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Charitable Giving in Your Will

April 13, 2021

For some people making a charitable bequest in a will is a big mistake and it’s not because the charity is not deserving. It’s because the will may not be the best source of that charitable gift if there are retirement accounts that are going to the children of the testator (the person making the will).

It is a matter of tax efficiency. Assume that the testator has plenty of assets owned in his or her name in addition to the (tax-deferred) retirement accounts. In this scenario the testator wants to give $100,000 to one or more charities and then the remaining $900,000 to children. (In this scenario there is no surviving spouse.)

Of that $1 million in assets, $100,000 is in traditional retirement (not Roth) accounts. If a charity is the beneficiary of the IRA account(s), then no income tax is paid after the death of the testator (who as account holder is naming the charity as the beneficiary of the accounts). There is an additional advantage to using the IRA account because it is easier to change the beneficiary of the account versus changing the recipient of the charitable bequest in the will.

If the charity is a named beneficiary of $100,000 in the will, there is still no income tax paid by the charity and the estate may receive an income tax deduction for the charitable bequest, which might not be that beneficial if it does not have much taxable income. However, if instead the $100,000 of IRA money is left to the children as part of the $900,000 going to them, then about 25-30% of income taxes (federal and state) will most likely be due on that $100,000. It might be even more if some or all of the children are in higher income tax brackets, or the tax rates are dramatically increased in future years to pay for the profligate spending currently in fashion in Washington.

Once upon a time the inherited IRA could be “stretched” over the life of a child who is a beneficiary with minimum required distributions each year based on the life expectancy of that child, re-calculated each year. In 2019 that rule was changed by the “Secure Act” and now, with exceptions for minors and disabled children, the inherited IRA must be completely distributed with the taxes paid by the end of the tenth year after the year of the death of the original account holder (in this scenario the parent).

There are details that should be worked out with one’s tax advisor before implementing a charitable giving plan with this approach. It might be feasible to name the charity of some of the IRA money with the balance going to the children. Until January 1, 2020 (the effective date of the Secure Act) it was a big mistake to mix charities with individuals in an IRA beneficiary designation because the after-death distribution rules depended on the life expectancy of the beneficiaries and a charity has no life expectancy. Now that there is a 10-year rule applicable to such distributions, it is possible that this is no longer a problem in “mixing” the beneficiaries.

This post does not constitute tax advice and under IRS rules cannot be relied upon in the completion of income tax returns. However, it is useful in raising the question of what is the best asset for charitable giving. One of my favorite aphorisms is that you can’t get the right answer unless you ask the right question.