Funding Charitable Objectives with Retirement Accounts

Planning Commentary

Funding Charitable Objectives with Retirement Accounts

September 2019

By James Landry, Director of Planning

Clients with sizable retirement assets often look to those funds to help them accomplish their recurring or one-time charitable objectives. 

Tax Reasons for Using Retirement Accounts to Fund Charitable Objectives

For individuals with significant philanthropic goals, there are tax advantages of giving qualified retirement plan and individual retirement account (IRA) benefits to a charity. Retirement accounts are terrific tools when it comes to accumulating assets, however they are tax-inefficient when it comes to distributing assets to the owner or his/her heirs. When funds are drawn out of retirement plans and IRAs by non charitable beneficiaries, federal income tax of up to 37% (in 2019) will have to be paid. State income taxes also may be owed. Furthermore, retirement funds possessed at death may be subject to substantial federal estate tax and state death tax (not to mention potential federal and state estate taxes). Retirement benefits are to be contrasted with other assets that can be passed to noncharitable beneficiaries free of income tax. For example, an individual inheriting stock worth $300,000 from his parent (that was purchased by the parent for $100,000) won’t have to pay income tax on the $200,000 appreciation. That’s not the case for retirement benefits. They are subject to both income tax and estate tax. A special income tax deduction (Income in Respect of a Decedent, or IRD deduction) for the estate tax helps noncharitable beneficiaries but the combined income and estate tax can still be quite substantial. Because of this double tax bite, someone who plans to make charitable gifts should consider naming a charity as beneficiary of his IRA or retirement plan to gain these advantages:

  • The retirement benefits going to the charity won’t be subject to federal estate tax and generally won’t be subject to state death taxes.
  • The estate won’t be considered to receive taxable income when the benefits are paid to the charity.
  • The retirement account owner’s surviving spouse, children and others who may be beneficiaries of the estate won’t be considered to receive taxable income when the retirement benefits are paid to the charity.
  • The charity won’t have to pay federal income tax on distributions from the qualified plan or IRA and generally won’t have to pay state income taxes.

Preserving tax-deferral for your heirs may soon become even more challenging. The House of Representatives passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act on May 23, 2019. If the bill, which has more than 20 sections, passes the Senate and is signed by the president, its impact could lead to shifts in retirement savings and planning. One of the provisions in the bill is that a beneficiary who inherits an IRA would be required to withdraw the assets from the IRA within 10 years of the IRA owner’s death. The Senate has their own billed called Retirement Enhancement and Savings Act (RESA) which is similar to the SECURE Act.

Replacement of donated assets for Heirs

Clients who wish to use all or a significant portion of their retirement account to fund a charitable objective should also consider replacing those assets with life insurance, if the cost of the coverage makes economic sense.

Other Options

For one who is not able to leave his entire retirement benefits to a charity, there are other options:

  • An individual with two or more retirement plans (e.g., an IRA and a profit-sharing plan, or two IRAs) can leave one to a charity and the other(s) to family members.
  • An individual with a single IRA can split it into two IRAs and leave one to a charity. This can be achieved tax-free through a rollover or a trustee-to-trustee transfer.
  • A married individual can have his benefits paid to a Marital QTIP trust for his spouse with a charity to receive the benefits that remain at the death of the surviving spouse. The marital deduction will shield the benefits from estate tax when the individual dies. When the surviving spouse dies, the remaining benefits will go to the charity free of estate and income tax.
  • An individual can have his will establish a charitable remainder trust at his death to provide a non charitable beneficiary with a fixed annuity for a set number of years (not to exceed 20) or for life, with the remainder going to charity.

Qualified Charitable Distributions – avoid the income recognition altogether

Another popular way to transfer IRA assets to charity is via a tax provision which allows IRA owners who are 70 ½ or older to direct up to $100,000 of their IRA distributions to charity. These distributions are known as qualified charitable distributions, or QCDs. The money given to charity counts toward the donor’s required minimum distribution (RMD) but doesn’t increase the donor’s adjusted gross income (AGI) or generate a tax bill. Keeping the donation out of the donor’s AGI is important because doing so can (1) help the donor qualify for other tax breaks (2) reduce taxes on the donor’s Social Security benefits; and/or (3) help the donor avoid a high-income surcharge for Medicare Part B and Part D premiums (which kick in if AGI is over certain levels). Further, because charitable contributions will not yield a tax benefit for those taxpayers who will no longer itemize their deductions (and thanks to the 2017 Tax Cuts and Jobs Act, this will be the case for many taxpayers), those who are age 70 ½ or older and are receiving RMDs from IRAs, may gain a tax advantage by making annual charitable contributions by way of a QCD from an IRA. This charitable contribution will reduce RMDs by a commensurate amount, and the amount of the reduction will be tax-free.

Pallas Capital Advisors, LLC and its representatives do not provide legal or tax advice. You should consult a legal or tax advisor regarding any legal or tax information as it relates to your personal circumstances.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice. The information in these materials may change at any time and without notice. The information contained herein is for informational purposes only, is not personalized investment advice, and should not be construed as a recommendation to purchase or sell any particular security, sector, or strategy to any individual person or entity.

Investment Advice offered through Pallas Capital Advisors, LLC, a registered investment advisor.

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