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The Allegiant Private Advisors team regularly helps guide our client families through many of the most crucial decisions in life, from purchasing a new business or preparing portfolios to support living life to its fullest, to the important duty of planning legacy gifts.
Many people wish to leave a gift to charity when they pass away. These legacy gifts are often outlined in a Will or Trust agreement. While this path works for many people, there may be a more tax-effective way to gift to charities after your death: naming them as the beneficiary of your IRA. This strategy can improve outcomes for all parties involved and can be especially attractive for those wishing to leave money to a mix of charities and family members, especially those in high tax rates.
All money that comes from a traditional IRA is taxed as ordinary income upon withdrawals. Individuals who inherit IRAs are required to take a small amount, called a required minimum distribution, of the balance out of the inherited IRA each year. This distribution is added to the individual’s (beneficiary’s) taxable income. For those in high tax brackets, this may mean that the beneficiary only gets to keep about 60% of the amount they take out from the IRA, while the federal and sometimes state government receives the remaining amount. In contrast, charitable organizations are not subject to income tax. Instead, they can take some or all the money from the IRA they receive and use 100% of the IRA’s value toward their mission.
To illustrate this principle, let’s imagine an estate of $2,000,000, split equally between a non-qualified Trust account and an IRA. The account owner wishes to leave half of the estate to her son and give the other half to charity. If she leaves her son the IRA, he would need to pay ordinary income taxes on all withdrawals, meaning he may get to access only 60% of the amount, or $600,000 after taxes. If she leaves the Trust account to the charity, it would be entitled to use the full $1,000,000 with no tax consequences. So, in effect, she’s left $600,000 to her son, $1,000,000 to charity, and $400,000 to federal and state governments! To contrast this situation, imagine that she switches the accounts that each party inherits. If she leaves the Trust account to her son, he would similarly be entitled $1,000,000 with no tax penalties. If she leaves her IRA to a charity, the charity would be able to use the full $1,000,000 from the IRA without income taxation due to the nonprofit status. This improves the math of her legacy: in the second scenario, she effectively leaves $1,000,000 to her son, $1,000,000 to charity, and nothing to the government!
It is important to consider taxation when you review your current estate plan and beneficiaries of your retirement accounts. If you aren’t sure about the best way to leave assets to your heirs and favorite charities, consult with your financial advisor, attorney, and tax advisor. The Allegiant Private Advisors team is readily available to help facilitate these conversations.
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