The following is a guest blog post by Chris Matthysse, Attorney, Mika Meyers.
Second Corinthians calls on Christians two be cheerful givers. Many extend their giving to their will or trust by including their favorite charities or church as a devisee along with their children. This is an effective way to accomplish one’s charitable intentions. However, if an individual has an IRA, the gift to the charity in either the will or trust may be coming at the expense of the children.
Except for moneys received from a retirement plan such as an IRA, 401(k) or 403(b), inheritances pass income tax free. So if someone inherits a car, house or bank account, that person does not have to claim the value of those items as income. This is true if the beneficiary of the will is an individual or a charity.
As an example, Mr. Smith has a will that directs his assets, valued at $300,000, be divided equally amongst his three children and his church. In this case, the assets will be divided into four separate shares. Neither the children nor the church will have to pay income taxes on the amounts received.
Retirement Account
Most individuals have some sort of retirement plan like an IRA, 401(k) or 403(b). These assets typically are not controlled by the dispositive provisions contained in a will or a trust. Beneficiary designations determine who receives the funds held in the accounts after the owner dies. If married, the most common beneficiary designation names the spouse as the primary beneficiary and the children as the contingent beneficiaries.
Coordinating Retirement Benefits with your Estate Plan
In the prior example, Mr. Smith is graciously supporting his church by making it a 25 percent beneficiary under his will. He is also providing for his children under the will and naming them as the beneficiaries of his IRA which, for our example, is also valued at $200,000. At first glance it appears he is doing everything he can to provide for his family and his church. However, unlike assets received through a will or trust, retirement benefits are taxable to the beneficiary. Mr. Smith’s children will have to pay taxes on the money they withdraw from the retirement plan, while the assets they and the church receive under the will are free of income tax.
Had Mr. Smith named his church as the beneficiary or partial beneficiary of the retirement account, the taxes could have been eliminated or reduced. The church is considered a charity for tax purposes, so it is tax exempt. This means that if the church was a beneficiary under Mr. Smith’s IRA, it would not have paid taxes on the money it received.
The church would have received twenty-five percent or $75,000 as a beneficiary under the will. Instead of naming the church as a beneficiary of the will, Mr. Smith could name the church as a beneficiary of his retirement plan. This would allow more tax free dollars to pass to his children.
If it is his desire that the church receive a specified amount, he would likely have to name it as receiving a specific percentage on the beneficiary designation because most retirement plan providers only allow for percentage designations and not specific amounts. For example, he could state that the church was to receive forty percent of the IRA. Overtime, he would have to adjust the percentage as the value of the retirement account value changed. In order to protect the church, he can also include language in his will that states that the estate will pay the difference between the amount he intends to give the church and the amount that the church is receiving from the IRA.
By actively coordinating a retirement plan with estate planning documents, a person can benefit both charities and family. Coordination allows for cheerful giving and maximization of assets passing to the children.