Using Retirement Plan Benefits In Charitable Giving

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As we all know, retirement assets constitute a significant portion of the net worth of many of our clients. And with the recent increases in contribution limits to retirement accounts authorized by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), this trend no doubt will continue, and likely will increase.

Thus, regardless of our varying focuses as professional advisors, we must be able to counsel our clients regarding the taxation of, and planning opportunities available with, retirement benefits.

This article reviews the taxation of retirement benefits (see sidebar), discusses charitable planning with retirement benefits, and addresses the potential use of life insurance in connection with such planning.

Structuring the Charitable Transfer of Retirement Benefits.

Two basic methods exist by which retirement assets can be transferred to charitylifetime transfer and testamentary transfer.

Lifetime transfers. With respect to a lifetime transfer of retirement assets, the account itself may not be given to charity; instead, the account owner first must take a distribution of the assets, pay any applicable income taxes and penalties, and then may contribute the net amount to the intended charitable organization.

If the account owner itemizes deductions, then he would be entitled to an income tax charitable deduction for the gift (subject to the applicable percentage limitations). From an estate tax standpoint, such a gift would reduce the value of the account owners estate for estate tax purposes.

Testamentary transfers. While lifetime charitable gifts of retirement account distributions no doubt result in tax savings to the account owner and possibly his beneficiaries, testamentary transfers of retirement assets in many cases will yield more significant tax savings.

There are four key tax benefits to keep in mind when considering charitable planning with retirement benefits:

–Since neither a qualified charity nor a charitable trust is subject to income tax, the receipt of IRD by such an entity will avoid income tax otherwise payable by an individual or non-charitable trust beneficiary.

–The account owners estate would be entitled to a federal estate tax charitable deduction for amounts passing to a charitable beneficiary.

–IRD does not receive a step-up in basis for income tax purposes upon the account owners death.

–The retirement benefits will not be available to be “stretched-out” over the beneficiarys life expectancy, which could produce significant tax-deferred growth during such period (assuming the estate tax attributable to such benefits can be paid from a source other than the retirement account itself).

2001 Proposed Regulations. On Jan. 11, 2001, the IRS released proposed regulations that would make sweeping changes to the minimum distribution rules pertaining to retirement accounts.

The proposed regulations eliminate much of the complexity currently applicable to retirement account distributions by (1) making it easier for account owners to calculate the amount they must withdraw during life; and (2) delaying the determination of the accounts designated beneficiary until the end of the year following the year of the account owners death. Ultimately, the proposed regulations reduce the amount of required distributions for the majority of taxpayers.

The principal change found in the proposed regulations is a uniform table, which is to be used by all account owners when determining required minimum distributions. Distributions under the new table are based on the joint life expectancy of the account owner and a hypothetical person who is 10 years younger than the account owner. Required minimum distributions are determined without regard to the beneficiary’s actual age.

There is only one exception. If a spouse who is more than 10 years younger than the account owner is the beneficiary, then the actual joint life expectancies can be used. This would allow the account owner to slow down the rate of required distributions during lifetime.

These newly proposed regulations simplify charitable planning with retirement benefits in two material ways. First, as a result of the uniform table, the designation during life of a beneficiary with zero life expectancy, including a charity or a charitable trust, will have no impact on lifetime distributions. Under the prior regulations, designation of a charity as beneficiary meant larger required minimum distributions during life.

Second, it is important to keep in mind that if the beneficiaries of a decedents retirement account include a charity or a charitable trust, then the account owner will be treated as not having a “Designated Beneficiary” for purposes of determining post-mortem distributions. However, because this years proposed regulations provide for determination of the account beneficiary as late as December 31st of the year following the account owners death, the charitable beneficiarys share can be paid out before that date–thereby allowing the individual beneficiary to receive distributions over his life expectancy.

While the acceptability of this approach was unclear under the prior proposed regulations, the new proposed regulations provide relief by allowing a portion of the benefits to be paid to the charitable beneficiary before December 31st of the year following the participants death.

If an account owner intends to leave a portion of the retirement account to a charitable entity, another (and perhaps preferable) approach is to divide the account into separate accounts during life. Once divided, the account owner could designate the charitable entity as the beneficiary of one account and the non-charitable entity as the beneficiary of the other. This approach may be difficult if the account is still under an employer-sponsored plan, rather than an IRA.

Charitable Remainder Trust as Beneficiary. If a client intends to provide for both a spouse and a charity, then he might consider use of a charitable remainder trust (CRT). A CRT is a trust that provides for payment of a specified amount to a non-charitable beneficiary (i.e. a child) for a specified term or for the beneficiarys lifetime.

Upon termination of the non-charitable beneficiarys interest, the remaining assets are distributed to charity. With a CRT, the account owners estate would be entitled to an estate tax charitable deduction equal to the actuarial value of the remainder interest; however, the non-charitable interest would be included in the decedents gross estate for estate tax purposes. Further, if the trust named the account owners spouse as the non-charitable beneficiary, then the entire value of the trust would be deductible for estate tax purposes, since the value of the spouses (non-charitable) interest would qualify for the estate tax marital deduction.

The Role of Life Insurance. Since amounts passing to charity will reduce the amounts passing to the clients children (or other non-charitable beneficiaries), the question often arises of how to replace amounts passing to charity. The clients might not feel the need to replace those amounts, and thus further planning may not be required.

However, as is often the case, clients might desire to replace, whether in whole or in part, the amounts passing to charity.

A common answer is life insurance. Because life insurance should be received both income and estate tax free at the insured persons death, it is a logical companion to charitable planning with retirement benefits.

The often-asked question to answer next is how the life insurance premiums will be funded. A discussion of the alternatives is beyond the scope of this article, however, some alternatives include the following:

–Use after-tax dollars to fund the premiums.

–Make taxable withdrawals from the retirement account to fund the premiums.

–Acquire the policy inside a qualified retirement plan, where applicable.

–Use the Qualified Plan Insurance Partnership(R) (QPIP(R)) strategy. (See NU, Sept. 10, 2001.)

Because of the rules governing the taxation of retirement benefits, these assets are often well suited to accomplish a clients testamentary charitable objectives.

The account owners estate would receive an estate tax charitable deduction, and the charitable entity will avoid income taxes on the entire account balance. Further, a properly structured life insurance policy can provide a tax-free replacement to the amount passing to charity, thereby maximizing amounts for future generations.

Jason R. Handal, J.D., is a shareholder in the law firm of Willms Anderson, S.C., Thiensville, Wis. He can be reached via e-mail at jhandal@

estatecounselors.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, December 10, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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