Due to recent changes under the SECURE Act, most IRA beneficiaries (accept for spouses) will now need to withdraw all funds from retirement accounts within 10 years of the account holder’s death. This change in the law limits the ability of most beneficiaries (other than a spouse, minor child, or disabled or chronically ill individual) to “stretch out” retirement account distributions, limits the ability to continue tax deferral, and compresses income taxes over a much shorter period of time. For IRA owners that are charitably inclined, there are some good options to consider when naming a beneficiary that can provide tax benefits as well.
It is simple to name a charity as beneficiary of all or a percentage of your IRA or company retirement plan. Because the charity is tax-exempt, after your death it can withdraw the assets from the retirement account without having to pay income taxes on the withdrawal. Any individuals named as beneficiaries of the retirement account must pay income taxes at ordinary rates on any distributions they receive from the retirement account. Hence, the best income tax result is to benefit a charity from the retirement account and your loved ones from other assets that will not be subject to income tax when they receive it. In addition, any amounts left to a charity at death would also receive an estate tax charitable deduction, thus reducing any applicable federal estate taxes.
Another option to consider, which could benefit both a charity AND a family member, is naming a Charitable Remainder Trust (CRT) as beneficiary of your IRA. An individual you choose will receive annual payments from the CRT for a period of time. A CRT can be either a Unitrust, in which case payments are based on a fixed percentage of the beginning-of-year CRT balance, or an Annuity Trust, in which a fixed payment is paid to the beneficiary. When the CRT terminates, the remaining amount is distributed to charities of your choosing. There are specific rules about how a CRT must operate, including how much an individual can receive from a CRT and how long he or she can receive it. In addition, the charities must receive a minimum percentage of the trust assets, based on the beginning balance of the CRT. Due to the various complexities of a CRT, an attorney is essential to create it properly.
The main reason to consider using a CRT is that the trust itself is tax-exempt during its existence (similar to a charity). When you name a CRT as beneficiary of the IRA, the CRT will receive funds from the IRA at your death and not pay any income taxes at that time. When the individual identified in the CRT receives annual payments, he or she will then owe income taxes on the amount received at that time. In addition, a partial estate tax deduction is allowed upon the IRA owner’s death.
These are a few of the many ways to benefit charities, either during your life or at your death. Which way you select can have different tax implications. Giving consideration to income and estate taxes with your charitable giving can ultimately increase the amount received by the charity and your family members/loved ones as well.
Mission Wealth does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
ARTICLE CREDIT: Greg Smith, CFP®, CLU®, ChFC®, CRPS®