Donating Retirement Plan Assets

There are no income taxes due on the money placed into the IRA. There are no income or capital gains taxes on the growth of the money inside the IRA. There are no estate taxes when transferring the IRA from John to Mary because of the unlimited marital deduction. There are no estate taxes when transferring the IRA from Mary to the charity because of the charitable deduction. Mary pays no income taxes because she never withdrew any money from the IRA. Her estate pays no income taxes as it never owned the IRA. The charity pays no income taxes because it is a tax exempt entity. Thus, $0 of taxes are generated by this series of transactions.

Before age 59 ½ withdrawing money from an IRA typically generates a 10% penalty that will not be offset by the charitable deduction.

The most obvious reason why making such withdrawals for charitable gifting are not tax efficient is the 10% penalty on withdrawals before age 59 ½. The withdrawals do count as taxable income, but that does not necessarily create a problem, as it is possible for the resulting charitable deduction to offset this taxable income. Charitable deductions do require itemization, but many taxpayers are itemizing deductions already (most commonly to take the mortgage interest deduction), so this is not an obvious disadvantage. There are limits on the amount of deductible charitable gifts that a person can make each year, but this applies to all forms of giving and doesn’t explain why making withdraws from an IRA account prior to age 59 ½ is particularly disadvantageous. Similarly, although it is true that required minimum distributions do not start until age 70 ½, this does not explain why it would be disadvantageous to make a withdrawal prior to age 59 ½.

Distributions taken before age 59 ½ are early and are usually subject to a 10% penalty. After age 70 ½, participants are required to take minimum distributions from the IRA, regardless of their desire or need for the funds.

According to the publication, about $16.5 trillion, or 36% of all household financial assets, were held in the form of retirement assets in 2010.

Failing to take a required minimum distribution results in a 50% penalty for the amount that should have been withdrawn but was not

Current gifts are not particularly attractive for living donors under age 60, especially if those donors are under age 59 ½, because then withdrawals from traditional IRAs are subject to a 10% penalty in addition to the withdrawal being taxable as income. All other reasons given would be valid reasons why a fundraiser would want to know about the possible interaction of charitable giving and retirement plans.

This goal can best be accomplished by naming a charitable remainder trust as the beneficiary. Naming the estate as the beneficiary combined with a specific dollar (pecuniary) bequest will result in the estate having to pay income taxes on the IRA. Charitable lead trusts should not be named as the beneficiary of retirement assets as these, unlike charitable remainder trusts, are not tax exempt entities. Donor advised funds are not allowed to distribute to charities where the distribution will provide any personal benefit for the advisee. Verbally informing the child of a post-death intention will have no legal effect.

Whenever possible, testamentary charitable gifts should be made from retirement plan assets because such assets are subject to both income taxes and estate taxes. Because no income taxes have yet been paid on the assets they are considered Income in Respect of a Decedent (IRD), and income taxes will be due on them. However, when received by a charity, no income or estate taxes are due because the charity is a tax exempt entity. Thus, non-charitable beneficiaries are much better off if they receive other assets, which do not generate income tax liability, than if they receive IRD assets – like retirement plan assets – that do generate income tax liability.

Paying the IRA to the estate and using those funds to fulfill the specific dollar (pecuniary) bequest to a charity will cause the estate to pay the income taxes on the IRA. No income taxes would have to be paid if the IRA were paid directly to a public charity or private foundation.

Nothing prevents a 401(k) account from naming multiple death beneficiaries in equal or unequal shares. However, the participant’s spouse must approve the beneficiary for any retirement accounts covered by ERISA, and 401(k) accounts, unlike IRAs, are covered by ERISA.

Roth conversions generate taxable income and charitable planning generates charitable deductions. When used alone it is possible for charitable planning to generate too many deductions for the donor’s income level. Similarly, a Roth conversion can generate too much taxable income creating the need to offset such income with large deductions such as those that can be created by charitable planning.

When congress has allowed the Qualified Charitable Distributions from IRAs to charities (permitting the transaction to generate no income or deduction) such QCDs have been limited to IRA or IRA rollovers by participants age 70 ½ or older only to public charities and in a maximum amount of $100,000

A defined benefit pension plan paying $50,000 for life has no residual value after the death of the participant. Thus, at John’s death there is no retirement asset remaining. Attempting to bequeath the asset has no effect.

Leaving money to a charitable remainder trust with the spouse as the sole income beneficiary gives less control over the funds to the surviving spouse than leaving the funds directly to the surviving spouse. In this case Mary cannot take any more than the fixed dollar (CRAT) or percentage of the trust (CRUT) described in the terms of the CRT. Leaving money to the CRT generates no estate tax because the remainder is excluded by the charitable deduction and the life income interest is excluded by the marital deduction. The income interest will qualify for the marital deduction so long as there are no income beneficiaries other than the spouse. In either case when Mary makes withdraws from the IRA or receives payments from the CRT the amounts will in all likelihood be ordinary income.

The two primary disadvantages of the IRA with charitable death beneficiary is that only a limited amount of funds can be placed into the IRA and that the IRA cannot avoid capital gains tax by accepting transfers of appreciated property. Because of these limitations, the donor would not normally be able to place more money into the IRA than into a Charitable Remainder Trust. All other examples are advantages to the donor of the IRA with charitable death beneficiary over the charitable remainder trust.

Qualified charitable distributions (QCD), when allowed by congress, result in no income and no deduction for the donor. Thus, the donors cannot be disadvantaged by either an increased income or the need to itemize deductions.

Withdrawing funds from the Roth IRA generally generates no taxable income and the subsequent gift creates a charitable deduction, thus resulting in a transaction that generates more deduction than income. A Qualified Charitable Distribution generates no income and no deduction. IRA withdrawals after age 59 ½ can, at best, result in a deduction as large as the reported income. Prior to age 59 ½, such withdrawals typically generate an additional 10% penalty.

Roth IRAs do not generate IRD (Income in Respect of a Decedent) because unlike traditional IRAs, the income taxes have already been paid. All other examples are valid ways in which Roth conversions and charitable planning can work together.