Why give an IRA to charity?

• Author: Chesser, Delton L.
• Position: Tax and planning

EXECUTIVE SUMMARY

* The objective is to fund a major part of the charitable contribution through tax savings without reducing the benefits to be received by heirs.

* A client can use an irrevocable life insurance trust to replace any reduced benefits heirs receive because an IRA was given to charity.

* Several reasons make the transfer of an IRA at death preferable to an inter vivos transfer.

More and more taxpayers have accumulated large retirement account balances, but may not know a tax-advantageous way to get them out of their estates. Through comprehensive examples, this article demonstrates how donating an IRA to charity can have a threefold purpose: remember charity, minimize taxes and leave sufficient assets to heirs.

After accumulating sizable savings over their lifetime, many retired people realize they have more than enough resources to meet their financial needs and want to share their wealth with others. These financially secure retirees usually have four primary financial goals:

1. Leave sufficient amounts to heirs.

2. Remember a favorite charity.

3. Minimize income and estate taxes.

4. Enjoy a comfortable lifestyle.

   Achieving these goals requires effective financial planning that involves an analysis of the related tax implications. Because the tax law is complex, most people seek a tax professional's advice to determine the best financial plan for achieving their goals. Tax advisers can help clients achieve these goals by identifying particular asset(s) in their estates to minimize taxes and to maximize charitable contributions, while leaving sufficient funds for family members and other heirs. The objective is to fund a major part of charitable contributions through tax savings without reducing the benefits to be received by heirs.

   Helping clients attain their financial goals is simplified, because retirement savings (the largest asset in most estates) provide a unique opportunity to fund charitable contributions, primarily through reduced taxes. While most taxpayers realize the special tax treatment of retirement benefits during the accumulation period, very few understand the tax consequences of these funds on the death of the owner and/or surviving spouse. These funds are the most highly taxed assets at death; severe tax consequences result because Congress intended that retirement funds provide individuals and their spouses a comfortable lifestyle during retirement, not serve to build an estate to be passed on to the next generation.

   To enforce its objective, Congress has enacted the following taxes, which are imposed on unused retirement benefits in an estate:

1. A 50% excise tax under Sec. 4974(a) for failure to make minimum distributions.

2. Income tax at rates up to 39.6% under Sec. 1(e) (plus state income taxes, if the heirs live in a state that assesses such tax) on any remaining balance.

3. Estate taxes under Sec. 2001 at rates up to 55% (plus a 5% surtax on estates over $10 million, but not over $21.04 million).

4. A 55% generation-skipping transfer tax under Sec. 2601.

   Careful estate planning, however, can circumvent or reduce these taxes, allowing clients to decide how their savings should be spent. This article presents two examples that illustrate how proper planning allows tax savings on retirement benefits at the death of the owner and/or surviving spouse to fund the majority of a charitable contribution. It also discusses how an irrevocable life insurance trust can be used to replace the reduced benefits heirs receive when clients transfer individual retirement accounts (IRAs) at death to charity. The analysis in this article is limited to estate and income tax consequences. Because all qualified retirement benefits receive the same basic tax treatment, IRAs are used to represent the tax consequences of all retirement funds.

   The tax implications of Roth IRAs are not examined, because they do not currently constitute a measurable percentage of taxpayers' estates. Additionally, many people who would use IRAs as charitable contributions are ineligible for Roth IRAs. Finally, more historical data is needed to accurately evaluate the tax implications of Roth IRAs.

   Assumptions

   The examples assume the following:

   * A 39.6% income tax bracket.

   * An unmarried taxpayer.

   * Other income that absorbs the tax benefits provided by the exemptions and deductions.

   Example 1: R, a 69-year-old client, died in January 1998 with a $5,000,000 total estate, consisting of a $2,000,000 IRA rolled over tax-free from a qualified pension plan and $3,000,000 of other assets.

   Example 2: M, a 65-year-old client, died in January 1998 with a $1,750,000 total estate, consisting of a $750,000 IRA rolled over tax-free from a qualified pension plan and $1,000,000 of other assets.

   Analyses

   Exhibit 1 in the box on p 164 illustrates the tax consequences of Examples 1 and 2 when the IRA is not contributed to charity.

   Exhibit 1: IRA not given to charity Example 1 Gross Estate: Assets other than IRA $3,000,000 IRA 2,000,000 Total $5,000,000 Calculation of estate...