In last week’s post, I covered the complex analysis involved in filling out a beneficiary form for a retirement account. For example, I stressed the benefits of leaving your retirement accounts to an Accumulation Trust, rather than outright to your kids. As I have been highlighting in this Family Legacy Planning series, it’s important to give careful thought to your kids’ inheritance. How much is too much to leave to your kids? What’s the right balance between leaving assets to your kids vs. leaving assets to charities?
When dividing assets between kids and charities, the asset mix usually contains retirement assets and non-retirement assets. All of these assets are potentially subject to estate tax. But retirement assets are also subject to income tax. When leaving retirement assets to your kids, there’s a double whammy tax hit, often leaving only 20 cents of each dollar to your kids.
However, if you fill out the beneficiary designation form to pass retirement assets to charity, the charity keeps 100 cents of each dollar. As you allocate assets between your kids and charities, it is most tax efficient to leave your retirement accounts to charity, avoiding both estate tax and income tax on those assets. The portion you leave your kids should come from the non-retirement portion of your estate.
Consider this simple example. Your estate contains a $100,000 IRA and $100,000 cash. You plan to leave $100,000 to charity and $100,000 to your kids. If you leave cash to charity and the IRA to the kids (who are in a 35% income tax bracket), the kids pay $35,000 income tax on the IRA. Net result: charity gets $100,000, kids get $65,000. Let’s reverse it and give the IRA to charity and cash to the kids. A charity is exempt from tax, so it pays no income tax on the IRA. Net result: charity gets $100,000, kids get $100,000.
Note that for any IRAs designated to pass to charity, do not elect to convert those to Roth IRAs. By converting to Roth, you would be unnecessarily incurring an income tax cost that would be avoided when the assets pass to charity. It’s more tax efficient to leave traditional IRAs to charity and Roth IRAs to your family.
In leaving retirement assets to charity, consider these choices:
- Outright to your favorite public charities;
- A Donor Advised Fund, where your family can designate the charities they would like to benefit and spread out the donations over the years following your death;
- A Private Family Foundation managed by your family, which can be a powerful source of “glue” for future generations to stay connected.
The Blum Firm works actively to help our clients structure their charitable and family inheritances in the most tax efficient way. We would be honored to assist you in this important endeavor.
Marvin Blum is in a quandary over how to fill out retirement plan beneficiary forms. Do I name my kids, or do I name a charity?