If you’re like many people, you have a great deal of your wealth tied up in traditional IRA accounts. Why? The tax-free benefits have motivated you. But there’s going to come a time when you—or your heirs—will have to pay taxes on this money. Instead of worrying about what you’re going to do about that, you can follow a tax-saving strategy that considers designating your favorite charity or charities as beneficiaries of all or a portion of your IRAs. Then you can leave other assets to family members and other heirs.
Your IRAs are considered part of your estate when you die, which means it’s subject to estate taxes. Although very few people are subject to the federal estate tax, some states have lower thresholds for their estate taxes. Also, your heirs will have to eventually withdraw the funds, and typically will pay income tax on it. And that could be substantial, if your heirs are already in a high bracket.
Fortunately, there’s a tax-smart solution: leave some or all of your IRA to charitable beneficiaries while leaving other assets to heirs of your choice. Name one or more tax-exempt charitable organizations as beneficiaries of your IRA to leave that money to charity. Leaving money directly to charities by designating them as account beneficiaries is very tax-efficient. First, an IRA balance left to charity avoids estate tax, since it’s removed from your estate. Also, there’s no federal income tax due on IRA money. (You may get a state tax break too.) No income taxes are due when your favorite tax-exempt charities take their withdrawals from the IRAs.
This strategy allows you to leave more to your favorite charities and more to your loved ones while keeping as much as possible from the IRS.
One final word, however. This information generally applies to traditional IRAs. Naming a charity as the beneficiary of your Roth IRA is generally inadvisable. Leave Roth balances to your loved ones by designating them as account beneficiaries. Why? As long as your Roth IRA has been open for more than five years before withdrawals are taken, all withdrawals will be federal income tax-free since the money went in after taxes. But if you leave Roth IRA money to charity, this tax break is wasted. (Roth IRA inheritance rules differ from the rules for traditional IRAs in several key ways.)
Looking at the Big Picture
Of course, this is just part of your estate plan, and there are lots of complexities. A giving strategy that makes sense for one family may not be appropriate for another. Also, the new tax law has changed the scenario for many. Finally, there are various limits and provisions you should be aware of before you proceed.
The bottom line? Talk to a qualified financial professional about your charitable goals and any traditional or Roth IRAs you have in order to take care of both your family and your designated nonprofits in as efficient a way as possible.