Many estate owners hold large IRA accounts as part of their taxable estates. With the growth of the equities markets over the last five years since the financial crisis of 2008-2009, IRA account values of $1 million or more are common.
Depending on the value of the taxable estate, a “double tax” may exist when the IRA owner dies. Under current law, a federal estate tax of 40 percent and a federal income tax on the IRA beneficiary upwards of 39.6 percent could be levied at death.
There is a federal income tax deduction for any federal estate taxes attributed to the IRA as “income in respect of decedent” (IRD). This means the IRA could shrink by a combined net tax of about 60 percent. State income taxes and state death taxes could deplete the IRA even further.
Many wealthy estate owners have a significant charitable motivation to provide both current and deferred gifts to the non-profit charitable organizations of their choice. In fact, IRS statistics clearly show that the wealthier the individual for which a Form 706 U.S. Estate Tax return is filed, the greater is the chance that significant charitable gifts will be made at death.
By naming a non-profit charitable organization as the beneficiary of the IRA, the “double tax” on the IRA can be reduced to $0. There is a 100 percent charitable estate tax deduction, which eliminates estate taxes on the IRA. And charitable organizations do not report “income in respect of decedent” (IRD), which eliminates any income taxes on the IRA.
Since the IRA owner will continue to own the account until death, required minimum distributions (RMD) must be distributed to the IRA owner starting at age 70½. The after-tax cash flow from IRA distributions could be used to fund gifts for a life insurance policy owned by an Irrevocable Life Insurance Trust (ILIT).
This insurance will provide a “wealth restoration” fund for the heirs to offset the value of the IRA, which will pass to the charity at death.