Donating Retirement $ (Pt. 1)

Submitted by Eric Meermann on Tuesday, January 20, 2015 - 12:00pm
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You may not naturally combine retirement funding and charitable planning, but often donating your retirement benefits to charity can be an ideal financial move for both you and your favorite charity.

The first and best reason to leave retirement benefits to a charity is, as with any philanthropic gift, to benefit the organization. Leaving retirement benefits to charity may help achieve other estate planning goals only if philanthropy is already one of your priorities.

Once you pinpoint a charity or two, donating retirement dollars can be a highly tax-efficient use of your savings.

Note: The retirement benefits I discuss in this article and the next are those where distributions typically trigger income tax, such as traditional individual retirement accounts or qualified retirement plans. (Distributions from Roth plans do not incur income tax and therefore offer no advantage for charitable giving.) Charities can receive gifts of retirement benefits tax-free as long as you structure your donation correctly.

In some situations, leaving retirement benefits to charity might not be your ideal estate planning solution. If you intend to leave money to a young individual beneficiary, for instance, that person may do better inheriting your retirement plan than inheriting an equivalent amount of after-tax dollars: Stretching payouts over his or her lifetime greatly increases the importance of the deferral of income tax, for example.

Minimum distribution rules for retirement accounts – under which you must take out money after you turn 70½ – also mean you might end up leaving a charity relatively little money if you live long enough to exhaust most of your plan’s value. You may want to give your minimum distribution directly to the charity each year or revise your estate plan to provide for the charity differently as your plan diminishes in value.

You have several methods for leaving your plan to a charity, each with advantages and disadvantages.

Maybe the most straightforward way is directly naming the charity as the beneficiary of the plan’s total value at your death. The charity then easily avoids income tax and your estate can take the charitable deduction for the full value of the gift. This method also works if you leave a retirement account to multiple beneficiaries, as long as all are charities.

With the above method as with most others, make sure all paperwork is in order. Some plan administrators may require documentation before allowing the charity to collect the benefits.

If you split a retirement account among several beneficiaries and not all are charities, your planning becomes slightly more complicated. The general rule: Either all beneficiaries must be individuals or none can use the life expectancy payout method.

For example, if you name your son and a charity as equal beneficiaries of your IRA, unless you take additional measures your son must forego the income tax deferral he otherwise enjoys. Note that this issue disappears if your spouse is the only non-charity beneficiary, since he or she can simply roll over the share of benefits into a retirement plan.

You can work around this rule in two ways. If the beneficiaries’ interests in the retirement plan constitute separate accounts, each account receives treatment as a separate retirement plan, so individuals can stretch payout options. This is useful but risky: Beneficiaries must establish separate accounts by Dec. 31 of the year after the year of your death or less-beneficial rules automatically take effect.

The other option involves the charity receiving a full payout of its share by Sept. 30 of the year after the year of your death. In this case, the charity is “disregarded” as a beneficiary and individual beneficiaries can take distributions as if no charity was co-named.

You do not need to split the account by percentages. You can also designate a fixed-dollar amount to go to charity and leave the remainder to other heirs.

Some IRA administrators may not accept such beneficiary designations, though. In addition, this sort of designation can trigger the same problem discussed above: Depending on how you structure the fixed-dollar gift, the option of separate accounts may not be available.

If leaving a small gift to charity, you can forego the slight tax benefit and simply make the charitable bequest from other assets, leaving your retirement funds solely for individual beneficiaries. You can also make the gift to charity conditional on payment by Sept. 30, though this move requires careful planning to make sure the estate receives the proper charitable deduction.

(Our next article looks at more ways to leave your retirement plan to charity, including trusts and special gifting funds.)

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Eric Meermann, CFP, CVA, EA, is client service manager and a member of the investment committee of Palisades Hudson Financial Group LLC in Scarsdale, N.Y.

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