Using Qualified Plans And IRAs In Charitable Giving

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Charitable giving can play a unique and valuable role in an estate or financial plan while making a lasting impact on a charitable organization. There is a broad array of charitable giving techniques which can be matched to the particulars of an individuals circumstances, objectives and preferences.

Charitable planning can be initiated either during lifetime, or upon death through testamentary planning. In addition, charitable contributions can be accomplished through outright transfers or with “split interest” arrangements such as a Charitable Remainder Trust (or “CRT”), which benefits both charitable and non-charitable beneficiariesincluding the donor, spouse or others.

A CRT is a special type of tax-exempt irrevocable trust which serves both charitable and non-charitable purposes. It is a split interest trust which is designed to benefit the donor or someone else the donor chooses for a period of time, followed by the charity or charities of choice. During the trust term, the term (or income) beneficiary receives an annual payout from the trust equal to a fixed percentage of the value of the trust property. The payout can be based on the initial value of the trust contribution using a Charitable Remainder Annuity Trust (“CRAT”), or the changing value of the trust property using a Charitable Remainder Unitrust (“CRUT”). Then at the end of the trust termfollowing the income beneficiarys death (or a specified term of years)the trust property (or remainder interest) passes to the named charity or charities. The charitable remainder beneficiary can be either a public charity or a private foundation created and managed by the donor and family.

Consequently, the appeal of a CRT is that it permits the donor (or someone else) to receive income from property transferred to the trust while providing for a deferred gift or bequest to the charity of choice, and affording many tax and non-tax benefits. CRT planning can be initiated either during an individuals lifetime (intervivos CRT) or upon death (testamentary CRT).

Tax Treatment of Qualified Assets Upon Death. Consider the tax treatment of IRAs and qualified retirement plans upon death. Perhaps more than any other asset comprising an individuals estate, these assets are likely to experience the most erosion upon death (or death of a surviving spouse), due to a combination of income and estate taxes.

If a surviving spouse is the plan beneficiary, an unlimited marital deduction may be available to postpone estate tax until second death. In addition, pursuant to a spousal rollover, income tax may be postponed. However, following the surviving spouses death, when the plan passes to non-spousal beneficiaries such as children or grandchildren, the plan balance may then incur significant estate tax, income tax or even GST transfer tax. The result is a diminished family legacyan asset eroded by taxes.

As a solution, consideration could be given to the benefits of naming a testamentary CRT the beneficiary of the IRA or qualified retirement plan upon the plan owners deathresulting in a more tax-efficient disposition of the plan, and providing an amplified legacy for family and charity.

To do this, the plan owner designates a CRT (an income-tax-exempt entity) the beneficiary of the plan, resulting in no income tax on the plan balance upon the owners death. Consequently, the undiminished value of the plan is invested on behalf of the surviving spousethe designated income or term beneficiary of the CRTfor life. The surviving spouse receives income from the CRT based upon a fixed percentage of the value of the trust property. Only after the surviving spouses death, the trust property (or remainder interest) passes to the designated charity or charities.

What are the estate tax benefits of this plan? The plan owner/decedents estate receives an unlimited marital estate tax deduction for the net present or actuarial value of the surviving spouses term interest in the CRT, and in addition, an unlimited charitable estate tax deduction for the value of the charitys remainder interest in the CRTresulting in no estate tax on the value of the plan upon the plan owners death. Furthermore, upon the surviving spouses death, the remainder passes to the designated charity and is not subject to estate tax in the spouses estate, since the spouses interest in the CRT terminates upon his or her death.

Enhanced Legacy For Charity And Family. In order to preserve and enhance the familys inheritance, consideration should be given to a wealth replacement life insurance policy owned outside the taxable estate as the ideal solution to replace the value of the donated asset and equalize bequests to family and charity. Consequently, upon the surviving spouses death, when charity receives the remainder value of the CRT, the family receives the equivalent value in the form of income tax-free and estate tax-free proceeds.

A testamentary CRT paired with properly structured life insurance delivers a valued added solution resulting in a more tax efficient disposition of retirement plan assets, ensuring lifetime income for a surviving spouse, a deferred bequest to charity, and an enhanced legacy for family, and demonstrates how an individual can accomplish charitable goals while preserving benefits for non-charitable beneficiaries. Furthermore, provided no significant taxable gift or bequest is generated, and the planning is desirable for tax and non-tax reasons, the CRT may make sense even in the currently uncertain estate tax climate.

Consider the following example illustrated in Chart 1. An IRA valued at $2,000,000 is received by a testamentary CRUT upon the IRA owners deathincome and estate tax free. The CRUT assets are invested to provide annual income of 6% and net annual appreciation of 2%. The surviving spouse (age 65) receives a 6% fixed annual payout from the CRUT for life, amounting to $120,000 a year and an aggregate value of $2,908,916 over her approximate 20-year life expectancy ($1,890,795 after 35% income tax). The surviving spouse can make annual gifts to a wealth replacement trust which holds a life insurance policy.

Upon the surviving spouses death (see Chart 2), the charity receives the remainder interest valued at $2,911,410, and the family receives a $2,000,000 life insurance death benefit (equal to initial value of the IRA) income tax and estate tax free.

Eva M. Victor, J.D., LL.M., is an advanced sales consultant with Penn Mutual Life Insurance Company, Horsham, Pa. She can be reached at victor.eva@pmlmail.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, November 26, 2003. Copyright 2003 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.