private foundations).
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There are some special VA benefits rules that can come to play with this type of gift, which are beyond the scope of this article, so you probably need advice from professionals with training in this area. Also keep in mind that you can not make an activated donation for liability exemption when the individual beneficiary is a fiduciary or administrator of a private foundation and the foundation is the contingent beneficiary.
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