As the end of the year gets closer, many taxpayers attempt to streamline their finances to ensure that transactions that can be deducted on their tax returns are completed in a timely way. This includes making gifts to charities. Do you plan to include your retirement assets in charitable donations? If so, consider how it may affect your finances. In some cases, it can be more beneficial to name the charity as a designated beneficiary of your retirement account, rather than gifting the assets during your lifetime. Here we highlight some of the issues to consider when you think about gifting your retirement assets to charity.
Should You Gift Now or at Death?
Instead of gifting your retirement assets to a charity during your lifetime, you may designate the charity as the beneficiary of your retirement account. Under this option, the charity - not you - will be treated as receiving the distribution; therefore, neither you nor your estate will owe income taxes on the amount. While the amount will be included in your taxable estate, your estate will receive a deduction for the amount inherited by the charity, resulting in an offset of the estate taxes. Furthermore, because charities do not pay income taxes on the donations they receive, the distribution will avoid being taxed as income.
If you decide to designate a charity as the beneficiary of your retirement account, you may want to do the following:
- Check with the plan administrator or financial institution to determine whether it has any restrictions on designating charities as beneficiaries for retirement accounts.
- If you are married, check with your plan administrator or financial institution to determine whether or not your spouse must consent to the designation. Failure to obtain spousal consent could result in a disqualification of the beneficiary designation, should it be determined that spousal consent was required.
- Make sure that the plan administrator or financial institution receives a copy of your beneficiary designation by requesting a written confirmation of receipt.
- Make sure that the individuals responsible for handling your financial affairs receive a copy of the beneficiary designation, or know where to find it when necessary.
Caution: If a charity is one of multiple beneficiaries for your retirement account, it may have a negative impact on the stretch options that are available to your other beneficiaries. For instance, if you should die before your required beginning date, your other beneficiaries will be required to distribute the assets by Dec 31 of the fifth year following the year of your death. This can be resolved by one of the following means:
- Establishing separate retirement accounts for each beneficiary. Thus, the charity's lack of life expectancy will not affect your other beneficiaries.
- The charity cashing out its portion of the inherited assets by Sept 30 of the year following the year you die. Under this rule, beneficiaries that receive a full distribution of their portion by Sept 30 are disregarded for the purposes of determining the life expectancies that affect distribution options.
Tax Implications of Gifting During Your Lifetime
If you donate your retirement assets to a charity during your lifetime, the amount is treated as a distribution from your retirement account and will be treated as ordinary income to you. This means that you may owe taxes on the amount. Technically, this rule also applies to Roth IRAs, since you would have already paid taxes on those assets, either when they were converted or when they were contributed to the Roth IRA.
While the income generated from gifting taxable retirement assets to charities can be offset by deductions allowed for charitable gifts, limitations on deductibility could result in your not receiving a full deduction for the entire amount that was gifted for the year.
Instead of gifting the amount in one year, you may want to consider gifting a small amount each year and leaving the bulk of the balance for the charity to inherit after your death. This arrangement is ideal for distributions that must be made from your retirement account anyway, such as required minimum distributions.
Gifting at Death - Retirement Assets versus Non-Retirement Assets
If you have both retirement and non-retirement assets in your estate, it may be more beneficial for the charity to inherit your retirement assets and for your heirs to inherit your non-retirement assets, as the non-retirement assets may have already been taxed. As mentioned earlier, the charity will not owe taxes on the amount inherited, whereas your heirs would likely owe taxes on the retirement assets they inherit. In addition, non-retirement assets inherited by your heirs may be eligible for stepped-up basis treatment.
Trusts with Charitable Provisions as Your Beneficiary
If you would like to make provisions for your heirs to receive an income stream from your retirement assets after you die, and for the balance to be paid to a charity, you may want to discuss alternate beneficiary designations with your tax professional, such as a qualified terminable interest property trust (QTIP) or a charitable remainder trust (CRT). Under a QTIP, income is paid to your surviving spouse, with the balance remaining at your spouse's death being paid to the charity. Under a CRT, a designated person receives a fixed amount from the assets each year, and the balance is paid to the charity upon the individual's death. Bear in mind, this is a high-level, overly simplified view of QTIPs and CRTs. Careful planning must be used when determining whether a trust should be the beneficiary of your retirement account. If you decide to designate any type of trust as the beneficiary of your retirement account, be sure to consult with a competent estate planning attorney or tax professional first.
When it comes to the rules that apply to gifting your retirement assets to charities and the issues that should be considered, this article only scratches the surface. If you are thinking about making such a gift, be sure to check with your tax professional. In addition to ensuring that the charity will use the funds appropriately, you'll want to make sure that the charity is a qualified organization for tax purposes.
Your tax professional should also be able to help you determine whether it is beneficial to gift your assets to a charity during your lifetime, or whether you should designate the charity as your beneficiary, and also whether you should gift your retirement or non-retirement assets.