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Donating retirement assets

Donating an IRA or other retirement assets to charity can be a tax-smart estate planning strategy

It is always possible to donate retirement assets, including IRAs, 401(k)s and 403(b)s,1 by cashing them out, paying the income tax attributable to the distribution and then contributing the proceeds to charity. In many cases, though, there is little to no tax benefit associated with this type of donation. However, a direct contribution of retirement assets to charity as part of an estate planning strategy can be very tax efficient. In some situations, it can mean more funds for charities and heirs alike.

For many people, a retirement account like an IRA or 401(k) may be the most significant source of assets accumulated in their lifetime. Others may find that, due to their other resources and investments, they are not in need of all the funds accumulated in their retirement accounts. For those who wish to give to charity, a natural question is whether they can donate retirement assets—and if there are any tax advantages for doing so.

Donating during your lifetime: In order to donate retirement plan assets during your lifetime you would need to take a distribution from the retirement account, include the distribution in your income for that year, account for any taxes associated with the distribution, and then contribute cash to the charity—with one exception. People who are age 70 ½ or older can contribute up to $100,000 from their IRA directly to a charity and avoid paying income taxes on the distribution. This is known as a qualified charitable distribution. It is limited to IRAs, and there are other exclusions and considerations as well.

As part of an estate plan: By contrast, there can be significant tax advantages to donating retirement assets to charity as part of an estate plan. When done properly, charitable donations of retirement assets can minimize the amount of income taxes imposed on both your individual heirs and your estate.

Retirement plan benefits are only payable to the employee or account holder who earned them, with a few exceptions for spouses or survivors. With the exception of a qualified charitable distribution as described above, distributions from non-Roth retirement plans are taxable as ordinary income to the person who receives them.

This is true whether the recipient is the original account holder or a beneficiary of the account holder. Unlike other inheritances that can be passed to heirs free of income tax, distributions from inherited retirement plans are taxable as ordinary income to the person who receives them.

TIP

TIP: If you want to support charities without dipping into your cash reserves, think about donating appreciated assets such as stocks or real estate directly . This strategy can eliminate capital gains taxes you’d incur by selling them separately before donating the cash, therefore ensuring that your intended charity receives the full value of the asset.

When you name a charity as a beneficiary to receive your IRA or other retirement assets upon your death, rather than donating retirement assets during your lifetime, the benefits multiply:

  • Neither you and your heirs nor your estate will pay income taxes on the distribution of the assets.
  • Your estate will need to include the value of the assets as part of the gross estate but will receive a tax deduction for the charitable contribution, which can be used to offset the estate taxes.
  • Because charities do not pay income tax, the full amount of your retirement account will directly benefit the charity of your choice.
  • It’s possible to divide your retirement assets between charities and heirs according to any percentages you choose.
  • You have the opportunity to support a cause you care about as part of your legacy.

When you’re ready, making a charity the beneficiary of your IRA or other retirement assets is typically straightforward: Fill out a designated beneficiary form through your employer or your plan administrator. Most banks and financial services firms also have beneficiary forms, or they can provide you with suggested language for naming beneficiaries to these accounts. Once the designated beneficiary forms are in place, the retirement assets will generally pass directly to your beneficiaries (including charities) without going through probate.

If you are married, ask the plan administrator whether your spouse is required to consent. If required but not done, this could result in a disqualification of the charity as your beneficiary.

Be clear about your wishes with your spouse, lawyer and any financial advisors, giving a copy of the completed beneficiary forms as necessary.

TIP

TIP: If your goal is to support charity as part of your legacy while also leaving assets to family members, it may be more tax efficient to leave cash and appreciated assets to heirs, while making charities the beneficiaries of retirement assets upon your death.

Although designating any qualified charity as a beneficiary usually allows an estate to claim a charitable contribution deduction, naming a public charity with a donor-advised fund program—such as Fidelity Charitable—as beneficiary of a tax-deferred retirement account such as an IRA or 401(k) gives clients and heirs more flexibility. A donor-advised fund is a program of a public charity that functions like a tax-advantaged charitable checking account that can be used solely for giving.

  • Upon death, your IRA assets can fund the donor-advised fund. It can then be distributed to charities immediately or over time through an endowed giving program. Or you can let a trusted friend or family member make the choice—a designated account successor can then make grant recommendations over time to the charities they would like to support.
  • Alternatively, you can use your assets to provide multiple heirs with a fund to support their individual charitable giving by specifying that the IRA be allocated across multiple Giving Accounts. In that case, each individual will have their own Giving Account, creating a legacy of giving that can stretch far into the future.

1 Traditional IRAs, 401(k)s and 403(b)s may contain after-tax contributions that are not subject to income taxes. If they do, there are special tax rules to determine what portion of a withdrawal is attributable to after-tax contributions. This article does not address those rules. Withdrawals from Roth IRAs, Roth 401(k)s and Roth 403(b)s, along with their associated earnings, are generally free from income taxes if certain conditions are met.

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