Opportunities for giving
The expiration of the PPA 2006 provision does not, however, mean that retirement plan assets should be overlooked as a funding source for charitable gifts. On the contrary, the income tax treatment they receive can make gifts of these assets a good choice during lifetime and at death.
In cases where there is a possibility of exposure to both income and estate taxes, retirement plan assets may be the best choice for charitable gifts, leaving other assets to provide for family.
Funds from retirement plans that are properly designated for charitable purposes will be received on a tax-free basis instead of largely being consumed by a combination of income and estate tax liability. These tax benefits may hold even greater appeal in the near future as the total amounts that can be left free of estate tax liability are scheduled to fall dramatically from $5.12 million in 2012 to the $1 million level in 2013 unless Congress acts.
Example: The $1 million estate tax liability in 2013
At the $1 million level, consider what might happen to a person with a home valued at $375,000, CDs valued at $200,000, stocks and bonds valued at $350,000, an IRA valued at $100,000 and other property worth $75,000. If she plans to leave the taxable $100,000 to charity and the remainder to others, if the heirs receive her IRA, a combination of income and estate taxes could consume the majority of the IRA, leaving less for her loved ones and charity. With better planning, the full $100,000 of the IRA’s value could be directed to charity and the heirs could receive the balance of the $1 million estate free of taxes.
The key rules for making gifts of retirement plan assets at death can be complex, but for this purpose we suggest using appropriate beneficiary designations on the relevant plan, and/or including the correct language in the will or trust to assure that charitable bequests shall first be paid out of so-called income in respect to the decedent (IRD) assets, such as deferred compensation, savings bonds or retirement plan assets.
But what about lifetime gifts?
Even though the provision for direct charitable transfers from traditional and Roth IRAs under the Pension Protection Act has expired, there is a retirement plan charitable giving strategy that can achieve a similar result for an even larger group of potential donors.
For many donors, giving retirement plan assets can still be a wash for tax purposes and could provide an advantageous source of funds for charitable giving.
How it works
Taxpayers over age 59½ can make withdrawals from retirement plans without regard to the 10 percent penalty that applies to younger persons. If a person over 59½ then contributes the amount withdrawn and fully deducts it as a charitable gift, that person will owe no federal income tax on the amount donated and will have removed the amount from his or her estate.
Gifts or transfers of this nature, like other cash gifts, may be deducted up to 50 percent of adjusted gross income (AGI) and for 2012 can be made without regard to the partial limitation of itemized deductions that affected some high-income taxpayers in the past. This limitation is scheduled to return in 2013.
Example: Yes, it’s affordable
Mary and Allen, in their early 60s, have an AGI of around $100,000. They would like to make a $10,000 gift but do not have the cash available to fund the gift. In addition to substantial salary and anticipated pensions, they also have retirement plan assets worth more than $1 million. Their combined estates are worth more than $2 million.
They decide to withdraw $10,000 from the retirement plan and use that amount to make their gift. In this case, the $10,000 is reported as income but also creates a fully offsetting charitable deduction. They are able to make the gift they want today without otherwise affecting their current cash flow. Further, they anticipate the retirement plan will replenish itself and become a favored source of charitable gifts in the future.
Example: A capital idea
Suppose an individual, age 62, would like to make a gift of $100,000 to a capital campaign. His adjusted gross income is $180,000 and, among his other assets, he has a retirement plan balance of almost $2 million. If he withdrew $100,000 from the plan and reported it as income, his new AGI would be $280,000. He could thus give the full $100,000 without bumping into the 50 percent of AGI limitation for charitable gifts of cash.
He could instead decide to make withdrawals and gifts over the full campaign period of several years to allow non-donated amounts to grow and minimize the future impact on his retirement plan. Even if the Pease Amendment (which required higher-income taxpayers to reduce their itemized deductions, including charitable gifts, by 3 percent of the amount by which their AGI exceeded certain amounts) returns, he has calculated that the limitations on his future deductions will be around 1 percent.
For persons over 70½ who are required to take retirement plan withdrawals they do not need, this charitable giving strategy could also be very appealing. Such donors would need to be sure they can fully itemize their gifts so the resulting charitable deduction creates a wash for tax purposes. In effect, they would be able to make full use of such withdrawals for charitable purposes without any net additional tax.
In the final analysis, the charitable giving opportunity from retirement plan assets that still exists today is actually broader than the expired IRA Rollover provision, in that such gifts are not limited to traditional or Roth IRAs and can be made from 401(k), 403(b) and similar qualified plans .They are also applicable to those older than 59½ versus a limitation to persons age 70½ or older.
Planning note: Taxpayers should check with their tax advisors about the possible impact of state taxes. Learn more on this topic and others by attending one of Sharpe’s popular seminars. See Page 8 for details.