Table of Contents
A Guide to Tax-Savvy Charitable Bequests
by James Lange, CPA/Attorney
Reprinted with permission from Forbes.com.
After reading this article, you are likely to think—that is so obvious. How could I and my estate attorney both have missed this? Don’t feel bad. We have reviewed thousands of wills and trusts and in our experience, hardly anyone gets this right. The mistake often costs families tens of thousands of dollars or more.
I’m referring to the decisions that you make when you are crafting your estate plan and are trying to figure out who gets what. In this article, I want to focus on the smartest solution for donations or inheritances that you leave to a charity after you and your spouse pass. There are several critical ideas to cover, but the most fundamental is: what are the tax implications to each recipient if they inherit your money? By being very selective about who receives which type of money—whether Traditional or Roth IRAs, after-tax brokerage accounts, life insurance, etc.—you can dramatically cut the share that goes to the IRS and increase the amount going to your family.
In most cases, Traditional IRAs subject to exception, are going to be fully taxable to your heirs. After the dreaded SECURE Act that effectively killed the stretch IRA, income taxes will be due on your IRA within a maximum of ten years after your death. Inherited Roth IRAs have the advantage of being able to continue to grow for ten more years after your death and then can be withdrawn tax-free. After-tax dollars and life insurance are generally not subject to income taxes. All of these different types of inheritances have different tax implications for your beneficiary…unless your beneficiary is a tax-exempt charity.
First and foremost, a charity that is recognized by the IRS as being tax-exempt does not care in what form they receive an inheritance. They never have to pay taxes on the money they receive. To them, a dollar is a dollar. So, a charity will look at bequests of Traditional IRAs, Roth IRAs, after-tax dollars, or life insurance in the same light. In sharp contrast, your heirs will face substantially different tax implications depending on the type of asset they receive after your death. Please note in this article we are only addressing income taxes, not estate or transfer taxes.
Imagine this scenario. You want to leave $100,000 to charity after you and your spouse die. You have both Traditional IRAs and after-tax dollars. For the sake of simplicity, I am going to say that your child is in the 24% tax bracket. So, Who Gets What? In most of the estate documents that we review, we see instructions directing that the charitable bequest come from after-tax funds—usually found in the will or a revocable trust. The problem is that your will (or revocable trust) does not control the disposition of your IRAs or retirement plans. By naming that charity as a beneficiary in your will or trust, you will likely be donating after-tax money to charity. The charity gets $100,000 so the “cost” of the bequest to your heirs is $100,000. Restated, the amount that your children inherit is reduced by $100,000 because you made that bequest to charity.
But what if you decide to leave $100,000 to XYZ charity through your Traditional IRA and/or retirement plan beneficiary designation? It makes no difference for the charity because they get $100,000 tax-free. If your heirs receive $100,000 from your IRA, they will have to pay taxes on the money. Assuming that they are in a 24% tax bracket, that would be $24,000—leaving them with $76,000 after the government takes their share. And the tax bite is even worse if your heirs are in a higher tax-bracket or live in a state that taxes Inherited IRAs. So, if you leave your Traditional IRA money to a charity that doesn’t pay taxes, you are in effect leaving your beneficiaries an extra $24,000!
This is a simple tweak to your estate plan that can be very beneficial to your heirs. On a smaller bequest, smaller savings. On a bigger bequest, even larger savings.
Consider the purchasing power, after taxes, available to your beneficiary if you have $100,000 in a Traditional IRA and $100,000 of after-tax dollars, and we switch who gets what.
Leave $100,000 to charity through your will or revocable trust and $100,000 to your heirs as the beneficiary of your Traditional IRA.
Impact on the charity: They get $100,000 and pay no tax.
Impact on your heirs: $100,000 IRA money – 24% taxes = $76,000.
Leave $100,000 to charity through your IRA beneficiary designations and $100,000 to your heirs in your will or revocable trust.
Impact on the charity: They get $100,000 and pay no tax.
Impact on your heirs: $100,000 and pay no federal tax.
This simple switch of who gets what saved this family $24,000. The savings would be even greater with a larger bequest or if your beneficiary’s tax bracket was higher.
Let’s imagine another scenario. Suppose that your child is well off and, as a parent, you are totally comfortable with reducing his or her inheritance by $100,000. Does that mean you can leave even more money to charity? Yes!
