Donating Retirement Accounts to Charity
Advisors can steer clients to a planned gift that provides unique benefits to both client and community.
If a donor has made a decision to give to charity at his or her death, retirement plans can be viable—and valuable—solutions. Such planned gifts not only maximize the charitable benefit, but also ease the income and estate tax burden on heirs.
Some community-minded clients are primarily attracted to the charitable advantage, while "bottom liners" tend to also focus on the income and estate tax advantages. "Advisors should prompt clients about their charitable intentions," says Stewart Welch III, CFP of the Welch Group in Birmingham, Alabama, and author of J.K. Lasser's New Rules for Estate and Tax Planning (Wiley, 2002). "If a client does have charitable intent, we would look at their assets, in particular IRAs, 401(k)s, and pension funds first."
Retirement funds can be among the most-efficient planned gifts, Stewart says, whether your client's intention is charitable or "bottom line." From the charitable viewpoint, these gifts are much easier to handle than complicated securities transactions and provide instant tax-free cash to charities. By contrast, many charities have a policy of selling off securities immediately, and may not get the best value out of them as a result.
In addition, donors have much more flexibility in directing their charitable dollars with a retirement fund gift. Research indicates that most donors have multiple charitable recipients in mind for legacy gifts. They can direct that a retirement fund be divided, for example, $30,000 to the community fund; $30,000 to the humane society; and $30,000 to their alma mater. And, best of all, Stewart says, changing the beneficiary of a retirement can be as simple as filling out a form, especially for the cookie-cutter IRA. "The piece of paper is free and you can change beneficiaries as often as you like. With other assets, the client may have to rewrite [his or] her will or add a codicil, which quickly racks up lawyer's fees." The flexibility and ease of changing beneficiaries allows clients to keep their estate plan in tune with their charitable values and interests over time.
Reducing Tax Obligations for Heirs
Donating retirement accounts to charity can also benefit heirs. For one thing, heirs avoid the future income and estate tax on the retirement fund, as well as the forced immediate payout for some types of funds. By contrast, bequeathing securities to heirs avoids an initial capital gains tax by taking advantage of the step-up in basis.
"If a security has been in the family for generations, its original cost basis, or value, may be difficult to determine," Stewart says. "Therefore, for estate purposes, the value of the stock is based on its value at the death of the beneficiary or six months later, whichever is higher." Heirs do not pay capital gains tax until the stock is sold, and that tax will likely be minimal, since it is based on the stepped-up cost as the new basis.
No matter what the clients' motivations are, advisors need to be vigilant in protecting their interests regarding estate planning. As of January 1, 2004, clients are permitted to pass on $1.5 million to a spouse, children, or grandchildren free of estate tax, says Harold Apolinsky, Esq., senior estate planning specialist with the law firm Sirote & Permutt, PC, in Birmingham. "The biggest mistake couples make is combining all of their assets together in one account," Apolinsky says. "Brokerage houses often encourage joint accounts so that they will retain the account after the first spouse dies, but that is not in the couple's interest. Spouses should hold separate accounts to each take advantage of the $1.5 million, or combined $3 million, estate tax free."
After the $3 million ceiling, clients' heirs will pay a combined 75 percent estate tax on the remainder. However, many beneficiaries, and even lawyers and accountants, overlook the fact that they may take a credit against their income tax for any estate tax paid (Section 691 of the IRS code), Apolinsky notes. "This credit is not advertised by the IRS. It's not reflected on your income tax form or even in TurboTax, but your client has a right to the credit."
Beware Changing Tax Laws
Advisors should also be aware that estate tax laws are changing and remain somewhat cloudy for the future. By 2010, the estate tax exemption will be $2 million or $4 million, and step-up in basis may be abolished. This makes estate planning complicated for the client, and it's your job to guide them with the help of a professional team, including an attorney and an accountant. You'll need to determine that your client has thoroughly considered every option and that the choice is in his or her own best interest.
In the end, advisors report that donating retirement funds to charity makes them—and their clients—feel great. "You feel like you're doing something great for your client and your community," Welch says. Ultimately helping clients reach their goals—especially when those goals are lofty—is what makes planning so fulfilling.
Eva Marer is a freelance writer based in New York City.
Copyright 2004 Community Foundations of America
Used with permission