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 advantageous to name the charity as a 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 donating your retirement funds to a charitable cause or non-profit organization.

Key Takeaways

  • Donating to charity is a social good, and philanthropists often get personal satisfaction and recognition for their good deeds.
  • One way to direct charitable giving is to assign retirement assets to eligible causes, especially if you have other sources of retirement income.
  • Gifting retirement assets while alive can be trickier than assigning your account beneficiary to the charity. You can also establish a charitable trust funded with retirement assets.
  • The SECURE Act, passed in December 2019, has changed distribution timing and tax implications of inherited retirement assets considerably for owners dying Jan. 1, 2020 or later.

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 acting as plan custodian to determine whether it has any restrictions on designating charities as beneficiaries for retirement accounts.
  • If you are married, check 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 options that are available to your other beneficiaries. For instance, if you should die before your required beginning date (RBD), 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 by Dec. 31 of the year following the year you die. Thus, other designated beneficiaries can use the 10-year rule established by the SECURE Act. Under the 10-year rule, there is no required minimum distributions (RMD) for the beneficiaries in any one year, but all retirement assets must be depleted by the end of the tenth year following the year of your death.
  • 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 distribution options.
  • The charity properly disclaiming its portion of the inherited assets by Sept. 30 of the year following the year you die. Under this rule, beneficiaries that disclaim their portion by Sept. 30 are disregarded for the purposes of determining the distribution options. Careful steps must be taken to ensure that a disclaimer is qualified under federal and state laws.

On the other hand, if the charity is one of multiple beneficiaries, it could have a positive impact on the options available to other beneficiaries. For instance, if you should die after your RBD, all beneficiaries would be required to use your remaining life expectancy to take distributions of the retirement assets. This could more beneficial for the multiple beneficiaries than the 10-year rule depending on the age at which you die.

Tax Implications of Gifting During Your Lifetime

The SECURE Act, passed in December 2019 and effective for retirement assets inherited on Jan. 1, 2020 or later, increased the required minimum distribution (RMD) age to 72 from 70 ½. This was the first increase in age since the Tax Reform Act of 1986 introduced the concept of RMDs.

The qualified charitable distribution (QCD) age is still set at 70 ½. This allows a tax planning opportunity during this 1 ½ year period. You may be able to reduce the amount you are required to take in RMD starting at age 72 if you donate to a charity between 70 ½ and 72. A QCD is not taxable. Even better, it is also not included in your adjusted gross income (AGI) calculations, so it can help reduce other taxes or your Medicare Part B premiums. 

The SECURE Act also removed the tax strategy of utilizing a “stretch IRA” option for beneficiaries. Previously, inherited retirement assets were able to be passed down for generations with proper planning. As of June 20th, 2020, most beneficiaries of inherited retirement assets (who are not non-person entities such as charities) must deplete the funds within 10 years following the year of the owner’s death. The shorter timeframe for distributions accelerates the payment of income tax on distributions taken by beneficiaries. Charities and tax-exempt nonprofit organizations are excluded from paying income tax, so it may be more beneficial from a tax perspective to leave retirement assets to them.

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 survivors to inherit your non-retirement assets, as the latter 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 tax treatment.

Trusts with Charitable Provisions

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 that individual's death. 

SECURE Act Changes to Trust Beneficiaries

If the trust identifies a specific beneficiary (or beneficiaries) to receive all withdrawals from the IRA account, that individual or entity is treated as the direct beneficiary of the IRA. This is only the case when the trust is unable to accumulate any funds prior to disbursing the IRA withdrawals directly to its beneficiaries. It is considered a “conduit trust,” as the trust’s existence is ignored for the purpose of identifying a classification of the beneficiary.

For example, if the beneficiary identified by the trust is a charity, the IRA is treated as having no designated beneficiary and will be subject to either the 5-year rule or life expectancy payout rule, depending on whether the owner was already taking distributions after the RBD at his or her death. On the other hand, if the beneficiary identified by the trust is an individual, the IRA is treated as having either an eligible designated beneficiary or a designated beneficiary, and the respective distribution rules apply depending on these classifications.  

Alternatively, if the trust can accumulate withdrawals from the IRA, rather than disbursing withdrawals in their entirety to the beneficiaries, it is considered an “accumulation trust.” This is the type of trust described above that is used to disburse funds to its trust beneficiaries over time. If a QTIP or CRT assigns a charity or other non-person entity as a beneficiary, even if there are other beneficiaries as well, the trust is subject to either the five-year rule or the life expectancy payout rule for non-designated beneficiaries.  

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 trust and estates attorney or tax professional first.

The Bottom Line

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. The best tax strategy may change overtime, based on your age, distributions you've already taken, and remaining life expectancy.