General

Charitable Giving With Retirement Benefits

Retirement funds and charitable planning may not be two areas most people would naturally think to combine. But in many cases, donating retirement benefits to charity can be an ideal solution, both for the donor and the recipient.

The first and best reason to leave retirement benefits to a charity is, as with any philanthropic gift, to benefit the organization. If you don’t want to help a particular charity achieve its goals, there is no advantage to making it any sort of gift. While you can certainly make charitable gifts in more or less cost-effective ways, the point of giving is to transfer assets to a cause you wish to support. Leaving retirement benefits to charity may help achieve other estate planning goals, as I will discuss later in this article, but only if philanthropy is already a priority.

That said, once you have one or more charities in mind, few people want to cut the government a larger piece of the pie than necessary. Giving retirement plan dollars to charity can be a highly tax-efficient use of your savings. Note that, throughout this article, the retirement benefits I am discussing are those where distributions typically trigger income tax, such as traditional IRAs or qualified retirement plans. Roth plans, where distributions are income tax-free, do not offer any particular advantage for charitable giving.

Since charities are exempt from income tax, they can receive gifts of retirement benefits tax-free, as long as the gift is structured correctly. Retirement plan assets are therefore worth more to a charity than they would be to an individual who would have to pay tax on any distributions.

In contrast, an inheritance is not considered income, so inherited cash would not be liable to income tax. Heirs must pay capital gains tax on other inherited assets such as stock or bonds, but generally only on gains that occur after the decedent’s death; taxes on gains that accumulated during the decedent’s lifetime are forgiven through a so-called step-up in the asset’s cost basis to its date-of-death value. A retirement plan, on the other hand, does not receive this stepped-up basis.

There are situations in which leaving retirement benefits to charity might not be an ideal estate planning solution. A young individual beneficiary may, in fact, do better to inherit a retirement plan than to inherit an equivalent amount of after-tax dollars. This is because, if he or she makes use of the mechanism that stretches payouts over the beneficiary’s life expectancy, the power of income tax deferral may leave the beneficiary better off.

The minimum distribution rules for retirement accounts also mean that you could end up leaving the charity relatively little if you live long enough to exhaust most of the plan’s value. Long-lived plan participants may wish to consider giving their minimum required distribution directly to the charity each year, or revising an estate plan to provide for the charity in a different way as the retirement plan diminishes in value.
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