You could leave $131,579 to charity through your IRA or retirement plan beneficiary designation. The same tax implications apply. A $131,579 IRA bequest will only “cost” your child $100,000. ($131,579 times 24% = $31,579). If you left that $131,579 IRA to your children instead of charity, your children would have to pay $31,579 in taxes leaving them $100,000.
By switching who gets what, you accomplish one of two things:
- You save $24,000 in federal taxes for your child, or
- If you increase your bequest to the charity to $131,579, you still only remove $100,000 from your heir’s total inheritance, and you increase the charitable gift by $31,579.
Who loses out with this strategy? You guessed it. The IRS. You are dramatically cutting the share that the IRS receives—giving the IRS a smaller piece of the pie. And I think that all of us can safely agree that we want more money to go to our kids, more money to go to our favorite charities, and less money to go to the IRS.
If you are only leaving a minimal amount to charity, it probably isn’t worth the time and aggravation to change your documents. If you are leaving a substantial amount to charity, it probably is worth it.
Finally, the application of the concept of who gets what can also save families a lot of money in taxes even without any charitable bequest involved. It is likely that not all your beneficiaries are in the same bracket. The different income tax brackets of your beneficiaries may create an opportunity for tax savings by changing who gets what. But you will have to wait for my next article to read about that technique.
Investment advisory services provided by Lange Financial Group, LLC. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. All information or ideas provided should be discussed in detail with an advisor, accountant, or legal counsel prior to implementation. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.
The Dreaded SECURE Act and Pending Tax Explosion
Threaten Your IRA and Retirement Plan
Million-Dollar IRA Owners Must Take Action to
Maximize Retirement Prosperity and Generational Wealth
Webinar Dates: Tuesday & Wednesday, February 23 & 24, 2021
Register to attend at https://PayTaxesLater.com/Webinars
TUESDAY, FEBRUARY 23, 2021
Session 1: 10 AM – NOON
6 Proven Strategies to Defend Your Family from Devastating Tax Losses
- Avoiding the decimating tax-accelerating consequences of the SECURE Act.
- Reducing your income tax liability with the Democrats in charge. Likely long-term tax rate increases make Roth IRA conversions more attractive.
- Using Roth conversions to minimize taxes on your IRA income for decades for both you and your heirs.
- Minimizing the impact of potential tax increases—other than income tax. Less obvious increases might come from eliminating the current step-up in basis provision and the favorable capital gains rates.
- Optimizing your Social Security distributions.
- Gifting strategies after the SECURE Act.
Session 2: 1:00 – 3:00 PM
Live Q&A with James Lange: Ask Me Anything
Jim will answer attendees’ questions submitted in advance of the webinar as well as during the webinar. This is a golden opportunity to get straight—and personalized—answers to your most perplexing retirement questions. You are also likely to hear someone else’s question that is applicable to your situation.
WEDNESDAY, FEBRUARY 24, 2021
Session 3: 10 AM – NOON
The Best Estate Plan for Married IRA Owners After the SECURE Act and the Election
- The SECURE Act triggers a massive income tax acceleration on your IRAs after you pass.
- Doing nothing to prevent it will set off a cascade of financial disasters for your heirs. We have strategies to minimize the negative impact.
- Can naming your heirs as beneficiaries of a charitable trust be a boon for them and the charity or should they inherit your IRA?
- For most IRA owners, the likely federal estate tax changes will not be nearly as severe as the anticipated income tax law changes. Just what will that mean for you and your family?
- Do you have children of unequal financial strength? Learn how tax-savvy strategies can benefit everyone.
- A unique multi-generational plan that could save hundreds of thousands of dollars for the grandchildren.
Session 4: 1:00 – 3:00 PM
Live Q&A with the Dream Team: Larry Swedroe, Adam Yofan of Buckingham Strategic Wealth, and James Lange Answer Your Questions on Investing and Wealth Management and Preservation.
Larry, Adam, and Jim will answer attendees’ questions submitted in advance of the webinar as well as during the webinar. Another golden opportunity to have your most nagging questions answered.
Larry Swedroe, Chief Research Officer of Buckingham Strategic Wealth, educates individuals on the benefits of evidence-based investing. Larry has authored 9 books and co-authored 7 books on investing, including his newest book, Your Complete Guide to a Successful & Secure Retirement. Larry has made appearances on NBC, CNBC, CNN, and Bloomberg Personal Finance.
