Make Charitable Bequests From An IRA

Published: 18th February 2010
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Use Different Accounts

Legacy from your IRA may stretch out benefits to heirs in the long run.

Making charitable gifts with appreciated securites is generous. It also offers you tax benefits. As long as you have held the securities more than one year, you will get a deduction for their full value.

You will gain from the appreciation without having to pay capital gains tax.

But a good tax strategy for you may not work out best for your heirs.

Instead of using appreciated stocks or funds in a taxable account, make a charitable bequest from your IRA.

Suppose Alexis Jones is a widow with two chidlren. She has two assets. One is a traditional IRA with $500,000. The other is a portfolio of stocks worth $500,000.

The stocks were brought years ago. Jones' cost basis is $200,000.

Say Jones wants to leave $500,000 to charity and $500,000 to her children. She might do that by leaving the appreciated stock to charity.

That way, her children will inherit the IRA. But they will owe income tax on every withdrawal.

Assume that Jones' children will owe 40% tax on withdrawals, counting federal and state income tax. The $500,000 IRA she leaves them is worth only $300,000, after-tax.

On the other hand, Jones could leave the appreciated stocks to her children. The charity could be named as beneficiary of her IRA.

At her death, the charity will recieve $500,000 from the IRA. As a tax-exempt entity, it can withdraw funds without owing tax.

So the charity escapes tax either way. But Jones' children will be much better off if they inherit the appreciated securities. Under current law, they will inherit with a basis step-up to current value.

Say the securities are worth exactly $500,000 on the day Jones dies. That would give her children a $500,000 basis in those stocks.

They can sell for $500,000. They would owe no income tax. That would be better than inheriting a $500,000 IRA and paying tax on all withdrawals.

Split The Account

But even with a $1 million estate, you may want to leave much less than $500,000 to charity. No matter how large or small the bequest, at your death charitable donations should come from your IRA.

That will cut income tax your heirs will owe on IRA withdrawals. And bequething assets from your IRA may leave more appreciated securities for loved ones, who will enjoy a basis step-up.

One way to make a partial charitable bequest from your IRA is to split the account. Say Jones wants to leave $50,000 to her alma mater.

She could transfer $50,000 from her $500,000 IRA to a new IRA. Her alma mater could be the beneficiary of this account.

Jones can monitor this IRA over the years, making sure that the amount in there is the amount she wishes to leave to the school.

For her original IRA, now a $450,000 account, her children can be the beneficiaries. They will inherit the account at her death and not have to worry about the school.

If you prefer to have only one account, you can include a charity or charities among the IRA beneficiaries.

Jones might designate her alma mater as a 10% beneficiary of her $500,000 IRA. Each of her children would be 45% beneficiaries.

There might be a tax trap to this strategy, though. When a charity is included among IRA beneficiaries, the account may have to be paid out relatively soon.

This can deprive your other heirs of valuable tax deferral.

In the above example, say Jones dies at age 70. That is before she is required to take minimum distributions, which occurs after 70 1/2. The inherited IRA must be depleted by Dec. 31 of the fifth year after her year of death.

Or say Jones dies at age 89, while she is taking minimum required distributions from her IRA. Those distributions must be continued by beneficiaries, based on life expectancy for someone 89 years old.

For greater tax deferral, the charitable beneficiary must be cashed out by Sept. 30 of the year following death. It doesn't matter how soon before that date the charity gets its gift.

The key is that the other IRA beneficiaries then can stretch distributions over their remaining life expectancies.

Live Long And Prosper

Suppose Alexis Jones dies in 2010 with a $520,000 IRA and her alma mater is a 10% beneficiary. The other beneficiaries can direct the IRA custodian to distribute $52,000 to the school before Sept. 30, 2011.

Then Jones' two children can split the inherited IRA into their own inherited accounts, in the name of their deceased mother. They must act by Dec. 31 of the year after her death. If one son is, say, 58 years old, he can stretch required distributions over 27 years.

So if you plan to include a charity among IRA beneficiaries, make sure that your heirs know the rules. Tell them to cash out the charity by Sept. 30 of the year after your death if they want maximum tax deferral.$

Ray Buckner (Chicago, Illinois) provides personal financial planning and wealth management services for professionals in the greater Chicago metropolitan area. His primary focus is serving pre-retirees who are preparing for a successful retirement as well as those who have already retired and want to develop a 100% retirement income personal paycheck. His pre-retiree clients want to focus on replacing 100% of their last year's income and keep their current standard of living through out their retirement adjusted each year for inflation.

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