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Donating Retirement Assets 

When your clients make testamentary gifts to charity, they can significantly reduce the tax burden of their estates and tailor their donations to fit their charitable goals.

July 19, 2007
by Mary Command

One of the most difficult tasks financial advisors face is how best to prepare clients for the ways in which their estates should be handled after death, given the heavy tax burden that falls upon improperly planned estates. However, one method — making testamentary gifts to charity of retirement assets such as IRAs and 401(k) plans — not only enables your clients to reduce taxes vastly, but also allows them to tailor their donation plans to fit their charitable goals.

Making a Difference

Donating retirement assets can even save a charity’s life. Some time ago, an organization aiding disabled children faced a major cash crisis and was forced to consider closing its doors. Unexpectedly, a donation of retirement assets from a recently deceased patron was announced. According to one financial advisor who was on the board at the time — Daniel Moisand, a principal at Spraker, Fitzgerald, Tamayo & Moisand, LLC, in Melbourne and Maitland, Fla., and the volunteer president of the Financial Planning Association — “The influx of cash basically saved the whole outfit — all of a sudden our financial worries were gone.”

The nonprofit is still going strong today, Moisand says. But unfortunately, such giving remains relatively rare. “Maybe one in 20 people I talk to have contemplated leaving retirement assets to any kind of charitable entity, and I’m probably being generous,” he says.

Avoiding Tax Burdens

Clients sometimes are unaware of just how much taxation their estate will face. During a client’s lifetime, retirement assets build significantly with minimal tax consequences. But Ross Levin, founding principal and president of Accredited Investors, Inc., explains a typical after-death scenario. Say that upon a client’s death there is a $5 million estate, $1 million of which is income in respect of a decedent (IRD), like a retirement plan:

  • The $1 million of IRD first loses $400,000 to estate taxes.

  • The remaining $600,000 is then distributed outright to descendants. The descendants may pay income taxes in the 35 percent range, which whittle away another $200,000 (actual tax depends on the recipient’s bracket).
  • At the end of the day, there is only $400,000 left for descendants to share and possibly contribute to charity.

On the other hand, by donating the entire amount of the IRD upon a client’s death, there is no tax burden. “The charity gets the full benefit of the million dollars,” Levin says.

Structuring Plans

When it comes to donating retirement assets, community foundations can play a major role. Foundations often serve as guides to local charities, pinpointing where a client’s testamentary gifts would be best served or tailoring a donation to fit a client’s needs. There are a number of methods by which a client can contribute, including: 

  • Donating assets directly to a charity.
  • Donating retirement assets into donor advised funds, to which clients’ families can continue to make suggestions.
  • Donating retirement assets into discretionary funds that community foundations supervise.

Donor advised funds are a popular method of contributing retirement assets, as their flexibility appeals to clients who can designate family members to suggest how the assets should be used for charitable purposes.

Discretionary funds support broad charitable goals and include unrestricted funds, which community foundations decide how to use, and field-of-interest funds, which are targeted to specific causes or locations. The latter enables community foundations to fulfill a client’s wishes even when situations change. Hans Dekker, president of the Community Foundation of New Jersey, offers this example: Someone upon death may donate to a homeless organization through a community foundation, but if the organization closes in 10 years, the investment income can be transferred to another nonprofit that works with affordable housing. “It’s a way to match your intent with current needs,” he says.

Conclusion

When it comes to the tough decision of how to best handle retirement funds upon a client’s death, donating retirement assets to charity is both financially wise and greatly rewarding. Community foundations are an excellent philanthropic resource, offering a flexible set of solutions that make donating both easy and rewarding for generations to come.

To contact your local community foundation, log on to www.communityfoundations.net.

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© 2006-2007, Council on Foundations