While you're alive and have philanthropic goals, give appreciated assets held in a taxable account to charity. For charitable bequests, designate your IRA or tax-deferred employer retirement plan. Why? Suppose a hypothetical Al Cole wants to give $10,000 to charity this year. Instead of cash, he donates $10,000 of ABC Corp. stock that he bought for $2,000. As long as Cole's holding period is more than one year, he'll get a full $10,000 charitable tax deduction. Yet those shares might be worth only $8,000 to Cole after paying tax if he sold them himself. The retirement planning and estate planning benefits are big. Say Cole has $1 million of securities: $500,000 in a taxable account and $500,000 in a traditional IRA. Cole wants to leave $500,000 to charity and $500,000 to his son Bob, who is in a high income tax bracket. If Cole leaves the taxable account to charity, Bob will inherit the IRA. Bob will have to take distributions, which will be highly taxed on top of his other income. Instead, Cole can leave his $500,000 IRA to charity. The charity or charities can cash in the IRA bequest and owe no tax, as they are tax-exempt. Now Bob will inherit the $500,000 taxable account. He won't owe any income tax on money he withdraws. He also won't owe any capital gain if he happens to sell securities in the account right away, before they gain more value. That's because he gets a cost basis step-up to market value on those assets.
Investor's Business Daily's recent article, "How You Can Squeeze Tax Breaks From Charitable Giving," says that this maneuver works very nicely if the taxable account holds appreciated securities. A Partial Payout strategy applies whether you want to bequest all or just some of your IRA. Experts suggest that it's better to use your IRA for donations in your estate plan. But you have to decide how you want to do it.
Consider the following scenario as an example: Ida Bass has a $500,000 traditional IRA, and she wants to leave $50,000 to charity from that IRA. The rest of the IRA is to be split evenly between her two children (Many IRA beneficiary forms require percentage allocations for multiple beneficiaries). Another way to do it would be for Ida to just leave 10% of her IRA to charity. The IRA form could designate that each of her kids will inherit 45% of the amount in the account at her death. This would leave the dollar size of her charitable bequest indefinite—potentially leaving more to the charity if the IRA grows or less if its value decreases.
Whether you implement the fixed amount or the percentage approach, problems can arise. Those who will inherit the balance of the IRA need to ensure that the charity is paid in full before September 30th of the year after the death of the donor. If you do that, those getting the balance can stretch out required distributions of the IRA balance and extend their tax deferral. However, if you miss the September 30th deadline, the taxable distributions will be accelerated. So individual beneficiaries should be aware of what they need to do if a charity also is on the form.
One other idea is to split the IRA. Bass could transfer $50,000 from her $500,000 IRA to a new IRA account, so that her favorite charity would be the beneficiary of the new IRA. That way her children won't have to worry about the charity if they want to claim the maximum tax deferral from the IRA they inherit.
Speak with an experienced estate planning attorney to learn more and to see if this strategy is right for you.
Reference: Investor's Business Daily (October 02, 2015) "How You Can Squeeze Tax Breaks From Charitable Giving"