Choose Charitable Bequests Carefully

When helping wealthy clients design their legacies, be mindful of how charitable designations fit into the mix.

This Practice Management article is intended for financial advisors only (registered representatives of broker/dealers or associated persons of Registered Investment Advisors).
 

Lifetime charitable contributions of appreciated assets often are tax-efficient while donations from IRAs can pose problems. In estate planning, though, tactics can be reversed. Charitable bequests may come from tax-deferred accounts, so human beneficiaries will have fewer taxable withdrawals from inherited retirement plans. Meanwhile, appreciated assets can be left to individual heirs.

Stepping Up
"In working with estate planning attorneys, I have found it advantageous in some cases to list private family foundations, donor-advised funds or direct charitable organizations as beneficiaries of IRAs, 401(k)s, and so on," says Robert Cron, senior portfolio manager in the Minneapolis office of Bronfman E.L. Rothschild, an investment advisory and consulting firm.

 "This planning strategy provides a way to reduce an individual's taxable estate and pass assets that will receive a step-up in cost basis to the heirs." With cost basis increased to current value at death, a subsequent sale may avoid income tax on lifetime appreciation or real estate depreciation.

Cron tells of a client who owns shares of a large financial institution as well as a great deal of real estate with a very low cost basis. "We have assigned a family foundation as the beneficiary for his IRA and 401(k) plan assets," says Cron. "The heirs will receive a rather large inheritance from the financial institution stock and potentially from the sale of the real estate. This client will continue to hold the company stock in his revocable trust until death, or until a change in tax law."

Different Designations
Similarly, Jen Dawson, a wealth manager with Balasa Dinverno Foltz, an independent private wealth management firm based in Itasca, IL, has a client who wants to leave assets to charity rather than to the government. "She has significant IRA assets," says Dawson, "but her trust originally named charities as beneficiaries, which makes things complicated. If a trust is a beneficiary of an IRA and the trust names a charity as ultimate beneficiary, then it is likely that the beneficiaries would be forced to take a full distribution of the IRA within five years, which is not ideal from an income tax perspective. It is better to leave IRA assets directly to charity and individuals."

Dawson reports that her client is carefully targeting a portion of her IRAs to go to charity. "She revised the IRA beneficiary designations so that 33% goes to one charity, 33% goes to another charity and the remainder is split between two family members," says Dawson. "We review the account values at least annually, to ensure that this plan is roughly accomplishing her goals of leaving IRA assets to charity and avoiding federal estate taxes. Her children will inherit primarily taxable, non-retirement assets."

—Donald Jay Korn

Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.