Adam Yofan, CPA, PFS, leads Buckingham’s Pittsburgh office. Adam navigates clients toward financial clarity by defining goals and needs, reviewing assets, providing recommendations, implementing and managing portfolios, and tracking progress as they pursue well-defined goals.
Register today at https://PayTaxesLater.com/Webinars
Past performance is no guarantee of future results. All investing involves risk, including the potential for loss of principal. There is no guarantee that any strategy will be successful. Indexes are not available for direct investment.
Jim on Bill Flanagan’s TV Show
Bill Flanagan, host of Our Region’s Business, interviewed Jim Lange, CPA/Attorney, on December 20, 2020. The topic: Who Gets What? To watch now, please go to: https://tinyurl.com/CharitableMistakes
by James Lange, CPA/Attorney
2020 was a rotten year.
Sadly, some long-time clients died of COVID.
One of the downsides of being an estate attorney for over 30 years is that you see clients who you know and like age, fall ill, and die.
This year was worse because of the suddenness of their passing. Some suffered terribly. Others watched aging parents die, unable to visit or comfort them. Usually, the sadness of having clients pass is partially offset by the joy of clients’ children’s weddings and babies, but we had less of that this year too.
On the business front, the news is much better. Our new book that was published in 2020, The IRA and Retirement Plan Owner’s Guide to Beating the New Death Tax, became an instant best-seller in July. It still ranks #8 on Amazon for Kindle sales under the category of personal taxes.
Before the pandemic, we had several of the best-attended, in-person workshops ever. We had to turn people away after reaching the room capacity of 90.
Then, the pandemic hit.
The workplace for most of our office employees shifted from our offices to their individual homes practically overnight. It was the roughest tax season ever. But everyone has been amazing, pulling together to fulfill the needs of our clients.
Despite the success and critical acclaim for the new book, once the pandemic hit, new business went on the skids. We then pivoted from in-person workshops to webinars. It took a while to get the hang of it, but now our webinars have become fantastically successful. The webinar we just did had 4,322 people register and 1,571 people show. We also got 46 consultations for new business. People love the information. If you haven’t heard from me for a while, you may want to register to attend (see p. 2).
Some of our new charitable strategies are being recognized throughout the region and the country. (You can read about them in the book, and in this newsletter too.) We conducted three webinars on the new strategies, two for charitable organizations and one for the Pennsylvania Bar Institute in January and anticipate more interest this year.
I am working on what will be the best financial book for college professors. (Pretty low bar). Kidding aside, we have 650 college professors as clients and we know our stuff with TIAA-CREF, etc. You can read a chapter titled One of the Great Mysteries of Life—How Should Professors Access their TIAA-CREF Accounts after Retirement? at https://faculty-advisor.com.
Alice Davis retired, but Diana Koch, her successor (no one could ever replace Alice) is proving to be a great find! Alice is doing well and is still doing some part-time work for us from her home. We also hired another CPA, Dominic Bonaccorsi, who also turned out to be an amazing find. Though only 32, he came in as a veteran CPA and is taking to “running the numbers” better than we could have hoped. He has four mentors, and he gets something different from all of us: me, Steve Kohman, Shirl Trefelner and Matt Schwartz.
We are currently looking for another number-crunching CPA. Do you know anyone who might be interested?
We distributed 33,000 KN-95 masks, roughly half to clients and family and a half to charities or other non-profit organizations. Many were distributed before they were widely available from commercial sources. As masks are becoming easier to find, I was about to retire distributing them. However, The Washington Post in a story dated January 29, 2021, said: “The discovery of highly transmissible coronavirus variants in the United States has public health experts urging Americans to upgrade the simple cloth masks that have become a staple shield during the pandemic…Some experts say it is time to buy the highest quality KN95.” So, maybe I am not done. If you would like more of the high-quality KN-95 masks, please call Diana (412-521-2732), and we will try to accommodate you.
On a personal note, Cindy, Erica, and I have all received our COVID vaccinations and are supremely grateful to feel more secure. I was treated with stem cells in October. I am feeling better than ever. I lost 20 pounds, gained 10 back, and now am trying to lose again. Sound familiar?
I hope you are safe and secure and have a much better 2021 than 2020. As always, we look forward to serving you and are available to help if you need us.